So long as it has a bank account and is managing its few remaining assets, a corporate “debtor’s business need not be operational to be eligible for . . . relief” in Subchapter V of chapter 11, according to Bankruptcy Judge William T. Thurman of Salt Lake City.
The corporate debtor developed and sold software to direct marketers. The company had financial difficulty and sold the software, its primary asset, in August 2020 in exchange for the buyer’s stock worth some $1 million.
The debtor filed a chapter 11 petition in December 2020 and elected treatment as a small business debtor under the Small Business Reorganization Act. The SBRA became effective in February 2020 and is codified primarily in Subchapter V of chapter 11, 11 U.S.C. §§ 1181 – 1195.
At the meeting of creditors, the debtor’s principal testified that the company’s remaining assets consisted of a bank account, accounts receivable, claims in a lawsuit against a third party, and stock from the buyer. The principal also testified that the company had no employees and was not conducting business as it had before the sale.
In addition, the principal said the company had no intention of reorganizing and was “using reasonable efforts to pay its creditors and realize value for its assets,” Judge Thurman said.
The schedules declared that the debts totaled some $3.5 million and that the estimated value of the assets was about $400,000.
Immediately after the meeting of creditors, the U.S. Trustee filed a motion objecting to the debtor’s eligibility to proceed under Subchapter V.
In his April 22 opinion, Judge Thurman laid out the four requisites for Subchapter V eligibility: the debtor (1) must be a person, which includes a corporation; (2) must be engaged in commercial or business activity; (3) may not have more than $7.5 million in debt on the petition date, and (4) must have more than 50% of its debt from commercial or business activities.
The U.S. Trustee only challenged the second test, which arises from Sections 1182(1)(A) and 101(51D). The term “small business debtor” means “a person engaged in commercial or business activities . . . .”
In sum, the U.S. Trustee argued that the debtor was ineligible for Subchapter V because the company was not operational on the filing date, had no employees and no intention of reorganizing, and aimed only to liquidate its remaining assets, including the purchaser’s stock.
Parsing the statute, Judge Thurman was constrained by Tenth Circuit authority, which calls for interpreting the Bankruptcy Code liberally in favor of debtors and “strictly against the creditor.” In re Woods, 743 F.3d 689, 694 (10th Cir. 2014).
First, Judge Thurman held that the debtor “must be presently ‘engaged in commercial or business activities’ on the date of filing the petition for relief.” [Emphasis added.] In that regard, he agreed with three recent cases holding that formerly being in business is insufficient. See In re Johnson, 2021 WL 825156 (Bankr. N.D. Tex. Mar. 1, 2021); In re Thurmon, 2020 WL 7249555 (Bankr. W.D. Mo. Dec. 8, 2020); and In re Ikalowych, 20-17547, 2021 BL 138960, 2021 Bankr. Lexis 997 (Bankr. D. Colo. April 15, 2021). To read ABI’s reports on those cases, click here, here and here.
Next, Judge Thurman decided that the debtor was “actively engaged in commercial or business activities by” having a bank account, holding accounts receivable, exploring claims against a third party, managing the stock of the seller, and “winding down its business and taking reasonable steps to pay its creditors and realize value for its assets.”
In reaching this conclusion, Judge Thurman said that the statutory words “activities” and “operations” are not “interchangeable.” The word “activities” is broader.
Had the statute only used “operations,” Judge Thurman said he would have ruled for the U.S. Trustee because the business was not operational on the filing date. When “considering the totality of the circumstances,” he concluded that the debtor’s “activities adequately demonstrate that it was “‘engaged in commercial or business activities’ on the Petition Date.”
Judge Thurman found “nothing in the legislative history or the text of the statute [that] precludes a small business debtor, who has gone out of business, from availing itself of Subchapter V and pursuing a liquidation plan.”
Along the way, Judge Thurman rejected the notion that filing bankruptcy and everything it entails would satisfy the requirements of Subchapter V. If filing were enough, “then any and every debtor that filed for bankruptcy relief and elected to proceed under Subchapter V would automatically satisfy the ‘engaged in commercial or business activities’ requirement.”
Ending his opinion, Judge Thurman addressed cases like Thurmon and Johnson and their holdings that someone who owns a nonoperating business is not eligible for Subchapter V. He agreed with Ikalowych’s “rationale that a debtor’s actions in winding down its business constitute ‘commercial or business activities.’”
Distinguishing Thurmon and Johnson, Judge Thurman said that both involved debtors who were individuals, not the defunct businesses they had owned. In those cases, he said, the debtors “were a level removed from the businesses themselves.”
Judge Thurman said that the factual distinction was “an important aspect of the eligibility analysis when considering the totality of the circumstances.”
Observations
“I believe that guarantors of commercial/business debt are eligible for Subchapter V even if the business is shuttered and will not reopen at the time of the individual’s filing,” Robert J. Keach told ABI.
Mr. Keach was involved in drafting the SBRA and testified for its passage before the Senate and House subcommittees. He believes that the “the statute was intended to be interpreted broadly, to facilitate restructuring and rehabilitation of businesses and individuals with business debt.”
In Mr. Keach’s opinion, “restructuring a commercial/business debt — the guaranty — is commercial ‘activity’ in and of itself, and that activity is ongoing at the time of filing.” In his view, “courts on the other side of this issue are interpreting ‘engaged in commercial or business activities’ too narrowly.”
Like Judge Thurman, Mr. Keach said that the “use of the word ‘activities’ as opposed to just ‘engaged in business’ expresses that breadth.” Indeed, Mr. Keach went further when he said that “the additional inclusion of a required nexus between the current activity and the qualifying debt is not found anywhere in the statute, although that nexus exists in the guaranty case.”
“A narrow interpretation, in my humble opinion, runs counter to the purpose of the statute,” Mr. Keach said.
The chair of the business restructuring and insolvency practice group at Bernstein Shur Sawyer & Nelson P.A. in Portland, Maine, Mr. Keach was the co-chair of the ABI commission that recommended the legislation Congress adopted in the SBRA.
So long as it has a bank account and is managing its few remaining assets, a corporate “debtor’s business need not be operational to be eligible for relief” in Subchapter V of chapter 11, according to Bankruptcy Judge William T. Thurman of Salt Lake City.
The corporate debtor developed and sold software to direct marketers. The company had financial difficulty and sold the software, its primary asset, in August 2020 in exchange for the buyer’s stock worth some $1 million.
The debtor filed a chapter 11 petition in December 2020 and elected treatment as a small business debtor under the Small Business Reorganization Act.