Benchnotes May 2025

By Aaron M. Kaufman, Bradley D. Pack and Christina Sanfelippo1

Priority Wage Claims Must Be Counted for Sub V Eligibility, Even if Paid Post-Petition

In a case of first impression, Hon. Eduardo V. Rodriguez of the U.S. Bankruptcy Court for the Southern District of Texas addressed a debtor’s eligibility as a subchapter V small business debtor. Months into the case, and after the court entered first-day orders allowing the debtor to pay all pre-petition priority wage claims totaling approximately $545,000, the debtor in In re Hub City Home Health Inc.2 filed a motion to exclude the now-paid pre-petition priority wage claims from the calculation of the “debt cap” for small business debtors eligible for subchapter V. The applicable “debt cap” under § 101(51D) was $3,024,725.

The debtor’s combined debt as of the petition date, including the now-paid wage claims, was more than $3.4 million, which was more than the statutory debt cap. The debtor argued that the wage claims should not be counted because they were paid post-petition. The U.S. Trustee objected to the debtor’s motion, arguing that the plain language meant that the debtor was ineligible for subchapter V as of the petition date, because those priority wage claims existed at the time of the petition date.

The court sustained the U.S. Trustee’s objection, concluding that the plain language of §§ 1182(1) and 101(51D) calculate the debtor’s debts “as of the date of the filing of the petition.” Further, the court found that the definition in § 101(51D), “liquidated secured and unsecured debts,” did not differentiate between priority unsecured claims and nonpriority unsecured claims. The court concluded that priority unsecured claims were to be counted for eligibility purposes, and as a result, the debtor here was ineligible for subchapter V. The court struck the debtor’s election and required the debtor’s case to proceed as a traditional chapter 11 case.

Court Adopts Less Restrictive Interpretation of § 363(f)(5)

The debtors in In re Urban Commons 2 West LLC 3 were five affiliated limited liability companies that collectively owned long-term leasehold interests in a Manhattan hotel subject to a ground lease. They had shuttered and ceased operations in the wake of the COVID-19 pandemic and sought to sell their assets under § 363. The first mortgage lienholder credit bid on the assets, but a subordinate mechanic’s lienholder objected to the “free and clear” relief, arguing that neither § 363(f)(5) nor any other subsection of § 363(f) authorized a sale free and clear of its mechanic’s lien.

Hon. Philip Bentley of the U.S. Bankruptcy Court for the Southern District of New York explained that when estate property is sold for less than the face amount of the liens asserted against the property, § 363(f)(5) is often the only available basis for a “free and clear” sale. In these cases, if the holder of a lien that is not in bona fide dispute refuses to consent, subsections (2), (3) and (4) of § 363(f) do not apply. Here, § 363(f)(5) provided the only potentially viable legal hook for free-and-clear relief.

The bankruptcy court analyzed Dishi & Sons v. Bay Condos LLC,4 in which the district court narrowly applied § 363(f)(5) and held that § 363(f)(5) was satisfied only where the debtor itself, as the property’s owner, could bring a legal or equitable proceeding under nonbankruptcy law to extinguish the interests in question. Under this narrow reading of the statute, a hypothetical foreclosure proceeding or sale under the Uniform Commercial Code was insufficient to satisfy § 363(f)(5), because only a creditor — not the property’s owner (such as a debtor) — can commence such proceedings.

Such a reading encompassed any conceivable hypothetical proceeding that could compel interest-holders to accept money satisfaction under § 363(f)(6), including eminent domain takings. However, the bankruptcy court in Urban Commons explained that this hypothetical standard would render subsections (1)-(4) superfluous. The bankruptcy court reasoned that an alternative, less constrictive interpretation is available — specifically, that not every potential hypothetical proceeding need be considered in construing § 363(f)(5).

In the present case, if the court lifted the automatic stay, the first mortgage lienholder would have proceeded with a foreclosure action in state court instead of making the credit bid under § 363(b) and (f). Thus, the bankruptcy court employed a “realistic possibility” standard in contrast to the “hypothetical standard” espoused by the Dishi case. Therefore, the court concluded that the “realistic” possibility of pursuing a foreclosure under state law was sufficient to satisfy § 363(f)(5). Thus, the debtor was allowed to sell the properties to the credit bidding mortgage-holder, free and clear of the mechanic’s lien.

Miscellaneous

• In re Gibbs, --- B.R. ---, 2024 WL 5055629 (Bankr. D. S.C. Nov. 21, 2024) (debtor’s nonfiling spouse did not have standing to object to secured claim filed by debtor’s residential mortgage lender; debtor was only obligor on loan documents, and previous bankruptcy court order had already determined that nonfiling spouse held no ownership interest in residence; thus, without evidence to contrary, even under Supreme Court’s broader interpretation of “party-in-interest” as espoused in Truck Ins. Exch. v. Kaiser Gypsum Co., 602 U.S. 268 (2024), nonfiling spouse failed to demonstrate his party-in-interest standing to object to secured creditor’s claim; court thus overruled claim objection for lack of standing and for want of prosecution (i.e., nonfiling spouse failed to appear at duly noticed hearing on his objection));

• Ottoman v. Walkley (In re Ottoman), --- B.R. ---, 2024 WL 5036307 (Bankr. E.D. Mich. Dec. 6, 2024) (in adversary proceeding filed by debtor to determine priority of liens asserted against debtor’s real property, bankruptcy court concluded that discretionary abstention was appropriate to further interests of justice; here, state court had already determined that debtor owned property, subject to one of defendant’s first-lien mortgages, and that none of other defendants held interest in property; bankruptcy court granted relief from stay to allow secured creditor to complete foreclosure sale of property; because final judgment had already been entered by state court, bankruptcy court concluded that even though adversary proceeding was “core” proceeding, interests of justice weighed in favor of discretionary abstention to allow state court to oversee foreclosure sale and any ancillary matters relating to foreclosure action; adversary proceeding was dismissed, without prejudice);

• In re Bagwell, --- B.R. ---, 2024 WL 5190413 (Bankr. S.D.N.Y. Dec. 20, 2024) (court automatically dismissed voluntary chapter 7 filing under § 521(i) where debtor failed to file schedules within 45 days of petition; court expressly rejected debtor’s arguments against automatic dismissal, concluding that court’s own sua sponte dismissal process is consistent with statutory language in § 521(i)(1), even if statute contemplates under § 521(i)(2) that parties-in-interest may also bring motions to dismiss for failure to file schedules; court observed that debtor was not seeking to game system by dismissal; rather, debtor was seeking “undeserved disregard for the express statutory command of § 521(i) ... leaving the Court with an un-administrable case in the continuing absence of necessary information from the debtor”);

• In re Ellingsworth Residential Cmty. Ass’n Inc., --- F.4th ----, 2025 WL 78887 (11th Cir. Jan. 13, 2025) (as matter of first impression, Eleventh Circuit held that nonprofit company can be “engaged in commercial or business activities” as required to qualify for subchapter V of chapter 11; court rejected argument that homeowners’ association (HOA) is ineligible as subchapter V debtor because it lacked profit motive, noting that text of § 101(51D) does not limit subchapter V to for-profit entities; rather, statute allows any entity involved in regular business-like functions to qualify for reorganization under subchapter V, and HOAs engage in “business activities” as matter of course; court noted that Congress could have included nonprofit companies in list of other excluded debtors under § 101(51D) but did not);

• In re Hilltop SPV LLC, 2025 WL 66433 (Bankr. W.D. Tex. Jan. 6, 2025) (addressing question of first impression, bankruptcy court held that executory contract containing covenants conveying real property interests might be rejected by debtor, but real property interests conveyed by those covenants survive debtor’s rejection of executory contract; court explained that § 365 grants broad authority to chapter 11 debtors to reject any executory contract; further, under U.S. Supreme Court’s opinion in Mission Prod. Holdings Inc. v. Tempnology LLC, 587 U.S. 370 (2019), rejection of executory contract breaches contract but does not rescind it, therefore all rights that would ordinarily survive contract breach remain in place; court also noted that most covenants running with land are not executory in nature, and therefore not rejectable; accordingly, bankruptcy court ruled that debtor could reject gas-gathering agreement as executory contract, but counterparty to gas-gathering agreement retained rights and interests conferred under executory contract, including covenants conveying real property interest, post-rejection, and seek any relief or remedy for damages caused by such breach);

• FI Liquidating Trust v. C.H. Robinson Co. Inc., 2025 WL 208536 (Bankr. D. Del. Jan. 15, 2025) (bankruptcy court rejected defendant’s assertion that certain challenged payments were protected from avoidance under objective standard of “ordinary course” defense in § 547(c)(2)(B) because defense relied on argument that it is customary in relevant industry to impose credit pressure on customers in financial distress; pointing to legislative history, court reasoned that ordinary-course defense is intended to leave undisturbed normal financial relations and discourage unusual actions, such as imposition of credit pressure, that might destabilize debtor nearing bankruptcy; further, in In re Molded Acoustical Prods. Inc., 18 F.3d 217, 227 (3d Cir. 1994), Third Circuit adopted “healthy debtor” standard for § 547(c)(2), explaining that “ordinary terms are those which prevail in healthy, not moribund, creditor-debtor relationships”; according to court, Molded Acoustical established proposition that regardless of whether relevant standard against which challenged payments are measured is subjective one of § 547(c)(2)(A) or objective one of § 547(c)(2)(B), standard is based on terms that prevail when debtor is healthy, not in financial distress; court rejected defendant’s argument that case law that preceded Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), such as Molded Acoustical, had effectively been abrogated by Congress and is no longer controlling, explaining that nothing about BAPCPA changes Third Circuit’s conclusion that relevant yardstick for purposes of § 547(c)(2) is healthy debtor; court also acknowledged circuit split on issue, but reasoned that Third Circuit’s approach better accorded with underlying congressional purpose in adopting ordinary-course defense, which was to keep distressed companies out of bankruptcy by creating incentive for vendors to continue extending credit; ultimately, court concluded that since “ordinary business terms” refers to terms that are ordinary when dealing with healthy company and since there was nothing in record before it to suggest that vendor in industry would apply credit pressure to financially healthy customer, ordinary-course-of-business defense was unavailable to defendant);

• In re Zarifian Enterprises LLC, 2024 WL 5165920 (Bankr. N.D. Ill. Dec. 17, 2024) (bankruptcy court held that involuntary chapter 7 debtor could convert its case to subchapter V case to file liquidating plan; court explained that under Supreme Court’s opinion in Marrama v. Citizens Bank of Massachusetts, 549 U.S. 365 (2007), chapter 7 debtors have limited right to convert to reorganization case, and if chapter 11 case could simply be reconverted to chapter 7 “for cause” under § 1112(b), motion to convert might be denied; in case at hand, chapter 7 trustee opposing motion to convert failed to demonstrate that “cause” existed under § 1112(b)(4)(A) to reconvert case back to chapter 7 because he did not establish that debtor had negative cash flow and no definite source of income, as required to satisfy first prong of “continuing loss to or diminution of the estate”; trustee emphasized debtor’s absence of positive cash flow, but court reasoned that absence of positive cash flow does not make for negative cash flow; therefore, while trustee satisfied second prong of § 1112(b)(4)(A) because debtor’s intended liquidation plan was sufficient to prove absence of reasonable likelihood of rehabilitation, court ruled that debtor’s motion to convert could not be denied on basis of § 1112(b));

• In re Pitassi, --- B.R. ---, 2025 WL 440920 (B.A.P. 1st Cir. Feb. 6, 2025) (debtor’s appeal from order denying confirmation of original chapter 13 plan that challenged validity of mortgages on her properties was equitably moot; because amended plan — which was subsequently confirmed — provided for surrender of those properties to secured creditors, debtor failed to obtain stay of confirmed amended plan, and creditors foreclosed on properties during pendency of appeal, court could no longer provide meaningful relief);

• In re Sharp, --- B.R. ---, 2025 WL 289478 (B.A.P. 9th Cir. Jan. 24, 2025) (reversing order confirming chapter 13 plan that allowed debtor to redeem her residence from pre-petition judicial foreclosure sale; state law statutory redemption period, even as extended by 60 days pursuant to 11 U.S.C. § 108, had already expired prior to plan confirmation; debtor could not rely on “cure” provisions of 11 U.S.C. § 1322(b)(3) or (5) to redeem property after expiration of redemption period because entity that purchased property at the judicial foreclosure sale was not creditor holding “claim” that could be modified in chapter 13 plan, and even if it was, § 1322(c) operated to “cut off any potential application of § 1322(b)(3) or (5)”);

• In re Christenson, --- B.R. ---, 2025 WL 441904 (Bankr. S.D.N.Y. Feb. 10, 2025) (granting summary judgment in debtor’s favor on trustee’s complaint to avoid transfer of properties to ex-husband pursuant to settlement of heavily litigated divorce proceedings; divorce court’s approval of settlement as fair and equitable conclusively established that debtor gave reasonably equivalent value for transfers absent fraud or collusion; trustee failed to present sufficient evidence of fraud or collusion, as debtor received substantial consideration for properties transferred, including ex-husband’s assumption of debts and obligation to pay spousal maintenance; parties’ contemplation that properties would eventually be transferred to their children was consistent with common practices and not fraudulent or collusive; trustee’s alternative claim for unjust enrichment was duplicative of fraudulent-transfer claims); and

• In re Hammond, --- B.R. ---, 2025 WL 261958 (Bankr. E.D. Wis. Jan. 21, 2025) (overruling chapter 13 trustee’s objection to confirmation and ruling that chapter 13 debtor was only required to pay interest on secured claims beginning on date that plan was confirmed, rather than date bankruptcy petition was filed; phrase “value, as of the effective date of the plan” as used in 11 U.S.C. § 1325(b)(5)(B)(ii) requires “discounting the value of future distributions to the plan’s effective date,” and plain meaning of “effective date” is date on which plan becomes operative, which is confirmation date).

Aaron Kaufman is a partner with Gray Reed in Dallas. Bradley Pack is a shareholder with Engelman Berger, PC in Phoenix. Christina Sanfelippo is a member with Cozen O’Connor in Chicago.