By: Donald L Swanson
Subchapter V eligibility requires a debtor to be “engaged in” commercial/business activities.
Case Law Consensus
Case law consensus is that such activities must exist on the petition filing date. That means a debtor cannot utilize Subchapter V when:
- business assets are fully-liquidated;
- unpaid debts are the only remnant of the failed business; and
- prospects for resuming such activities are nil.
So . . . here’s the question: Is that the right eligibility standard?
I say, “No.”
A Hypothetical
Here’s a hypothetical illustrating why:
- Entrepreneur operates a struggling business for many years;
- then, a pandemic hits and kills Entrepreneur’s business;
- so, Entrepreneur decides to give up the entrepreneur thing and starts winding the business down [at this point, Entrepreneur IS “engaged in” eligible activities];
- Entrepreneur finishes the wind-down and gets a job [at this point, Entrepreneur IS NOT eligible for Subchapter V]; and
- Finally, Entrepreneur learns of Subchapter V and how it might have helped.
How is it Right?
How is it right that Subchapter V:
- will help Entrepreneur, if filed on the day before the wind-down is complete; but
- won’t help entrepreneur, if filed a day later?
Since when is “reorganization” synonymous with continued operations? Liquidation is a common type of reorganization.
And since when does “reorganization” apply only to assets? Reorganizing/discharging debts is a bankruptcy essential.
Look at it this way:
- closely held businesses are a huge part of the U.S. economy;
- a large percentage of closely held businesses fail;
- such failures leave their entrepreneurs with large business debts;
- outside Subchapter V, the Bankruptcy Code offers no effective relief for such entrepreneurs; and
- if a winding-down entrepreneur waits too long, Subchapter V is not available.
How can that be right?
- What about entrepreneurs who don’t even know about Subchapter V until their wind down efforts are complete?
- Why punish them with no-eligibility?
- Shouldn’t our bankruptcy laws provide down-side relief for all our entrepreneurs: the ones who take the risks that make our economy work?
Recent Opinion Departure
A recent opinion follows the case law consensus. But it departs from that consensus in this respect:
- it finds that defense of a lawsuit, asserting a personal guaranty of business debts, satisfies the “engaged in commercial or business activities” requirement for Subchapter V eligibility.
The opinion is In re Hillman, Case No. 22-10175 in Northern New York Bankruptcy Court, decided June 2, 2023 (Doc. 147).
In In re Hillman:
- Debtor files Subchapter V, and Creditor contests eligibility under the “engaged in” standard;
- Debtor’s businesses are closed down;
- Debtor’s only income is from Social Security and distributions from an annuity; but
- Debtor has been defending a guaranty claim in State Court involving debts from Debtor’s closed businesses.
The Bankruptcy Court:
- adopts the consensus view that “Debtor must demonstrate she was presently engaged in commercial or business activities as of the Petition Date”;
- adopts the totality-of-circumstances approach to deciding wither “engaged in” eligibility exists;
- declares that the “engaged in” analysis:
- is not “whether the debtor was making a profit, actively operating, or intending to operate in the future”;
- can be satisfied by “winding down activity,” including the defense of a guaranty lawsuit; and
- finds that the State Court guaranty action against Debtor “was pending as of the Petition date.”
So, the In re Hillman opinion concludes that Debtor’s defense of the guaranty action “is sufficient winding down activity” for Debtor to satisfy the “engaged in” eligibility standard.
Conclusion
It will be interesting to see if other courts follow the In re Hillman approach.
Here’s hoping they do.
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