In the first opinion anywhere on the subject, Bankruptcy Judge Elizabeth L. Gunn of Washington, D.C. revoked the small business designation and appointed an “ordinary” chapter 11 trustee when the debtor was unable to confirm plan.
The debtor had 700 “members” who paid dues for the debtor’s referrals and marketing assistance for the members’ small businesses. Embroiled in litigation with two parties, the debtor filed a petition and designated itself as a small business debtor under Subchapter V of chapter 11.
The debtor plowed through four amendments of its plan before Judge Gunn denied confirmation of the fifth amended plan. At trial, the parties had not addressed the topic, but Judge Gunn analyzed whether conversion, dismissal or something else would be in the best interests of the debtor and creditors.
In her June 29 opinion, Judge Gunn evidently believed that the debtor’s business had promise and that members were receiving valuable services. Dismissal or conversion would have meant the demise of the business and would not have been in the best interests of creditors, the judge believed.
Did Judge Gunn have any alternatives beyond dismissal or conversion to chapter 7? She said that the question was a matter of first impression. The issue, she said, was the “converse” of the often-raised question of whether a debtor in an “ordinary” chapter 11 case could “convert” to Subchapter V.
Judge Gunn said that “conversion” from ordinary chapter 11 to Subchapter V was incorrect. Rather, the debtor should amend a petition by electing to proceed under Subchapter V.
Consequently, Judge Gunn said she could not “convert” to ordinary chapter 11. She therefore examined whether she had the statutory power to revoke the designation to proceed under Subchapter V.
In terms of statutory power, Judge Gunn observed:
Section 1185 specifically provides for the dispossession of a debtor in possession while remaining in Subchapter V,
but nothing in Subchapter V discusses the revocation of election to proceed thereunder by the Court or any other
party.
Judge Gunn therefore “look[ed] to chapter 11 and the Bankruptcy Code as a whole to determine [whether] the election by a debtor to proceed under Subchapter V may be revoked post-petition.”
“[I]f a petition may be amended to elect to proceed under Subchapter V post-petition, logically it follows that the opposite must also be an option for debtors and courts,” Judge Gunn said. She found “[v]arious sections of the Bankruptcy Code [that] allow for a debtor to seek conversion from one chapter to another if the debtor is an eligible debtor under such chapter.”
Judge Gunn reasoned:
[T]he ability to revoke a Subchapter V election is consistent with the Bankruptcy Code but also the Congressional
goals of ensuring that Subchapter V cases provide a quicker reorganization process. If a debtor discovers post-
petition that it is unable to meet the deadlines of Subchapter V, the option to revoke such designation provides the
ability to continue to attempt to reorganize under the rigors and requirements of standard chapter 11.
When a debtor cannot comply with the truncated deadlines inherent in Subchapter V, Judge Gunn said that “allowing for the revocation of the Subchapter V designation so that the debtor may proceed under standard chapter 11 is consistent with the right conferred to a debtor in the Bankruptcy Code to convert a case to another chapter therein.”
Judge Gunn found “benefits to both debtors and creditors to allow a case to remain under chapter 11 with a revocation of the Subchapter V election in lieu of requiring a debtor to have its case dismissed and immediately refiled.” She held that, “in the appropriate situations and based upon a totality of the circumstances, the Court is able order the revocation of the Debtor’s Subchapter V election, even where the revocation is not specifically provided for in the Bankruptcy Code.”
Judge Gunn went on to find that the debtor should not retain operational control. She called for appointment of a traditional chapter 11 trustee on revocation of Subchapter V status.
Observations
Robert J. Keach told ABI why he found the opinion “troubling.” “The concern,” he said, is “that only the debtor can file a plan in a Sub V, and that is a key provision driving the election to file under Sub V. If that election can be involuntarily rescinded, a key element of the statute is undermined and a basis for choosing to file is at risk. Subchapter V was passed in response to debtors avoiding chapter 11 altogether.”
However, Subchapter V does not have a get-out-of-jail free card like chapter 13, where the debtor has a right to dismiss “at any time” under Section 1307(b). The absence of a provision like Section 1307(b) could be understood as leaving a debtor stuck in bankruptcy, whether the debtor likes it or not.
Mr. Keach saw alternatives. He noted that the “court could have just appointed a section 1104 chapter 11 trustee without changing the election.” Although the “trustee could still not have filed a plan, it could have done a lot of things (operate the business, sell the assets, etc.) short of that to move the case forward. If not, the options are to dismiss or convert, not fundamentally alter the statute.”
If the case were converted or dismissed, the business presumably would fail, extinguishing the debtor’s interest in the enterprise. With revocation of Subchapter V status, the debtor would retain the right to file a plan. If the debtor were ultimately able to craft a confirmable plan continuing the business, the debtor at that juncture might seek redesignation under Subchapter V to retain ownership and avoid the absolute priority rule, a major feature Subchapter V.
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 Small Business Reorganization Act.
In the first opinion anywhere on the subject, Bankruptcy Judge Elizabeth L. Gunn of Washington, D.C. revoked the small business designation and appointed an “ordinary” chapter 11 trustee when the debtor was unable to confirm plan.
The debtor had 700 “members” who paid dues for the debtor’s referrals and marketing assistance for the members’ small businesses. Embroiled in litigation with two parties, the debtor filed a petition and designated itself as a small business debtor under Subchapter V of chapter 11.
The debtor plowed through four amendments of its plan before Judge Gunn denied confirmation of the fifth amended plan. At trial, the parties had not addressed the topic, but Judge Gunn analyzed whether conversion, dismissal or something else would be in the best interests of the debtor and creditors.