On March 29, 2021, in In re BK Technologies Inc.,[1] newly appointed Chief Bankruptcy Judge McKay Mignault dismissed the first Small Business Reorganization Act (SBRA) case filed in West Virginia due to a lack of a realistic ability to reorganize and the debtor’s bad faith. One of the key issues in the case was whether the SBRA debtor could utilize the bankruptcy process to liquidate what little it had left even after it had already been shut down for months. In dismissing the case, the court ruled that it could not.
The holding in the BK Technologies case sheds light on the newly enacted SBRA and whether an SBRA debtor’s business can be DOA (dead on arrival) on the petition date.
In 2020, the pandemic changed our economic landscape. So many small businesses are now temporarily or permanently closed as a result. Can these “dark” businesses still file an SBRA petition? Will a court approve a liquidating SBRA plan? Will the filing of such a case still serve some objective utility, even if the goal of the case is not a reorganization?
Case Background
BK Technologies, Inc., a construction company, filed the first SBRA case in West Virginia in February 2020. Prior to the bankruptcy filing, a doctor and his wife hired the debtor to renovate their home, and a restauranteur hired the debtor to build his new restaurant. Both the home and restaurant projects remained unfinished when the debtor ceased operations in the summer of 2019.
To accomplish the cessation of its business pre-petition, the debtor purportedly sold its assets to a third party, with whom the debtor had a prior existing significant relationship, for $100,000 (of which only $75,000 was paid), with no formal writing. The third party was to absorb the debtor’s employees and complete the home and restaurant projects, despite those contracts being unassignable. The debtor alleged to have used sale proceeds to pay vendors and creditors as it concluded its business. Post-petition, the debtor had no employees or contracts and did not own any equipment, tools, real estate or vehicles. It had no plans to continue operating in the future.
In October 2019, the doctor and his wife filed a civil action against the debtor, its equityholders, the purchaser, and several other entities and individuals. On Feb. 27, 2020, the debtor filed its SBRA petition more than 272 days after ceasing operations. The couple filed a motion to dismiss the case on May 22, 2020. The restauranteur also joined in the motion. The basis for the motion was the debtor’s bad-faith filing and lack of ability to reorganize.[2] First, the debtor filed the case in bad faith simply as a litigation strategy after the couple filed their civil action. Second, because the debtor sold substantially all of its assets pre-petition, it cannot reorganize, thus there is a “failure to satisfy the reorganizational purposes of subchapter V small business filings.”
The debtor, on the other hand, contended that it filed its case in good faith simply to resolve loose ends following the pre-petition sale of its business and that it hoped to achieve continuity for its employees and customers by selling its assets to the third-party purchaser. The debtor argued that chapter 11 permits the confirmation of a liquidating plan.
After a lengthy evidentiary hearing on Nov. 16, 2020, Judge McKay Mignault dismissed the case and issued a memorandum of opinion on March 29, 2021.
The Court’s Two-Pronged Inquiry to Determine Good Faith
In dismissing the case, the bankruptcy court held that “‘[t]he right to file a Chapter 11 bankruptcy petition is conditioned upon the debtor’s good faith — the absence of which is cause for summary dismissal.’”[3] “A lack of good faith in filing a Chapter 11 petition requires a showing of ‘objective futility’ and ‘subjective bad faith.’”[4]
The objective test is “designed to [e]nsure that there is embodied in the petition ‘some relation to the statutory objective of resuscitating a financially troubled [debtor].’”[5] In terms of the subjective inquiry, the aim is to determine whether the debtor’s intent is to abuse the process and cause hardship and delay to creditors “without intent or ability to reorganize his financial activities.”[6] “The overall aim of the twin-pronged inquiry must of course be to determine whether the purposes of the Code would be furthered by permitting the Chapter 11 petitioner to proceed past filing.”[7]
Having considered the record, the BK Technologies court found it appropriate to dismiss the case as having been filed in bad faith since the record satisfied both prongs. First, the court found no bankruptcy purpose — reorganization or liquidation — for the debtor to achieve. The debtor had sold all of its assets pre-petition except for an overencumbered truck (which was eventually sold to an affiliate post-petition), some cash and accounts receivable. The court said that “[a]lthough Chapter 11 may permit liquidation, the court finds … such a characterization … to miss the mark.” Second, the court found that the case was not motivated by an honest intent to reorganize or liquidate for the benefit of creditors. The debtor itself admitted that it had liquidated pre-petition and paid creditors what it believed it had.
The court observed that only after being sued by the homeowners did the debtor feel compelled to file a chapter 11 case. The court also noted that in its plan, the debtor sought to enjoin collection activity against its equityholders and related entities, even though the debtor was simply an empty shell. The court found no bankruptcy purpose to the filing and, to the contrary, believed the case served as a proposed vehicle to insulate the debtor’s equityholders and related entities.
Observations
Even if a potential SBRA debtor has indeed gone dark, how many assets does your potential SBRA debtor have left to liquidate in a chapter 11 case? Are they substantial? Is your SBRA debtor filing the case with motives other than to liquidate for the benefit of creditors? Is your SBRA debtor trying to halt litigation by filing the case or proposing vehicles to insulate its equityholders or affiliates?
Conclusion
The decision of the BK Technologies court seems to indeed imply that an SBRA debtor that has gone out of business can file a liquidating plan so long as the debtor is not just an empty shell and there are significant assets to liquidate, and so long as there is an honest intent to liquidate such assets.
[1] Case No. 20-bk-170 (Bankr. S.D. W.Va. March 29, 2021).
[2] The author represented the doctor and his wife and also the restaurant in prosecuting the motion to dismiss.
[3] In re Premier Auto. Servs. Inc., 492 F.3d 274, 279 (4th Cir. 2007); see also Carolin Corp. v. Miller, 886 F.2d 693, 698 (4th Cir. 1989).
[4] In re Premier, 492 F.3d at 279-80 (citing Carolin Corp., 886 F.2d at 700-01).
[5] In re Paolini, 312 B.R. 295, 304 (Bankr. E.D. Va. 2004) (quoting Carolin, 886 F.2d at 701).
[6] Id. at 304-05 (quoting Carolin, 886 F.2d at 702).
[7] Carolin, 886 F.2d at 701.