What Constitutes a Debtor Engaged in Commercial or Business Activities?

By enacting the Small Business Reorganization Act of 2019 (SBRA), Congress sought to provide small businesses the opportunity to avail themselves of the benefits of chapter 11 reorganization under the Bankruptcy Code.^[2] As the heart of the SBRA, subchapter V aims to lower the high costs and complexities associated with chapter 11 reorganization and to streamline the confirmation process to enable small businesses to effectively reorganize under the Bankruptcy Code.^[3] A mere six months after the introduction of subchapter V, small businesses that filed under subchapter V accounted for approximately 18% of chapter 11 filings.^[4]

Even under the SBRA, the road to effective reorganization remains a winding one for many small business debtors. Electing to proceed as a “small business debtor” under subchapter V does not automatically qualify debtors for subchapter V treatment. A debtor that identifies as a “small business debtor” on a bankruptcy petition and chooses to proceed under subchapter V enjoys subchapter V treatment unless and until the court enters an order stating otherwise after an objection to the designation.^[5] The Bankruptcy Code defines a “small business debtor” as a person engaged in commercial or business activities with “aggregate noncontingent liquidated secured and unsecured debts as of the date of the filing of the petition ... in an amount not more than $2,725,625^[6] ... not less than 50 percent of which arose from the commercial or business activities of the debtor.”^[7]

Bankruptcy courts take varying approaches when defining what constitutes a person engaged in commercial or business activities in order to determine eligibility under subchapter V. Most published bankruptcy court decisions about subchapter V designation hold that debtors who have ceased business operations as of the petition date qualify as persons “engaged in commercial or business activities.”^[8] According to the majority line of cases, subchapter V’s statutory language is broad and unambiguous, and nothing in the definition of a small business debtor restricts the application of subchapter V to debtors currently engaged in commercial or business activities.^[9] The majority focuses on whether the debtor’s debts arose from “residual business activity”^[10] to determine eligibility under subchapter V.^[11] These courts evaluate whether at least half of the debtor’s debts arose from the debtor’s commercial or business activities, relying upon the wording of the Bankruptcy Code’s definition of a small business debtor.^[12] The majority maintains that so long as most of the debtor’s debts arose from the operation of a business, the debtor should be afforded the opportunity to reorganize under subchapter V, regardless of whether the debtor presently engages in business operations.^[13]

The majority also asserts that the legislative history of the SBRA shows no intent to prohibit the application of subchapter V to debtors not presently engaged in commercial or business activities as of their petition date.^[14] This position rests on the argument that Congress enacted the SBRA to improve the ability of small businesses to reorganize under subchapter V and that preventing debtors without current business operations from receiving relief under subchapter V would subvert Congress’s intent to provide small businesses with the opportunity to effectively reorganize on the same scale that large corporations enjoy.^[15]

In contrast, the U.S. Bankruptcy Court for the Western District of Missouri, making up the minority on its own, took a different approach to defining what constitutes a person “engaged in commercial or business activities.” The court in Thurmon^[16] held that a debtor cannot be a mere “shell company”; rather a debtor must be presently “engaged in commercial or business activities” as of their petition date.^[17] According to the Thurmon court, a debtor who sold her business with no intent to resume business operations does not qualify as a debtor “engaged in commercial or business activities” who can proceed under subchapter V.^[18]

The Thurmon court juxtaposed the meaning of “engaged in” with the Eighth Circuit’s definition of a “family farmer” under the Bankruptcy Code.^[19] Similar to the Eighth Circuit’s^[20] assertion that some member of the family at a minimum had to play an active role in the farming operation for a debtor to constitute a “family farmer,” the Thurmon court asserts that the meaning of “engaged in” demands that the debtor had an active role in the business’s operations at the time of the bankruptcy petition.^[21]

The Thurmon court contends that the plain meaning of “engaged in” implies present or active involvement, and as a result, any statutory qualification requiring a debtor to be currently or presently engaged in business operations would be superfluous.^[22] The Thurmon court argues that other chapters of the Bankruptcy Code, such as chapters 12 and 13, demonstrate that Congress knows how to restrict recourse to the avenues of bankruptcy relief.^[23] The Thurmon court argues that Congress explicitly would have stated that it intended for all debtors with business debts below the statutory debt cap requirement to qualify as a small business debtor regardless of whether the business was still operating.^[24]

Bankruptcy courts’ disagreement about the definition of a debtor “engaged in commercial or business activities” represents what is to come. Courts likely will continue to grapple with the issue of what constitutes “engaged in commercial or business activities” as small businesses seek relief under subchapter V. In time, the development of subchapter V case law will determine whether the schism between bankruptcy courts will resolve itself or will widen, requiring a determination from higher courts in order to obtain a uniform statutory interpretation across circuits.