An individual debtor filed a chapter 11 petition and elected treatment under Subchapter V. The debtor owned two corporations that had been in chapter 7 for five and seven years, respectively.
Bankruptcy Judge Jeffery W. Cavender of Atlanta ruled that the debtor was ineligible for Subchapter V because the debt of the debtor exceeded $7.5 million when combined with the debt of the two companies long in chapter 7. In other words, companies in liquidation under the tutelage of chapter 7 trustees remain “affiliates” whose debt can make an owner ineligible for Subchapter V.
The December 13 opinion by Judge Cavender is apparently the first decision on the issue. We invite our readers to tell us whether they agree or disagree by providing remarks in the “comment” box at the foot of this story.
The Debtor’s Affiliates
The individual debtor elected treatment under Subchapter V on filing his own chapter 11 petition. Originally, the debtor disclosed that he was an affiliate of two companies that he had owned.
One of those companies had filed a chapter 11 petition in 2016, which was converted to chapter 7 in 2018. More than $50 million in proofs of claim were filed in that case. The debtor owned 65% of the stock of that company.
The debtor was the 99% owner of another company that had filed a chapter 7 petition in 2018.
The U.S. Trustee objected to the election made by the debtor-owner to proceed under Subchapter V, contending that the debt of the debtor and his two “affiliates” exceeded $7.5 million.
The Burden of Proof
While there is a split of authority, Judge Cavender said that “a significant majority of courts” believe that the debtor bears the burden of proof to establish Subchapter V eligibility.
Judge Cavender decided that the debtor “bears the burden of proof on eligibility under Subchapter V,” given “the clear trend . . . to place the burden on the debtor.”
The Focus on “Voting Securities”
The outcome turned on the interpretation of Section 1182(1)(B)(i), which excludes a debtor from eligibility under Subchapter V if the debtor is a “member of a group of affiliated debtors under this title that has aggregate noncontingent liquidated secured and unsecured debts in an amount greater than $7,500,000.”
The term “affiliate” is defined in Section 101(2)(B) to mean a “corporation 20 percent or more of whose outstanding voting securities are directly or indirectly owned, controlled, or held with power to vote, by the debtor . . . .” [Emphasis added.]
The debtor took the position that he was not the owner of “voting securities” because the chapter 7 trustees took away whatever voting rights he had. Without meaningful voting power, the debtor said he held something less than “voting securities.”
To that end, the debtor relied on a regulation promulgated by the Securities and Exchange Commission that says that the “term voting securities means securities the holders of which are presently entitled to vote for the election of directors.” 17 C.F.R. § 230.405.
The debtor also pointed to legislative history in a House Report, which says that “affiliate” is “intended to cover situations where there is an opportunity to control” a debtor. H.R. Rep. No. 595, 95th Cong., 1st Sess. 309 (1977)).
The debtor also made an argument based on fairness, because courts have held that developments after filing don’t affect a debtor’s eligibility for Subchapter V on the filing date. For instance, in In re Free Speech Systems LLC, an affiliate with too much debt for Subchapter V later filed a petition under “ordinary” chapter 11, but the previously filed debtor-affiliate was entitled to remain in Subchapter V. See, e.g., In re Free Speech Systems LLC, 649 B.R. 729, 733 (Bankr. S.D. Tex. March 31, 2023); and In re Dobson, 23-60148, 2023 BL 168846 (Bankr. W.D. Va. May 17, 2023). To read ABI’s reports, click here and here.
Plain Language Prevails
Judge Cavender said that the debtor’s arguments were “contrary to common bankruptcy usage and practice.” He found no cases “even suggesting that an owner of 20% or more of a debtor’s voting securities ceases to be an affiliate of a debtor in chapter 7 upon appointment of a trustee.”
Next, Judge Cavender said that “the plain language of § 1182(1)(B)(i) includes debtors under all of title 11, not just debtors in non-chapter 7 cases or non-trustee cases.”
Even if the SEC’s definition of “voting securities” were appropriate, Judge Cavender said he was “not convinced that [the debtor] is not ‘presently entitled to vote for the election of directors.’” In that vein, he recounted how the debtor offered “no authority suggesting [that the debtor] is not able to elect directors of a debtor in chapter 7, limited power though they may have.”
Judge Cavender discounted dicta where he described the Supreme Court as having said “that a chapter 7 debtor’s directors are ‘completely ousted’” by a chapter 7 trustee. Commodity Futures Trading Com v. Weintraub, 471 U.S. 343, 352-53 (1985).
Even so, Judge Cavender said that “chapter 7 debtors have various obligations and retain various rights in a chapter 7 case, and someone must perform those obligations and exercise those rights on behalf of a corporate debtor.” To the same effect, he said, “nothing in the definition of ‘affiliate’ or ‘voting securities’ requires that voting rights have value, and the rights can continue to exist even after a chapter 7 case is fully administered and closed.”
Judge Cavender was also worried about opening “Pandora’s Box” if he were to agree with the debtor. He had a “particular concern” that restricting the definition of “affiliate” would affect rules regarding venue and insider status.
Policy
Judge Cavender concluded his analysis by addressing “policy concerns.” What if the two corporations had filed their chapter 7 petitions only five days before the debtor’s filing in Subchapter V? If the filings had occurred so close together, he doubted that his “ruling would raise an eyebrow, or that [the debtor] would even make the argument.”
“Where should the line be drawn?,” Judge Cavender said. “What if it were five weeks, or five months?”
“[E]ven from a pure policy perspective,” Judge Cavender said that he was
not convinced that owners of chapter 7 debtors with liabilities exceeding the Subchapter V debt limit are the type of small business debtors for whom Subchapter V was designed, or that excluding those owners from Subchapter V while their businesses are liquidated in chapter 7 is inherently unfair, even if the chapter 7 business cases take longer to administer than expected.
Summing up, Judge Cavender said that the “plain language of § 1182 provides that the aggregate liabilities of affiliated debtors under title 11 are to be considered when determining Subchapter V eligibility.” He sustained the U.S. Trustee’s objection to the Subchapter V election, because he was “not persuaded that chapter 7 debtors were meant to be excluded from that affiliated group through the interpretation of ‘voting securities.’”
An individual debtor filed a chapter 11 petition and elected treatment under Subchapter V. The debtor owned two corporations that had been in chapter 7 for five and seven years, respectively.
Bankruptcy Judge Jeffery W. Cavender of Atlanta ruled that the debtor was ineligible for Subchapter V because the debt of the debtor exceeded $7.5 million when combined with the debt of the two companies long in chapter 7. In other words, companies in liquidation under the tutelage of chapter 7 trustees remain “affiliates” whose debt can make an owner ineligible for Subchapter V.
The December 13 opinion by Judge Cavender is apparently the first decision on the issue