The owner of a defunct business was eligible for reorganization under Subchapter V of chapter 11 when she earned “material” income from part-time personal services not attributable to employment by a company she didn’t own.
The May 7 opinion by Bankruptcy Judge Benjamin A. Kahn of Durham, N.C., isn’t altogether favorable to a prospective debtor under the Small Business Reorganization Act, which became effective in February 2020 and is codified primarily in Subchapter V of chapter 11, 11 U.S.C. §§ 1181 – 1195.
The debtor had owned a corporation in the business of providing information transport consulting services. The company went out of business about two years ago and has no assets. The debtor did not intend to resurrect the corporate business.
Following the failure of her corporate business, the debtor became a salaried employee of a company in the same industry. She had no ownership interest in her new employer and received a W-2 as an employee.
In addition, the debtor worked part-time as an independent contractor-consultant for two other companies, where she helped with their information technology. She received 1099s from both.
The debtor filed a chapter 11 petition and elected treatment as a small business debtor. The U.S. Trustee and the SBRA trustee both objected. Judge Kahn denied the objections.
First, Judge Kahn dealt with the question of whether the debtor was “engaged in commercial or business activities,” as required by the definition of a small business debtor in Section 101(51D). There is no definition in the statute and “scant” legislative history, the judge said.
Judge Kahn recited how the “majority” of recent decisions require the debtor to be currently engaged in business, citing Offer Space, Ikalowych and Thurman. To read ABI’s reports on those decisions, click here, here and here.
Although she was no longer operating her failed company, Judge Kahn did not rule against the debtor, because he held that her 1099 work as a sole proprietor and consultant “is clearly the delivery of services in exchange for a profit.” Persuaded particularly by Offer Space, he said that her services as a sole proprietor “provide a material contribution to Debtor’s income.”
Judge Kahn found nothing in the statute or legislative history requiring that the debtor’s self-employment be full-time.
The U.S. Trustee and the Subchapter V trustee also objected, claiming there must be a nexus between the business debt arising from the defunct business and the debtor’s current business activities.
Judge Kahn rejected the idea, finding “no such implication” in the statute. Furthermore, requiring the debt to have arisen from current business activities “would be far too limiting for the remedial purposes of Subchapter V.”
Judge Kahn found support for his conclusion in Blanchard, where a bankruptcy court in New Orleans held that personal guarantees of a defunct business’s debts will suffice for an individual to qualify as a debtor under the SBRA. To read ABI’s report on Blanchard, click here.
Finding no requirement for a nexus in the statute, Judge Kahn said that a contrary rule would “disqualify meritorious small businesses from the remedial purposes of subchapter V simply by having significant debts from former operations.”
There being no theoretical disqualification, Judge Kahn turned the numbers and the question of whether more than half of the debtor’s debt arose from “commercial or business activities,” as required by Section 101(51D).
The debtor owed about $60,000 on a home mortgage that originally had been her principal residence. However, the debtor now lived elsewhere and had rented the home continuously for almost 20 years. The debtor had been unable to rent the home for the last two years because she could not afford the necessary repairs to make the home habitable.
Judge Kahn decided that the debtor could not count the mortgage among her business debts because she had originally obtained the mortgage as her residence. It therefore “did not arise from the Debtor’s commercial or business activities,” he said.
On the other hand, Judge Kahn did count debt incurred to repair the previously rented home as business debt.
Counting the business debts against personal debts, Judge Kahn found that just over half qualified the debtor for Subchapter V. He overruled the objections to proceeding under the SBRA.
The owner of a defunct business was eligible for reorganization under Subchapter V of chapter 11 when she earned “material” income from part-time personal services not attributable to employment by a company she didn’t own.
The May 7 opinion by Bankruptcy Judge Benjamin A. Kahn of Durham, N.C., isn’t altogether favorable to a prospective debtor under the Small Business Reorganization Act, which became effective in February 2020 and is codified primarily in Subchapter V of chapter 11, 11 U.S.C. §§ 1181 – 1195.
The debtor had owned a corporation in the business of providing information transport consulting services. The company went out of business about two years ago and has no assets. The debtor did not intend to resurrect the corporate business.
Following the failure of her corporate business, the debtor became a salaried employee of a company in the same industry. She had no ownership interest in her new employer and received a W-2 as an employee.
In addition, the debtor worked part-time as an independent contractor-consultant for two other companies, where she helped with their information technology. She received 1099s from both.
The debtor filed a chapter 11 petition and elected treatment as a small business debtor. The U.S. Trustee and the SBRA trustee both objected. Judge Kahn denied the objections.