Bankruptcy Judge Craig T. Goldblatt of Delaware laid out the arguments for and against the court’s power to de-designate a Subchapter V case to proceed under “regular” chapter 11.
In his December 16 opinion, Judge Goldblatt decided it was unnecessary to rule on the “close” question, because the evidence led him to conclude that it was “abundantly clear” that he instead should remove the Subchapter V debtor as debtor in possession.
Before filing under Subchapter V, the debtor was in litigation with its primary creditor. The district court had imposed a preliminary injunction which the debtor had violated. The injunction was not of a type that would be vacated by the automatic stay in bankruptcy.
In bankruptcy court, the creditor filed a motion asking the court (1) to de-designate the case from proceeding under Subchapter V and to appoint a trustee under “regular” chapter 11 or (2) remove the debtor as debtor in possession, thus allowing the Subchapter V trustee to manage the business.
The U.S. Trustee wanted Judge Goldblatt to remove the debtor as debtor in possession under Section 1185 or dismiss the case for cause.
At the ensuing hearing, evidence included “dozens” of emails sent by the debtor’s principal which were “repugnant and undoubtedly violate the district court’s injunction,” Judge Goldblatt said. He characterized the messages as including “vulgarity, racism, misogyny, and homophobia.”
More troublesome, the debtor’s principal had said in messages that he would take actions to cut off the debtor’s income. The principal also said he was willing to defy court orders.
De-Designation
Judge Goldblatt first addressed his power to de-designate the case from proceeding under Subchapter V.
As background, he said that Section 1185 “permits a court to remove the debtor from possession on a showing of cause, in which case (under § 1183(b)(5)) the subchapter V trustee is empowered to operate the debtor’s business.” If removed, the debtor in Subchapter V would nonetheless retain sole authority to file a plan.
So long as the plan devotes disposable income to the payment of creditors’ claims, the absolute priority rule would not apply even though the debtor in possession had been deposed. However, the creditor wanted Judge Goldblatt to de-designate the case under Subchapter V and require the case to proceed under “regular” chapter 11 with a “regular” chapter 11 trustee.
The power to de-designate may (or may not) be found in Bankruptcy Rule 1009(a), which provides that the court, on motion of a party in interest and after notice and a hearing, “may order any voluntary petition, list, schedule, or statement to be amended and the clerk shall give notice of the amendment to entities designated by the court.”
However, Rule 1009(b) says that the “statement of intention may be amended by the debtor at any time before the expiration of the period provided in §521(a) of the Code.”
Judge Goldblatt observed that neither the Rules nor the Code contains standards for ruling on a motion to amend a petition. He found “sound reasons” for believing that a case could be de-designated on motion by someone other than the debtor.
Judge Goldblatt also saw a “serious argument” against de-designation by anyone other than the debtor. Most persuasively, he said:
[D]e-designating a subchapter V case so that another party in interest may propose a plan or so that a trustee may be appointed under § 1104 would be an improper end run around the contrary provisions contained in subchapter V itself.
Removal of the DIP
Even if he had power to de-designate, Judge Goldblatt said that his authority should be exercised “only as a last resort” and not before giving the debtor an opportunity to file and confirm a plan.
Section 1185(a) gives the court power to remove a Subchapter V debtor in possession “for cause, including fraud, dishonesty, incompetence, or gross mismanagement of the affairs of the debtor. . . .” Given the facts, Judge Goldblatt found the debtor was “poorly suited” to fulfill its statutory obligations in the operation of the business.
By removing the debtor as debtor in possession, Judge Goldblatt invoked Section 1183(b)(5), which says that the Subchapter V trustee shall, “if the debtor ceases to be a debtor in possession … be authorized to operate the business of the debtor.”
Recognizing that the deposed Subchapter V debtor alone retains the right to file a plan, Judge Goldblatt said that the debtor’s “efforts [toward confirmation of a plan] should be exhausted before the Court considers more drastic measures.”
Having no need to decide if he could de-designate, Judge Goldblatt removed the Subchapter V debtor as debtor in possession, denied the motion to de-designate and denied the motion to dismiss as moot.
Bankruptcy Judge Craig T. Goldblatt of Delaware laid out the arguments for and against the court’s power to de-designate a Subchapter V case to proceed under “regular” chapter 11.
In his December 16 opinion, Judge Goldblatt decided it was unnecessary to rule on the “close” question, because the evidence led him to conclude that it was “abundantly clear” that he instead should remove the Subchapter V debtor as debtor in possession.
Before filing under Subchapter V, the debtor was in litigation with its primary creditor. The district court had imposed a preliminary injunction which the debtor had violated. The injunction was not of a type that would be vacated by the automatic stay in bankruptcy.
In bankruptcy court, the creditor filed a motion asking the court (1) to de-designate the case from proceeding under Subchapter V and to appoint a trustee under “regular” chapter 11 or (2) remove the debtor as debtor in possession, thus allowing the Subchapter V trustee to manage the business.
The U.S. Trustee wanted Judge Goldblatt to remove the debtor as debtor in possession under Section 1185 or dismiss the case for cause.