By: Donald L Swanson

When a Subchapter V debtor is removed from possession, the Subchapter V trustee steps into the possession role.  That’s according to statute.

Statutes

Here are the statutory provisions (emphasis added):

1. 11 U.S.C. § 1182(2) is titled, “Debtor in Possession” and says, “The term ‘debtor in possession’ means the debtor, unless removed as debtor in possession under section 1185(a).”
2. 11 U.S.C. § 1185 is titled “Removal of debtor in possession” and says, “(a) . . . the court shall order that the debtor shall not be a debtor in possession for cause, including fraud, dishonesty, incompetence, or gross mismanagement . . . , or for failure to perform the obligations of the debtor under a plan confirmed under this subchapter.”
3. 11 U.S.C. § 1183(b)(5) says, “(b) Duties.—The trustee shall . . . (5) if the debtor ceases to be a debtor in possession, perform the duties specified in . . . , including operating the business of the debtor.”

In re Young

We now have an example of how this removal / replacement works in an actual case and controversy.  The opinion and order are from In re Young, Case No. 20-11844 in the New Mexico Bankruptcy Court (issued 3/26/2021, Doc. 174 & 175) (appeal is pending).

Here is the Bankruptcy Court’s ruling:

• Debtors’ plan is not confirmable; and
• Grounds exist to convert the case to Chapter 7; but
• Instead, at the request of a creditor and the Subchapter V Trustee, Debtors are removed from possession,” effective immediately; and
• The Subchapter V Trustee shall take on additional trustee duties, per 11 U.S.C. § 1183(b)(5).

Multiple Bankruptcies

Debtors are Husband (in his late 80s and retired) and Wife (in her late 70s and a real estate broker). 

This is Debtors’ fifth chapter 11 case in ten years.  The first four (filed in 2011, 2013, 2017 and 2019) delayed creditors but did not result in a discharge, a confirmed plan, or any payments to creditors—all were dismissed.

Non-disclosures

Wife has back trouble and wants to get platelet rich plasma (“PRP”) treatments offered by a doctor in California. Such treatments are not covered by insurance, and Debtors are unable to guess how much they cost.

Debtors’ attempts at disclosing set-aside funds for this treatment include:

1. Debtors’ initial schedule B does not disclose that funds were set aside for the PRP treatments;
2. Debtors’ first amended schedule B says $30,000 in “cash and cash-equivalents” was set aside for the treatments;
3. Debtors’ second amended schedule B reduces that amount to $800;
4. Under cross-examination, Wife admits that she set-aside at least $10,500 for PRP treatments three weeks before filing the bankruptcy;
5. In closing argument, Debtors’ counsel referred to the $30,000 amount; but
6. Debtors’ monthly operating reports and plan fail to mention any set-aside.

The Court finds that Wife “accumulated at least $30,000 pre- and post-petition for PRP treatments,” of which at least $19,500 was set-aside post-petition.

Conversion Motion / Removal Response

Creditor had filed a motion to convert the case to chapter 7.

In response, the Subchapter V Trustee asks, as an alternative to conversion, that Debtors be removed from possession, per § 1185(a).

Debtors’ Plan

Meanwhile, Debtors file a Plan of reorganization, which proposes:

• A liquidating trustee will sell certain real property for an estimated net proceeds of $125,000, of which $100,000 will be kept by Debtors and $25,000 will be distributed to creditors;
• As to Debtors’ house and condominium, the automatic stay will terminate upon confirmation so that secured creditors can continue their foreclosure actions, but with no deficiency remaining thereafter; and
• Wife will retire, leaving Debtors with no disposable income, so Debtors will make no payments under the Plan.

–Modifications?

In opening argument at the Plan confirmation hearing, Debtors’ counsel represents that Debtors resolved many objections by Plan modifications that include, (i) deleting the $100,000 retained by Debtors, (ii) deleting the deficiency claim cancellation, and (iii) relief from stay so that foreclosure can continue on the condominium.

Debtors never provide a written copy of the Plan modifications to the Court, and the Creditor and Subchapter V Trustee continue to oppose confirmation.

–Not Confirmable

The Bankruptcy Court finds that the Plan is not confirmable because:

• Creditors would do better in a hypothetical Chapter 7 liquidation;
• Surrendering collateral to creditors can provide “indubitable equivalence,” but (i) “mere stay relief does not,” (ii) Debtors have not waived any defenses to foreclosure, and (iii) this is “not tantamount to surrender” of collateral;
• It ignores the “projected disposable income” requirement under the guise of not having any—but Wife earned $50,000 in four post-petition months, set-aside $19,500 of such earnings for PRP treatments, and “will continue to work”;
• If Wife does retire, Debtors will no longer be “engaged in commercial or business activities” (required by § 1182(1)(A) for Subchapter V eligibility); and
• It is not proposed in good faith—they’ve misused Chapter 11 for the last ten years, have a “lackadaisical attitude toward their reporting obligations” and cannot explain discrepancies, and have failed to make home and condominium mortgage payments for many years.

Grounds for Conversion Exist

Creditor moves to convert this case to chapter 7 for “cause.”  

The Court finds that cause exists to convert Debtors’ case because:

• Their bankruptcy history shows that they filed this case “solely to frustrate the legitimate efforts of a legitimate creditor”;
• They did nothing toward a post-petition sale of real estate, paid nothing to secured creditors for five post-petition months, and their estate is worse off today;
• They have proven themselves to be unreliable debtors in possession and have no reasonable likelihood of rehabilitation; and
• The combination of their post-petition actions, inactions, and inability to propose a confirmable plan, constitutes gross mismanagement.

Removing Debtors From Possession / Replacement

The Court finds that cause exists to remove Debtors from possession for the same reasons that cause exists for conversion to Chapter 7.  And conversion is a plausible option.

The main advantages of keeping the case in chapter 11 and replacing Debtors in possession with the Subchapter V Trustee are that, (i)  the Subchapter V trustee is familiar with the case, and (ii) if he is able to liquidate the estate and distribute money to creditors, his fee may be lower than a chapter 7 trustee’s fee.

During closing argument, Creditor’s counsel supported this removal / replacement relief.

One problem is this: only a debtor may file a plan under subchapter V (§ 1189(a)). Because of that, the Subchapter V Trustee may need to seek conversion at some point. But that is for another time.

By separate order, the Court will remove Debtors as debtors in possession, effective immediately, per § 1185. And the subchapter V trustee shall take on additional trustee duties, per 11 U.S.C. § 1183(b)(5).

Conclusion

A Subchapter V debtor in possession can be removed from possession for “cause”—which standard is similar to “cause” for converting a Chapter 11 case to Chapter 7.

Upon removal of the debtor from possession, the  Subchapter V trustee takes on additional duties under § 1183(b)(5), which can include “operating the business of the debtor.”

The In re Young case provides an example of how the removal / replacement statutory provisions can work in an actual case and controversy.

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