Subchapter V Debt Limit: Lease Rejection Damages and PPP Loans (In re Parking)

Well-defined limits (photo by Marilyn Swanson)

By Donald L. Swanson

The opinion is In re Parking Management, Inc., Case No. 20-15026, in the Maryland Bankruptcy Court (decided August 28, 2020, Doc. 224).

The Question

The question is whether Debtor has too much debt to qualify for Subchapter V relief.

Background

—Subchapter V

The new Subchapter V of Chapter 11 provides small businesses a streamlined Chapter 11 process that’s less costly and time-consuming than before.

To be eligible for Subchapter V relief, a debtor must have “noncontingent liquidated secured and unsecured debts as of the date of the filing of the petition . . . in an amount not more than $7,500,0000.” 11 U.S.C. §1182(1)(A).

Debtor sought relief under Subchapter V. 

The dispute before the Bankruptcy Court is whether Debtor is eligible under the debt limit criterion.

—Lease Rejection Damages

On the petition date, May 7, 2020, Debtor sought to reject 12 leases. Two weeks later, the Bankruptcy Court approved the proposed rejections: seven leases were rejected as of the petition date and five were rejected as of May 12, 2020.

Creditors and the U.S. Trustee contend that resulting lease rejection damages should be included in the debt-limit determination.

—Paycheck Protection Program Benefits

Prior to filing bankruptcy, debtor obtained funds totaling $1.8 million from the Paycheck Protection Program (“PPP”) created by the Coronavirus Aid, Relief, and Economic Security Act (aka the “CARES Act”).

A creditor contends that PPP obligations should be included in the debt limit determination.

–Summary

If either the lease rejection claims or the PPP claim is included in the debt limit, Debtor would exceed the $7.5 million eligibility limit in §1182.

The Bankruptcy Court concludes:

  • The lease rejection claims were contingent as of the bankruptcy filing date;
  • The PPP claim was both contingent and unliquidated as of that date; and
  • Since contingent and unliquidated claims are excluded from the debt limit determination, Debtor is eligible to proceed under Subchapter V.

What follows is a summary of the Bankruptcy Court’s rationale.

Findings of Fact

Debtor is one of the largest parking operators in the Mid-Atlantic area, leasing or managing around 100 parking facilities and employing nearly 200 people.

–Lease Rejections

Debtor filed a first-day motion to reject twelve parking leases. This motion represents that Debtor had already closed those facilities due to pandemic-related drops in revenue.

Several of the landlords objected to having the petition date be the effective date of rejection. So, the Court approved, (i) rejection of seven leases as of the Petition Date, and (ii) rejection of five leases as of May 12, 2020.  Proofs of claim for five of the seven leases rejected as of the petition date are in the aggregate amount of $1,765,542.63.

–PPP Benefits

Before filing bankruptcy, Debtor applied for PPP funding and received $1,862,723.84 on April 30, 2020. In return, Debtor executed a Paycheck Protection Program Promissory Note in that amount.

Debtor’s Debts

–Disputing Creditor

Debtor and a Disputing Creditor are in an ongoing adversary proceeding, where it is established that Debtor and Disputing Creditor entered into a parking management agreement in January of 2006, under which Debtor manages and operates 42 parking facilities for Disputing Creditor: Debtor collects parking revenue, pays certain authorized expenses, pays itself a management fee, and remits the net parking revenues to Disputing Creditor.

Disputing Creditor contends that on the Petition Date, Debtor held $2,803,376 of Creditor’s net monthly parking revenues that Debtor failed to pay to Creditor. In the adversary proceeding, Disputing Creditor seeks to impose a constructive trust over the funds, contending that its $2.8 million claim is noncontingent and liquidated, until that claim is satisfied.

–Scheduled Debts

Debtor’s original Schedules list:

  • No secured claims;
  • $6,169,500.01 of priority and unsecured claims;
  • Disputing Creditor’s claim as contingent in an “unknown” amount;
  • $1,862,723.84 for “Paycheck Protection Program,” without any designation as contingent or unliquidated; and
  • Unpaid prepetition rent claims due on its leases as of the petition date.

–Amended Schedules

Debtor files amended schedules, again showing it was below the debt limits of §1182.  Debtor listed (i) noncontingent liquidated secured claims of $50,997.39, and (ii) total priority and unsecured claims of $8,871,931.56.

However, the $8.87 million amount includes:

  • Disputing Creditor’s claim in the amount of $2,655,942.11, designated as contingent and disputed;
  • The $1,862,723.84 PPP claim, also designated as contingent, unliquidated and disputed; and
  • Unpaid prepetition rent claims due on its leases, as of the Petition Date, without including any lease rejection claims.

Conclusions of Law

–Subchapter V History

Subchapter V became effective on February 19, 2020.

When enacted, Subchapter V was limited to debtors with no more than $2,725,625 in noncontingent liquidated debts as of the date of the filing of the petition. In response to the pandemic, the CARES Act temporarily increased (until March 27, 2021) the Subchapter V debt limit to $7,500,000.

The debtor filed this case after enactment of the CARES Act, with its $7,500,000 debt limit for Subchapter V.

–Guidance from Precedents

The court is not aware of any decisions addressing the Subchapter V debt limit.

But there are many cases on similar debt limits under Chapters 12 and 13.  The court begins by looking at these decisions for guidance.

Many courts have recognized the need for an efficient, expedient resolution of the debt eligibility determination in Chapter 13 cases—similar to limits for diversity jurisdiction in federal courts.  The following general rules apply:

  • Procedures for determining initial jurisdiction cannot be allowed to dominate the proceedings themselves nor to delay them unduly, since time is of the essence in bankruptcy proceedings;
  • Debtor resources are limited, so eligibility determinations must be efficient and inexpensive; and
  • Eligibility should normally be determined by the debtor’s schedules, checking only to see if the schedules are made in good faith.

A court should neither (i) place total reliance on a debtor’s characterization of a debt, nor (ii) rely unquestionably on a creditor’s proof of claim.  The court should:

  • review debtor’s schedules, the proofs of claim and other available evidence to decide only whether the good faith, facial amount of the debtor’s liquidated and non-contingent debts exceed statutory limits;
  • scrutinize and re-designate the characterization by a debtor of any given debt, when that characterization is the subject of a case or controversy; and
  • include a debt scheduled as “unknown” or “unliquidated” when a legal certainty exists on the amount owed.

Scrutinizing the Claims Record in This Case

Typically, Subchapter V cases will have greater levels of financial complexity than Chapter 13 cases, which requires greater levels of scrutiny of scheduled debts and proofs of claims. 

–Lease Rejection Claims.

Debtor did not include lease rejection claims on its schedules.

The question is this: were lease rejection claims “contingent” as of the petition date?

Noncontingent debts are those where all events necessary to give rise to liability take place prior to filing the petition.

A debt is deemed contingent if liability relies on a future extrinsic event which may never occur.           

Under § 365(a) a trustee or debtor in possession, “may assume or reject any . . . unexpired lease of the debtor.”  This is important because, (i) rejection can release the debtor’s estate from burdensome obligations that can impede a successful reorganization, and (ii) the power to assume and/or assign an unexpired lease provides flexibility in managing the estate. 

General assumption and rejection rules include:

  • Assumption or rejection of an unexpired lease is subject to court approval under §365(a);
  • A debtor’s decision to assume or reject an unexpired lease is governed by the sound business judgment rule; and
  • A leasehold interest can be the most valuable asset in a small business bankruptcy.

Rejection or assumption of an unexpired lease establishes the nature of the claim as either a pre-petition obligation or as an administrative expense entitled to highest priority:

  • Rejection constitutes a breach of the contract, and resulting damages are treated as a pre-petition, general unsecured claim;
  • Assumption grants administrative expense priority to claims under the contract; and
  • Until assumed or rejected, the debtor’s obligations under the contract are an administrative expense claim.

In this case, all lease rejection claims were contingent as of the petition date, because Court approval of the rejections did not occur until a couple weeks after the bankruptcy filing.  Accordingly, all rejection claims were contingent on the petition date. 

This is even true of the seven leases whose rejections were “as of” the petition date.  Superficially, it may be true that the petition date, as the deemed effective date of rejection, was “as of” the petition date.  But the substance and reality is this:

  • While numerous post-petition events may affect a debtor’s total secured or unsecured debt (e.g., collateral liquidation, a contingent guarantee becomes liquidated, etc.), most courts who’ve considered the issue in Chapter 13 conclude that post-petition events should not be considered in determining eligibility—otherwise a debtor could float in and out of Chapter 13 eligibility during the bankruptcy, which makes no legal or practical sense.
  • The plain language of § 109(e) requires consideration of the debts as they exist as of the petition date, irrespective of post-petition events.

–PPP Funds.

Before filing bankruptcy, Debtor received $1,862,723.84 of PPP funds.

On May 13, 2020, the court ordered Debtor “to abide by the certifications the debtor has made as to the limited use of PPP funds in a manner and for purposes permitted by the CARES Act and other laws governing the use of such funds.”

Debtor declares that it has used all of the loan proceeds in accordance with the PPP requirements and intends to seek forgiveness of the entire balance in accordance with the PPP requirements.

Debtor contends that any obligation to repay the PPP funds was both contingent and unliquidated as of the petition date: PPP funds are a government grant and must be repaid only if Debtor does not comply with PPP requirements.

Creditor contends the PPP obligation is evidenced by a promissory note in a fixed amount, and therefore the funds were a noncontingent and liquidated debt as of that date.

The court concludes that, (i) Debtor’s obligation to repay the PPP funds was contingent and unliquidated as of the petition date of filing, and (ii) the PPP debt is therefore excluded from the eligibility determination. 

Contingent. Here’s why it is contingent:

  • PPP was created by the CARES Act and intended to provide emergency economic assistance to help individuals and businesses cope with the economic and public health crises triggered by the worldwide pandemic;
  • The CARES Act provides for forgiveness of up to the full principal amount of qualifying PPP loans;          
  • The central characteristic of the PPP is that the recipient fully anticipates that it will not be required to repay the PPP funds;
  • The obligation to pay a contingent liability does not arise until the occurrence of a triggering event or occurrence reasonably contemplated by the debtor and creditor at the time the event giving rise to the claim occurred;
  • The PPP Borrower Application Form anticipates loan forgiveness as follows: “I understand that loan forgiveness will be provided for . . . [specified uses]”;
  • Neither lenders nor SBA are conducting typical loan underwriting analyses;
  • The CARES Act waives regular SBA requirements that small businesses be supported by a personal guarantee or collateral; and
  • The PPP form promissory note expressly incorporates the PPP forgiveness provisions.

Forgiveness is the essential characteristic of the debtor’s obligation under the PPP Note and requirements. Without forgiveness, there is no PPP. Accordingly, as of the petition date, the debtor’s liability to repay the PPP is dependent on some future extrinsic event which may never occur. Therefore, the debtor’s PPP obligation was contingent as of the date of filing.

Unliquidated. Here’s why it is unliquidated:

  • A liquidated debt in Chapter 13 relates to the amount of liability, not the existence of liability—a debt is liquidated for debt limit purposes, if the amount of the debt is readily determinable.
  • The key factor is whether the process for determining the claim is fixed, certain, or otherwise determined by a specific standard.
  • Debtor will have no obligation to repay PPP funds, if PPP rules are satisfied.
  • Debtor declares it has used all of the loan proceeds in accordance with PPP requirements and will seek forgiveness of the entire loan balance.
  • The PPP obligation was not liquidated as of the petition date because it was not then known, and could not be determined, whether the debtor would use the PPP funds for ineligible expenses or would fail to maintain employee staffing levels in accordance with the PPP.
  • Further, the loss of forgiveness is not an all or nothing proposition—a borrower may be granted forgiveness for the portion of PPP funds used properly while being required to repay the other PPP funds.

Therefore, Debtor’s PPP obligation was unliquidated as of the date of the filing, and it is excluded from the debt limitation determination under §1182.

Conclusion

The In re Parking Management opinion is helpful for filling-in some of the many blanks surrounding Subchapter V eligibility.

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