Litigating Legacy Debt: “Commercial Or Business Activities” for Subchapter V Eligibility? (In re Fama-Chiarizia)

By: Donald L Swanson

“courts agree that . . . evaluating, asserting, pursuing, and defending litigation claims . . .  can satisfy Section 1182(1)(A)’s requirement of ‘commercial or business activities.’”

• In re Fama-Chiarizia, Case No. 21-42341, E.D.N.Y. Bankruptcy Court, issued 9/15/2023, Doc. 238, at 37.

One of the earliest Subchapter V opinions found “engaged in commercial or business activities” from an individual debtor’s defense of a lawsuit on personal liability for debts of a closed business.  In re Wright, Case No. 20-01035, South Carolina Bankruptcy Court, issued 4/27/2020, Doc. 37.

The In re Wright opinion declares (at 6):

• Debtor “is ‘engaged in commercial or business activities’ by addressing residual business debt.”

Some later cases, however, have rejected the idea that defending against personal liability qualifies as “engaged in commercial or business activities.”

But the idea is making a comeback as part of a “totality of circumstances” standard for finding “engaged in” eligibility.

In re Fama-Chiarizia is the latest of the comeback opinions.   

Essential Findings

Here are the essential Fama-Chiarizia findings on the “engaged in” portion of Subchapter V eligibility.

On the petition date, Debtor engaged in these commercial or business activities:

• “addressing the residual business debt” of the closed business in litigation;
• “marshaling the business assets” of the closed business by pursuing counterclaims against former business partners; and
• renting out a portion of Debtor’s residence, “a two-family home.”

Such activities are sufficient for Subchapter V eligibility, even though:

• Debtor’s former business no longer exists;
• Debtor’s primary commercial or business activities are “principally in the form of litigation”; and
• Debtor’s rental activities do not have a nexus to the debt being addressed.

Precedents

The Fama-Chiarizia opinion cites a number of precedents for its ruling, including In re Hillman.[Fn. 1]

The In re Hillman opinion declares (at 8):

• “Debtor’s defense of the State Court Action which involves a defaulted commercial lease agreement . . . and the Debtor’s personal guaranty of same is sufficient winding down activity for the Debtor to satisfy the ‘engaged in’” eligibility requirement.

Perhaps Hillman even represents a full-circle return to the In re Wright approach of finding “engaged in” eligibility from litigating a defense to personal liability on remaining debts of a closed business?  

Many Paths

The Fama-Chiarizia opinion describes the “many paths” to reorganizing a business, including the path of litigating remaining business debt.  Here’s the description:

• “both within and outside of Subchapter V, individuals and businesses follow many paths to addressing their financial circumstances”;
• “these paths include the restructuring of an operating business,” so that it may “reorganize and ultimately remain in business”;
• these paths “include combinations, mergers, and sales of all or a portion of an operating business”; and
• these paths may also include:
  • winding-up;
  • liquidating;
  • pursuing claims and assets of the enterprise through litigation; and
  • addressing legacy and residual debt related to the enterprise.

All these paths, the opinion declares, “bring about the pursuit and recovery of assets for the benefit of creditors.”

“It would be odd indeed, if Subchapter V”:

• “somehow was available for some, but not others, of these paths to addressing debt and meeting the needs of creditors”; and
• that’s especially true, since Subchapter V “was adopted to facilitate greater access to all of the tools of Chapter 11 for smaller enterprises.”

Policy Considerations

And why should entrepreneurs of failed and wound-down businesses be excluded from Subchapter V?  Shouldn’t they be entitled to deal with legacy business debts through Subchapter V?

Consider this:

• small businesses are a huge portion of our economy—both in employing people and in producing goods and services;
• a high number of small businesses fail every year; and
• entrepreneurs of failed businesses are often saddled with large guaranty debts they will never be able to repay.

Why should those entrepreneurs:

• be eligible for Subchapter V relief for short time (i.e., for as long as wind-down efforts are still occurring); but
• lose that eligibility as soon as the wind-down efforts conclude?

And what if an entrepreneur did not even know about Subchapter V until after the wind-down effort is over?

As a matter of policy, entrepreneurs should be entitled to Subchapter V relief for as long as their legacy debts remain a threat.

Conclusion

The idea that litigation over remaining business debts can, in itself, qualify as “engaged in commercial or business activities” for Subchapter V eligibility:

• found acceptance shortly after enactment of Subchapter V;
• fell into disfavor shortly thereafter; but
• appears to be making a comeback in recent times.

Here’s hoping that comeback makes it all-the-way back, so that entrepreneurs with failed-and-closed businesses can receive the bankruptcy help they deserve to address legacy debt.

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Footnote 1. This opinion is in Case No. 22-10175, N.D.N.Y. Bankruptcy Court, issued June 2, 2023, Doc. 147.

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