An Example Of Subchapter V Accomplishing Its Purpose (In re Chip’s)

By: Donald L Swanson

It’s great to see a bankruptcy process that works—i.e., where both the debtor and its creditors are on board with a course of bankruptcy action.

An excellent and recent example of such a thing involves a PPP loan, in which Debtor:

• dismisses its Subchapter V bankruptcy to get a PPP loan;  
• then, gets the PPP loan; and
• then, reinstates the bankruptcy to achieve a reorganization—with the support of both its pre-petition creditors and the SBA (as PPP lender)!

Such example is in this opinion: In re Chip’s Southington, LLC, Case No. 20-21458 in the Connecticut Bankruptcy Court, issued July 16, 2021 (Doc. 245).

Filing and Dismissal

Here’s what happened.

• Debtor operates in five locations as “Chip’s Family Restaurant.”
• The pandemic hurts Debtor’s revenue, and Debtor can’t make monthly rent payments.
• In April 2020, Debtor receives its first PPP loan.
• On December 14, 2020, Debtor’s landlord begins eviction efforts, which forces Debtor into Subchapter V bankruptcy (on December 29, 2020),
• On March 30, 2021, Debtor files its Subchapter V Plan and proposes to assume the landlord’s lease.
• To effectuate the Plan, Debtor attempts to obtain a second PPP loan but fails because of its pending bankruptcy—Debtor even brings a mandamus action to compel the SBA to provide the loan, which action also fails because of the pending bankruptcy.
• After failure of the mandamus action, the U.S. Attorney (on behalf of the SBA) encourages Debtor to voluntarily dismiss its bankruptcy to obtain the second PPP loan.
• In reliance on that encouragement, Debtor files a Motion to dismiss its bankruptcy, declaring its intention to eliminate the bankruptcy impediment and obtain a second PPP loan—in such Motion, Debtor is open, transparent, and forthright about its strategic path and about the financial necessity of obtaining a second PPP loan.
• On April 23, 2021, the Bankruptcy Court, (i)  grants Debtor’s Motion to dismiss the bankruptcy case without prejudice, and (ii) approves an agreement with the landlord for a 3 months forbearance. 
• Whereupon, Debtor received a second PPP loan of $300,000.

Motion to Reinstate

On June 17, 2021, (after receiving the second PPP loan proceeds) Debtor files its Motion to vacate the dismissal Order and reinstate Debtor’s bankruptcy case, so it can prosecute its Subchapter V Plan.  Debtor argues that a reinstatement would be more efficient and effective than filing a new bankruptcy petition. 

The U.S. Trustee objects.

Debtor argues that, during the gap period (i.e., between dismissal and reinstatement), no detrimental action has occurred:

• management and officer compensation and benefits stayed the same;
• Debtor continued operating under the Court-approved cash collateral order;
• Debtor’s creditors are supporting Debtor’s good faith efforts;
• no payments were made outside of the ordinary course; and
• Debtor’s second PPP loan was predominantly used to fund payroll.

Ruling

The Bankruptcy Court grants Debtor’s Motion to reinstate the Subchapter V case—under Fed.R.Civ.P. 60(b) and Fed.R.Bankr.P. 9024.

Rule 60(b) Standard

Rule 60(b) lists six grounds for relieving a party from a judgment or order, including this catch-all: “(6) any other reason that justifies relief.”  The catch-all:

• is a “grand reservoir of equitable power to do justice in a particular case”;
• should be applied when “there are extraordinary circumstances”; and
• “should be liberally construed when substantial justice will thus be served.”

In determining whether extraordinary circumstances are present, a court may consider a wide range of factors, including:

• “the risk of injustice to the parties and the risk of undermining the public’s confidence in the judicial process”;
• a balancing of the broad Rule 60(b)(6) language with the interest in finality of judgments;
• the burden of proof “is on the party seeking relief from judgment”;
• “evidence in support of a 60(b)(6) motion must be highly convincing”;
• “undue hardship will not result to other parties”; and
• the movant must have “a meritorious claim or defense.”

Applying the Standard

–Extraordinary Circumstances Beyond Debtor’s Control

Here, a global pandemic and related regulatory restrictions (including statewide stay-at-home orders and prohibitions against on-site service by restaurants) paralyzed the service industry and damaged Debtor’s ability to operate its restaurant.

As a result, Debtor had to shutter its restaurant, and revenues plummeted.  Debtor needed a second PPP loan to survive—so it could keep people employed and provide a meaningful distribution to creditors.  But it could not get one, under SBA rules, because of the pending bankruptcy [notably, controversy and disagreement exist over the legality of such a discrimination against bankruptcy debtors].

So, it became necessary for Debtor to pursue a bankruptcy dismissal, a second PPP loan, and a reinstatement of the bankruptcy.

All of what happened represents an extraordinary circumstance that was beyond Debtor’s control.  Moreover, the path Debtor is pursuing has been endorsed by at least two other courts.

“Accordingly, the Court finds that the Debtor has met its burden by demonstrating the extraordinary circumstances beyond its control that caused its Chapter 11 case to be dismissed.”

–Prejudice to Others & Best Interests of Estate

The Court finds no perceivable prejudice to parties in interest from a reinstatement of the bankruptcy.  For example:

• The case after reinstatement will be the same as before dismissal;
• Any delay between dismissal and reinstatement is beyond Debtor’s control—is driven by the need to work through and comply with Covid-relief programs;
• Debtor’s actions will benefit its bankruptcy estate significantly—and not prejudice anyone;
• Proceeds from the second PPP loan free up cash from Debtor’s operations to repay creditor claims;
• Without the dismissal, Debtor’s business would have failed, employees would have lost their jobs, creditors would receive no distribution, and the Landlord would receive no rent payments;
• The policies and remedial mandates inherent in a Subchapter V case argue against requiring the filing of a new bankruptcy petition, which filing would involve additional delay, costs, legal complications, and duplicative work;
• Debtor has shown a reasonable likelihood that it will be able to confirm a Subchapter V plan, which likelihood would be diminished by the requirement of a new bankruptcy filing; and
• The path Debtor has chosen, (i) is intended to save its business and its employees’ jobs and to provide a meaningful distribution to creditors, (ii) has been transparent to everyone, and (iv) has been encouraged by the SBA.

“Accordingly, the Court finds that obtaining the [second PPP loan] was in the best interests of the Debtor’s estate and that vacating the Dismissal Order and reinstating the Debtor’s Chapter 11 case will not unfairly prejudice any party in interest.”

Conclusion

Subchapter V is proving to be a valuable tool for addressing risks faced by small businesses in our market-based economy. Small businesses are a lifeblood of our economy, and an effective tool for managing market-based risks and failures is extremely important.

The value of Subchapter V is apparent from the consensual and uncontested plans that are frequently being confirmed.

And the In re Chip’s Southington, LLC, opinion is an example of Subchapter V flexibility toward making consent-based arrangements work—it avoids technical impediments to consensual arrangements.

Kudos to all who made this happen!

** If you find this article of value, please feel free to share. If you’d like to discuss, let me know.