By: Donald L Swanson
We are starting to get appellate opinions on Subchapter V cases and issues. Here is one of the earliest: In re SSRE Holdings, LLC, Case No. CC-21-1027, Ninth Circuit BAP (issued August 26, 2021, “Not for Publication”).
The issue in SSRE Holdings is whether the person who signed the Subchapter V petition on Debtor’s behalf had authority to do so.
Facts
In the beginning, Stanley Wetch is Debtor’s sole member, with exclusive and unlimited authority to manage and control the debtor.
Then, Wetch conveys a 50% ownership interest to an outside group (called Zirkle) but retains the other 50%. Their Members’ Agreement specifies:
- Wetch will serve as Debtor’s manager and CEO; but
- Wetch and Zirkle have “joint operational control” over “day to day business decisions.”
Substantial friction develops between the parties, almost immediately. Chaos, business disruptions, and litigation ensue, with allegations of fraud, misappropriation, and breach of contract.
But the battle for ownership and control over Debtor is at the heart of it all.
The disputing parties enter into a “Rescission Agreement,” under which they agree:
- their Members’ Agreement is “void ab initio and of no force or effect”; and
- Debtor is to repay $30,000 to Zirkle.
Before the $30,000 repayment is due, Zirkle sends an email revoking the Rescission Agreement. Debtor sends the $30,000 check anyway—but then stops payment before it is cashed.
Bankruptcy & Dismissal
Then, Debtor files Subchapter V bankruptcy, on Wetch’s signature as its manager.
Zirkle moves to dismiss, alleging:
- Wetch lacks authority to sign Debtor’s bankruptcy petition without Zirkle’s consent; and
- Debtor’s failure to repay the $30,000 negates the Rescission Agreement, so that Zirkle is still a member on the petition date.
Debtor counters:
- Wetch has sufficient authority under the Operating Agreement to file the bankruptcy petition; and
- The Rescission Agreement is effective, so that Wetch is the only member on the petition date.
The bankruptcy court:
- Finds that Zirkle is a 50% member because the Rescission Agreement is ineffective;
- Rules that, under the agreements and California law, the bankruptcy filing is outside Debtor’s ordinary course, requiring consent from all members; and
- Dismisses the bankruptcy case.
BAP Reverses
Debtor appeals to the Ninth Circuit BAP, and the BAP reverses. Here’s why.
–Authority Under Operating Agreement
Wetch has unilateral authority to file Debtor’s bankruptcy under the Operating Agreement.
While it is true that controlling California law requires consent from all members for actions outside the ordinary course, members can agree to a different rule.
The Operating Agreement provides the different rule:
- “The business, property and affairs of the Company shall be managed by Stanley J. Wetch”; and
- It is “the intent of the Agreement that no limitations be placed on the powers of the Manager.”
This expansive grant of authority includes the filing of a bankruptcy petition.
Under the subsequent Members’ Agreement between Wetch and Zirkle:
- Wetch and Zirkle have joint operational control over “day to day business decisions”; but
- All other authority of the manager is unchanged; and
- Wetch is confirmed as manager.
–Effect of Rescission Agreement
Wetch is Debtor’s sole member on the petition date because, (i) the Rescission Agreement is a binding contract, and (ii) Zirkle did not properly rescind it.
Zirkle erroneously contends that the Rescission Agreement never became effective, because Wetch never repaid the $30,000. But the Rescission Agreement specifies it is “in full force and effect immediately upon execution.” So, Zirkle’s release of its interest in Debtor became effective “immediately.”
Zikle’s contention also misses the crucial distinction between “rescission” of a contract by mutual agreement and “rescission” as a unilateral remedy for breach of contract.
- Zirkle tries to unilaterally rescind the Rescission Agreement for Debtor’s failure to repay the $30,000; but
- When Zirkle sends its rescission email, Debtor’s duty to repay the $30,000 has not yet expired.
An essential element of a unilateral rescission for breach of contract is this: the rescinding party must give notice of rescission after the breach has occurred.
In this case, Zirkle sends the rescission email before the $30,000 repayment is due (when it had no right to do so)—and fails to provide a rescission notice after the due date.
The BAP concludes:
- the Rescission Agreement is a mutual agreement to terminate Zirkle’s membership in Debtor;
- Zirkle’s effort to unilaterally rescind the Rescission Agreement is ineffective;
- The Rescission Agreement remains a valid, existing contract, despite the repayment breach; and
- Therefore, Zirkle Group is not a member of Debtor on the petition date.
Accordingly, the Bankruptcy Court’s dismissal ruling is reversed and the Subchapter V case may proceed.
Conclusion
It’s good to see an appellate court weigh-in with an opinion on a Subchapter V case.
The In re SSRE Holdings opinion is fascinating—and one of the earliest appellate opinion on Subchapter V cases and issues. Too bad it’s designated as “Not for Publication.”
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