Did Congress Intend Greater Subchapter V Protection To Corporations Than To Individuals? (In re Vertical Mac)

Protecting (photo by Marilyn Swanson)

By: Donald L Swanson

Did Congress intend that Subchapter V provide greater bankruptcy protection to corporations than to individuals?

The answer is, “Yes,” according to a recent line of opinions:

  • it’s easier for a corporation to be “engaged in business or commercial activities” than it is for the corporation’s owners; and
  • the latest in such line of opinions is discussed below (following the Hypothetical).

A Work-Around?

But what about the inclusion of “affiliate” in the operative statutes, which read (emphasis added):

  • “In this subchapter . . . the term ‘debtor’—(A) . . . means a person engaged in commercial or business activities (including any affiliate of such person that is also a debtor under this title . . . )” (§ 1182(1)); and
  • “The term ‘affiliate’ means—(A) entity that directly or indirectly owns, controls, or holds with power to vote, 20 percent or more of the outstanding voting securities of the debtor” (§ 101(2));
  • “The term ‘entity’ includes person” (§ 101(15)); and
  • “The term ‘person’ includes individual” (§ 101(41)).

Hypothetical

  • Husband and Wife own Corporation (50% each), in which Wife is CEO, CFO, COO, sole employee, etc.;
  • Husband is employed elsewhere on a W-2 salary and has no involvement in Corporation, other than as a co-guarantor of its debts, with Wife;
  • Corporation’s business shuts down; and
  • Shortly thereafter, Wife is engaged in numerous business activities within Corporation, when all three file Subchapter V bankruptcies—Corporation in one case and Husband/Wife in another.

In this hypothetical, all three debtors are eligible for Subchapter V relief—Husband’s eligibility (as “engaged in”) is based on his status as an “affiliate” (i.e., >20% owner) of Corporation. 

If, however, Husband and Wife file Subchapter V, without Corporation also being a bankruptcy debtor, Husband will not be eligible for Subchapter V relief, under the recent line of opinions mentioned above.  That’s because Corporation and Wife are “engaged in business and commercial activities” without him—and the “affiliate” inclusion in § 1182(1)(A) can’t bail him out.

Is this what Congress intended?  If so, then every Subchapter V case filed by a Husband-type person had better include an earlier-or-contemporaneous bankruptcy filing by the affiliated corporation as well!

Latest Opinion in Recent Line

The latest opinion in the recent line is In re Vertical Mac Construction, LLC, Case No. 6:21-bk-01520, Middle Florida Bankruptcy Court (issued July 23, 2021, Doc. 88).

–Facts

Debtor is a contractor, specializing in residential stucco installations.

In 2017, Debtor begins facing claims for improper stucco installation, as its insurance coverage lapses and cannot be renewed.  So, Debtor ceases operations in October 2020.

On April 6, 2021, Debtor files its Subchapter V petition, seeking to liquidate its assets and disburse sale proceeds to creditors.  Debtor’s bankruptcy schedules disclose:

  • assets valued at $308,000, consisting of $13,000 cash, $200,000 accounts receivable, $75,000 vehicles and equipment, and a $20,000 stockholder receivable; and
  • claims of $800,000 unsecured and over 200 contingent, unliquidated and disputed construction claims.

The U.S. Trustee files an Objection to Debtor’s Subchapter V election, and Debtor responds.

–Eligibility Question and Arguments

The opinion addresses this Subchapter V eligibility question: Does Debtor qualify as “a person engaged in commercial or business activities” under § 1182(1)(A)?

The U.S. Trustee agues Debtor is not eligible because Debtor:

  • ceased operations in October 2020;
  • did not actively collect account receivables or pursue lawsuits against third parties;
  • had no intent to resume operations;
  • planned to sell substantially all its assets; and
  • is merely using Subchapter V to liquidate assets and not reorganize a business.

Debtor argues that § 1182(1)(A) does not require continued operations—it only requires that Debtor be engaged in commercial or business “activities.” Debtor engages in the following activities:

  • maintains a bank account;
  • has accounts receivable;
  • works with insurance adjusters and insurance defense counsel to resolve construction claims; and
  • is preparing for the sale of its assets.

Debtor contends these activities, (i) occur before and after the Petition Date, (ii) qualify as “commercial or business activities,” and (iii) render Debtor eligible for Subchapter V relief.

–Legal Standards

Legal standards for answering the question include:

  • Debtor has the burden of proof on eligibility;
  • Since “engaged” and “commercial or business activities” are not defined in the Bankruptcy Code, the Court must look to the plain language of the statute and the ordinary, contemporary, common meaning of the words used; and  
  • If the statute’s plain language is unambiguous, the court’s inquiry is complete.

–Court Findings

The Court concludes that Debtor is eligible for Subchapter V relief, based upon these findings. 

First, the statute’s language is unambiguous and has a broad and very inclusive meaning:

  1. The word “engaged” means “involved in activity: occupied, busy”—it is an active term, referring to the present and not the past, and means debtor actively had commercial or business activities on the petition date;
  2. The word “commercial” includes “occupied with or engaged in commerce or work intended for commerce,” “of or relating to commerce” and “viewed with regard to profit,” and “commerce” is “the exchange or buying and selling of commodities on a large scale involving transportation from place to place”;
  3. The word “business” is defined as “a usually commercial or mercantile activity engaged in as a means of livelihood” or “dealings or transactions especially of an economic nature.”
  4. The meaning of the word “activities” is embedded within the word itself: “the quality or state of being active: behavior or actions of a particular kind”—an act or actions; and
  5. Taken together, the phrase is a broad one intending to encompass any act of a business or commercial nature—other courts construe the phrase as broad with a very inclusive range of commercial or business activity;

Second, on the Petition Date, Debtor’s actions are commercial or business in nature, are economic in nature—and Debtor engaged in such acts with a view toward profit, or at least minimizing loss. Accordingly, such acts qualify as “commercial or business activities.” 

–The Corporate v. Individual Distinction

Two prior opinions, finding no commercial or business activity, are distinguished like this:

  • the few cases which have denied Subchapter V eligibility for lack of “engaged in commercial or business activities” involve individual debtors;
  • Such individual debtors are “a level removed from the businesses themselves” and “faced the challenge of bridging the gap between their commercial or business activities and their businesses’ commercial or business activities”; and
  • Where the debtor itself is the business, it has no gap to bridge regarding its commercial or business activities.

The two prior and distinguished cases are:

  1. In re Thurmon, 625 B.R. 417 (Bankr. W.D. Mo. 2020), in which individual Debtors own a limited liability company that operates two pharmacies.  The two pharmacies close and business assets are sold, leaving substantial business debts unpaid.  Debtors files Subchapter V three months later with no employees, no customers, no vendors, no intent to resume business activities, and no other commercial or business activity.
  2. In re Johnson, Case No. 19-42063, Northern Texas Bankruptcy Court (decided March 1, 2021, Doc. 87), in which individual Debtors file Subchapter V with no interest in an operating business: they don’t sell any goods or services, don’t have any employees, don’t have any business expenses, and are W-2 employees.

Conclusion

It’s hard to believe that Congress actually intended to provide greater Subchapter V relief to corporations than to their individual owners.

But a recent line of cases says that’s exactly what Congress intended.

Presumably, there is an “affiliate” work-around for individual eligibility, by filing Subchapter V cases for both the corporation and the individual owners/guarantors, under § 1182(1).

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

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