A Missing Piece in Subchapter V Eligibility & A Potential Work-Around

By: Donald L Swanson

One of the missing pieces in Subchapter V is this:

• it’s easier for a corporate business to meet the “engaged in commercial or business activities” standard for eligibility than it is for an individual owner/guarantor of that business.

Here’s how one court describes the missing piece [fn. 1]:

• early cases finding a lack of “engaged in” eligibility involve individual debtors—not business entities; and
• differences between individuals and their business entities, for “engaged in” eligibility, are significant:
  • to prove engagement, individuals must tether themselves to activities of their business entities and “bridge the gap” to those activities; but
  • when “the Debtor is the business,” there is “no gap to bridge.”

This missing piece needs to be added to Subchapter V.

A Hypothetical

Here’s a hypothetical that demonstrates the missing piece:

• Husband and Wife own Corp 50/50 – but it’s Wife’s business;
• Husband is a guarantor – but he has no other involvement in the business and is employed elsewhere as a wage earner; and
• Business fails – Wife and Corp are still engaged in business activities through the liquidation and wind-down process, but Husband is not.

The issue: Can Husband be eligible for Subchapter V? 

The answer is, “No,” because of the missing piece in Subchapter V:

• Wife and Corp are eligible for Subchapter V under the “engaged in commercial or business activities” standard; but
• Husband is not so engaged, even though he is a 50% owner of Corp and a guarantor of Corp’s debts.

A Potential Work-Around

Such “No” answer may have a work-around.  Consider this:

• If Husband and Corp both file Subchapter V cases, Husband becomes eligible for Subchapter V relief, because:
  • he qualifies as an “affiliate” of Corp; and
  • a Subchapter V “debtor” includes “any affiliate of such person that is also a debtor.”

Here are statutory details for the work-around:

1. A “debtor” in Subchapter V is defined as “a person engaged in commercial or business activities (including any affiliate of such person that is also a debtor . . . )” [§ 1182(1)(A) (emphasis added)];
2. The word “affiliate” includes an “entity that directly or indirectly owns, controls, or holds with power to vote, 20 percent or more of the outstanding voting secuirties of the debtor” [§ 101(2)(A)]; and
3. The word “entity” includes a “person,” and a “person” includes an individual [§ 101(15)&(41)].

So, as long as Corp is eligible for Subchapter V relief and files for such relief, Husband as its 50% owner is also eligible for Subchapter V relief because of his 50% ownership interest—that’s true whether he is engaged in business or commercial activities, or not.

Conclusion

One of the missing pieces in Subchapter V is the difficulty individual owners/guarantors of a corporate business might have with the “engaged in commercial or business activities” eligibility standard.

Perhaps the “affiliate” work-around described above can provide the missing piece in appropriate circumstances?

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Footnote 1.  The opinion is  In re Offer Space, LLC, 629 B.R. 299 (Bankr. D. Utah 2021).

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