Moving Old Chapter 11 Cases Into Subchapter V? Bankruptcy Courts Say, “Yes”

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Ready to move (photo by Marilyn Swanson)

By: Donald L Swanson

Five different bankruptcy courts have allowed Subchapter V designations for debtors whose Chapter 11 cases were already existing on the effective date (February 19, 2020) of the Small Business Reorganization Act (“SBRA”). And their opinions are instructive on procedures and legal standards for doing so.

These five cases run the gamut of debtor possibilities: from “couldn’t wait long enough” cases, to “old and mostly-unsuccessful” cases, to even a “no prior small business designation” case.

Each of these five cases involves an amended petition under Fed.R.Bankr.P. 1009(a) electing a Subchapter V status.

Here is a summary of each of the five cases, in chronological order of their opinions issued.

First: Old and Mostly-Unsuccessful

The first opinion is In re Progressive Solutions, Inc., Case No. 18-14277 in the Central District of California, decided February 21, 2020 (Doc. 157). Here’s how it came about:

  • On November 21, 2018, (fifteen months before the SBRA becomes effective) Debtor files its Chapter 11 petition as a small business case, and subsequent efforts at getting a small business plan confirmed are unsuccessful;
  • On January 30, 2020, (in anticipation of the SBRA’s effective date) Debtor files its (i) Motion for Order Authorizing Amendment of Chapter 11 Petition Re Subchapter V Election and Extension of Plan Deadline (Doc. 143), (ii) First Amended Chapter 11 Small Business Plan (Doc. 144), and (iii) Motion to Confirm Plan Under 11 U.S.C. section 1191(b) (Doc . 145);
  • The U.S. Trustee objects because a Subchapter V trustee would be unable to satisfy its obligations at this late stage as to Debtor’s plan (Doc. 148), a creditor objects on similar grounds (Doc. 151), and on February 20, 2020, the Bankruptcy Court holds a hearing; and
  • On February 20, 2020, (one day after SBRA became effective) Debtor files its “Amended Voluntary Petition for Non-Individuals Filing For Bankruptcy re Election to Proceed Under Subchapter V of Chapter 11” (Doc. 154).

On February 21, 2020, the Bankruptcy Court issues a twelve-page opinion (Doc. 157-2) allowing the case to proceed under Subchapter V.  Here’s why:

  • The Court finds “no legal reason to restrict a pending Chapter 11 case to re-designate to a Subchapter V case, on the facts underlying the Motion”;
  • “No party has provided any legal reasoning to support a blanket prohibition of such re-designation by the Debtor”; and
  • Arguments against designating this as a Subchapter V case “all have to do with practicality and not legality.”

Procedurally, the Court focuses on Fed.R.Bankr.P. 1009 (“Amendments of Voluntary Petitions . . . ”) and declares:

  • “an amendment to a Bankruptcy Petition can be made . . . as a matter of course at any time before the case is closed”;
  • the last sentence of Rule 1009(a), requiring a motion for amendment, applies only to non-debtor parties who demand that a debtor make changes to the petition—it does not apply to a debtor;
  • there is no legal requirement for a court to grant leave to amend the petition, and there are clear procedures for parties to object to any amendments or designations (including an amended designation under Subchapter V);
  • Debtor’s Motion for permission to amend and elect Subchapter V “is unnecessary and not required by law”; and
  • Once Debtor files an amended petition electing Subchapter V, opposing parties may file timely objections, whereupon the Court may undertake eligibility considerations.

The Debtor did file an Amended Petition electing Subchapter V.  No one objected, and the case continues under Subchapter V.

Second: Couldn’t Wait Long Enough

The second opinion is In re Moore Properties of Person County, LLC, Case No. 20-80081 in the Middle District of North Carolina, decided February 28, 2020, (Doc. 42). Here’s what happened:

  • On February 10, 2020, Debtor files its Chapter 11 petition as a small business case—Debtor had wanted to wait until SBRA became effective, but couldn’t because of two foreclosure actions;
  • On February 13, 2020, the Bankruptcy Administrator objects to Debtor’s designation of itself as a small business generally (not to the Subchapter V issue, which had not yet arisen) (Doc. 14), and the Court schedules a hearing for February 25, 2020 (Doc. 20);
  • On February 24, 2020, (five days after SBRA became effective and one day before the hearing), Debtor files an amended Petition (Doc. 27), electing to proceed under Subchapter V; and
  • On February 25, 2020, the Bankruptcy Court’s hearing addresses all small business and SBRA issues.

The Bankruptcy Court’s February 28, 2020, opinion rejects the Bankruptcy Administrator’s objection. Here’s how the Court rules:

  • This is not a case in which the Court is asked to apply new law retroactively in violation of precedents, so the law in effect at the time the Court is asked to render its decision governs;
  • Debtor qualifies as a “small business debtor,” both before and after the effective date of SBRA, and may elect to proceed under Subchapter V;
  • Under Fed.R.Bankr.P. 1009, an amendment to a Bankruptcy Petition can be made as a matter of course at any time before the case is closed; and
  • Debtor was, therefore, entitled to amend its Petition to elect Subchapter V.

Third: Couldn’t Wait Long Enough

The third opinion is In re Body Transit, Inc., Case No. 20-10014 in the Eastern District of Pennsylvania, decided March 24, 2020 (Doc. 113). Here’s what happened:

  • On January 2, 2020, Debtor files its Chapter 11 petition as a small business debtor—Debtor could not wait to file because of a levy on cash assets;
  • On February 19, 2020, (the SBRA’s effective date), a creditor files a Motion to appoint a Chapter 11 trustee (Doc. 65), and multiple relief from stay motions are involved (see, e.g., Docs. 47, 72, 88, 95 & 97);
  • Also on February 19, 2020, Debtor files its amended Petition (Doc. 67) electing to proceed under Subchapter V; and
  • On March 2, 2020, Debtor files its “Motion for Order” to proceed under Subchapter V (Doc. 84), and a March 11, 2020, hearing is held (Doc. 100).

The Bankruptcy Court issues its March 24 opinion (Doc. 113), allowing Debtor to proceed under Subchapter V. Here’s its rationale:

  • Practically, Debtor is on the ropes—(i) two of its three locations are terminated, (ii) the third could be lost if relief from stay is granted, and (iv) the primary secured creditor wants a court appointed trustee;
  • Procedurally, under Fed.R.Bankr.P. 1009, a small business debtor may amend its petition to elect a Subchapter V status, and the case then proceeds under subchapter V until an timely objection is granted;
  • Under Fed.R.Bankr.P. 1009, the ability to amend a petition is subject to objection, if the amendment is made in bad faith or would unduly prejudice the objector—this is the appropriate standard for “evaluating an objection to a belated election to proceed under subchapter V”;
  • Objecting creditor is “the de facto moving party” and has the burden of showing “the level of prejudice required to override the Debtor’s right to amend its petition under Fed.R.Bankr.P. 1009”;
  • Creditor makes no viable argument that its vested property interests are impaired by Debtor’s Subchapter V election—so, there is no “impermissible retroactive application of the statute”; and
  • Creditor wants a trustee appointed, instead of a Subchapter V election, but fails to show the requisite prejudice—e.g., the remedy for a failing business with with no hope of reorganizing, is conversion to Chapter 7 or dismissal, not appointment of a trustee.

Fourth: No Prior Small Business Designation

The fourth opinion is In re Mark M. Bello, Case No. 19-46824 in the Eastern District of Michigan, decided March 27, 2020 (Doc. 156). Here’s what happened procedurally:

  • On May 3, 2019, the individual Debtor files his Chapter 13 petition;
  • During the Chapter 13 proceeding, a disputed claim against debtor is liquidated by summary judgment, which puts Debtor over the debt limit for Chapter 13 eligibility (see Doc. 83);
  • On December 12, 2019, Debtor moves to convert his case to Chapter 11 (Doc. 89), with no mention of a small business status—the Bankruptcy Court grants this motion, over objection, on January 15, 2020 (Doc. 102);
  • On March 2, 2020, Debtor files an amended voluntary petition, electing to proceed under Subchapter V as a small business debtor (Doc. 135);
  • The Bankruptcy Court issues a show cause order (Doc. 138), noting that a Subchapter V trustee has not been appointed and requiring Debtor to explain in writing “why the Court should not strike” Debtor’s “purported election to proceed as a small business debtor under Subchapter V”; and
  • Three parties respond to the show cause order: Debtor (Doc. 138), the U.S. Trustee asserts a neutral position (Doc. 153), and a creditor objects (Doc. 154).

After reviewing the show cause responses, the Bankruptcy Court concludes that the case may proceed under Subchapter V. The Court cites the reasoning and holding of In re Moore Properties as persuasive and “applicable to the facts of this case,” which is “still in the early pre-confirmation stage as a Chapter 11 case” (Doc. 156).

Fifth: Old and Mostly-Unsuccessful

The fifth opinion is In re Samha Foods, Co., LLC, Case No. 19-80424 in the District of Nebraska, decided March 31, 2020 (Doc. 106). Here’s what happened:

  • On March 18, 2019, Debtor files its Chapter 11 petition as a small business debtor;
  • One day less than one year later (on March 17, 2020), Debtor files its amended voluntary petition, electing to proceed under Subchapter V (Doc. 96); and
  • The U.S. Trustee objects, based on long-expired small business deadlines that Debtor did not meet (Doc. 99), and a creditor objects during the hearing on Debtor’s Subchapter V status.

The newly-appointed Bankruptcy Judge, in a ruling from the bench, denies the objections and allows Debtor to proceed under Subchapter V (see Doc 106).

Conclusion

One of the transition questions for SBRA, that we’ve all been anticipating, is this: Will Courts allow Chapter 11 debtors, already in bankruptcy as of the SBRA effective date, to elect Subchapter V status.

We now have an answer from five separate bankruptcy courts. And their collective answer is an emphatic, “Yes.”

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