Mopping up a defunct business qualifies a corporate debtor for liquidation under the flexible rules for chapter 11 laid down in the Small Business Reorganization Act, or SBRA.
According to Bankruptcy Judge Christopher M. Lopez of Houston, collecting accounts receivable and maintaining the physical assets qualify as being engaged in commercial activities, even when the historical business is no longer operating.
The Nonoperating Plant
The debtor owned and previously operated a facility that converted waste heat from a nearby plant into electricity and steam sold to other nearby plants. After disputes with its primary creditor and supplier of waste heat, the debtor halted operations. The debtor and its creditor were mired in litigation and arbitration when the debtor filed a chapter 11 petition and elected to be treated as a small business under the SBRA.
The debtor filed a chapter 11 plan to liquidate the assets, collect accounts receivable, prosecute claims and distribute proceeds to creditors.
The primary creditor and the U.S. Trustee objected to the SBRA election, because the debtor was no longer operating its historical business. Judge Lopez overruled the objection in his July 1 opinion and allowed the debtor corporation to continue as a small business.
Qualification Under the SBRA
The SBRA became effective in February 2020 and is codified primarily in Subchapter V of chapter 11, 11 U.S.C. §§ 1181 – 1195. The issue before Judge Lopez arose under the definition of a “debtor” in Section 1182(1)(A), which “means a person engaged in commercial or business activities . . . .”
Although the quoted terms are not defined in the Bankruptcy Code, Judge Lopez applied the “plain meaning” of the words. He agreed with cases holding that “‘engaged in’ commercial or business activities means a debtor was actively participating in one of these activities on the petition date.” The word “commercial,” he said, means “‘of or relating to commerce.’”
Although the debtor was no longer producing and selling steam and electricity, Judge Lopez identified the following commercial activities: The company was
- Managed by two principals of its limited partner and employed an independent contractor;
- Litigating a multi-million-dollar lawsuit with its principal creditor;
- Collecting $160,000 in accounts receivable from its principal creditor;
- Maintaining its facilities;
- Working on a plan to pay creditors by selling assets with an estimated value of $3 million; and
- Filing reports and tax returns with state and federal authorities.
Judge Lopez held that pursuing litigation, collecting accounts receivable, selling assets and maintaining assets “are all commercial and business activities.”
The objectors argued that the debtor had no W-2 employees, but Judge Lopez said that “neither do many U.S. small businesses, and, regardless, that is not required under Section 1182(1)(A).” He said that the section “also does not require a debtor to maintain its core or historical business operations on the petition date.”
Contending that Subchapter V was not intended for liquidations, the objectors relied on the SBRA’s legislative history by saying it was designed to promote reorganizations. “But this does not change the outcome,” Judge Lopez said. The language of the statute is clear, leaving no room to consider legislative history. To the contrary, he noted how the SBRA permits the sale of a debtor’s assets.
Judge Lopez agreed with In re Offer Space, LLC, Case No. 20-27480, 2021 WL 1582625, at *2 (Bankr. D. Utah Apr. 22, 2021), where Bankruptcy Judge William T. Thurman of Salt Lake City held that a debtor need not be operational so long as it had a bank account and was managing its few remaining assets. To read ABI’s report on Offer Space, click here.
Judge Lopez distinguished and declined to follow two cases where individuals owned defunct businesses and were held ineligible for Subchapter V, even though their debts arose from the defunct business. He was referring to In re Johnson, 2021 WL 825156 (Bankr. N.D. Tex. Mar. 1, 2021); and In re Thurmon, 2020 WL 7249555 (Bankr. W.D. Mo. Dec. 8, 2020). To read ABI’s reports on those cases, click here and here.
Unlike Johnson and Thurmon, where the debtors were individuals, the debtor before Judge Lopez was a corporation. He found that this debtor was “engaged in commercial or business activities,” overruled the objections and allowed the debtor to proceed under Subchapter V.
Mopping up a defunct business qualifies a corporate debtor for liquidation under the flexible rules for chapter 11 laid down in the Small Business Reorganization Act, or SBRA.
According to Bankruptcy Judge Christopher M. Lopez of Houston, collecting accounts receivable and maintaining the physical assets qualify as being engaged in commercial activities, even when the historical business is no longer operating.