Loans made to finance a leveraged buyout may be included in calculating eligibility for reorganization under Subchapter V of chapter 11, even if the loan also conferred benefits on the buyers, according to Bankruptcy Judge Thomas J. Catliota of Greenbelt, Md.
In his October 26 opinion, Judge Catliota said that Section 1182(1)(A) does not require “excluding debt that directly benefitted others,” such as the buyers in a leveraged buyout, or LBO.
The LBO Loans
Two individuals arranged to buy a corporation. To effect the purchase, the buyers formed a holding company of which they were the exclusive owners.
For the holding company to acquire the equity interests in the target corporation, a lender made three loans totaling $5.75 million. The target corporation (soon to be the chapter 11 debtor) was the borrower and pledged all of its assets.
The corporate borrower filed a chapter 11 petition and elected treatment as a small business debtor under Subsection V of chapter 11. The debtor listed debts of about $6.4 million.
The former owner (that is, the seller in the LBO) purchased a $500 claim to have status as a creditor. As a creditor, the former owner objected to the debtor’s eligibility to proceed as a small business debtor.
Must a Debt Benefit Only the Debtor?
The outcome of the objection was controlled by Section 1182(1)(A), which says that a small business debtor must be
a person engaged in commercial or business activities . . . that has aggregate noncontingent liquidated secured and unsecured debts as of the date of the filing of the petition or the date of the order for relief in an amount not more than $7,500,000 . . . not less than 50 percent of which arose from the commercial or business activities of the debtor.
The creditor conceded that the debtor was a “person” with no more debt that the statute allows. The creditor also admitted that the loans were “commercial or business activities.”
However, the creditor argued that the $5.75 million in LBO loans could not be counted because they did not arise “from the commercial or business activities of the debtor.” [Emphasis added.] According to the creditor, the LBO loans primarily benefitted the two buyers in acquiring the corporate debtor.
Interpreting “the commercial or business activities of the debtor,” Judge Catliota said that “virtually” all courts “have applied a liberal construction of the phrase in keeping with the [Small Business Reorganization Act’s] purpose and the language of § 1182(1)(A).” He cited Bankruptcy Judge Thomas B. McNamara of Denver, who said in In re Ikalowych, 629 B.R. 261, 276 (Bankr. D. Colo. 2021), that the phrase is “exceptionally broad.” To read ABI’s report on Ikalowych, click here.
The creditor relied on In re Ventura, 615 B.R. 1 (Bankr. E.D.N.Y. 2020). To read ABI’s report on Ventura, click here.
To Judge Catliota’s way of thinking, Ventura was inapposite. Ventura decided whether a debt was primarily a commercial or consumer debt under Section 101(8).
Judge Catliota said:
The primary purpose test is applied to resolve the binary question of whether a debt is commercial or consumer. A transaction can have both commercial and consumer attributes, and a court must determine whether it is one or the other by assessing why the debt was “primarily” incurred. § 101(8). The language of § 1182(1)(A) does not require, or even invite, this inquiry where the debt so clearly arose from the commercial or business activities of the debtor.
“Primacy,” Judge Catliota said, “is not included in the assessment once the debt is determined to be incurred through the debtor’s commercial or business activities.” The statute, he said, “does not require the court to dissect the various benefits obtained by all the parties and, for purposes of § 1182(1)(A), include only debt that is linked to a direct benefit obtained by a debtor, while excluding debt that directly benefitted others.”
Judge Catliota noted several benefits received by the debtor from the LBO loans. Among other things, he pointed to a $250,000 working capital loan and a covenant requiring $600,000 in working capital.
“It simply cannot be disputed,” Judge Catliota said, “that, under the ordinary, contemporary, common meaning of the phrase, the debt ‘arose from the commercial or business activities . . . of the debtor.’” He denied the objection to treatment under Subchapter V because the objection was “not consistent with the statutory language and ignores the substance of the transaction, including an assessment of the direct and indirect benefits the Debtor obtained.”
Loans made to finance a leveraged buyout may be included in calculating eligibility for reorganization under Subchapter V of chapter 11, even if the loan also conferred benefits on the buyers, according to Bankruptcy Judge Thomas J. Catliota of Greenbelt, Md.
In his October 26 opinion, Judge Catliota said that Section 1182(1)(A) does not require “excluding debt that directly benefitted others,” such as the buyers in a leveraged buyout, or LBO.
The LBO Loans
Two individuals arranged to buy a corporation. To effect the purchase, the buyers formed a holding company of which they were the exclusive owners.
For the holding company to acquire the equity interests in the target corporation, a lender made three loans totaling $5.75 million. The target corporation (soon to be the chapter 11 debtor) was the borrower and pledged all of its assets.
The corporate borrower filed a chapter 11 petition and elected treatment as a small business debtor under Subsection V of chapter 11. The debtor listed debts of about $6.4 million.
The former owner (that is, the seller in the LBO) purchased a $500 claim to have status as a creditor. As a creditor, the former owner objected to the debtor’s eligibility to proceed as a small business debtor.