By: Donald L Swanson

This ideal is floating around:

• upon removal of a Subchapter V debtor from possession, for fraud or other cause,
• the Subchapter V trustee has no expanded right, power, function or duty beyond operating debtor’s business (the “Ideal”).

This Ideal is both:

• contrary to unambiguous language of the Bankruptcy Code, as a matter of law; and
• in Never-Never Land, as a matter of practice.

I’ll try to explain.

Law: No Statutory Ambiguity

This is a truism:

• upon removal of a debtor from possession under § 1185(a), all the specified rights, powers, functions and duties of a trustee, that the debtor in possession had been exercising, revert to the Subchapter V trustee.

We know this because:

• § 1184 says, “a debtor in possession shall have all the rights, . . . , and powers, and shall perform all functions and duties . . . of a trustee serving in a case under this chapter, including operating the business of the debtor”; and
• § 1185(a) says, “the court shall order that the debtor shall not be a debtor in possession for cause.”

The language of the same § 1184 also provides two identifications of “rights” and “duties”:

• “rights” include “compensation under section 330 of this title”; and
• “duties” include “operating the business of the debtor.”
  • Note: a trustee operating debtor’s business is clarified (in both § 1108 & § 1183(b)(5)) as something a trustee is authorized to do—not something the trustee must do.

–Regular Chapter 11 Trustee

Everyone knows—and agrees—that the debtor in possession, in a regular Chapter 11 case, exercises the full range of specified rights, powers, functions and duties of a trustee, under § 1107(a).  But upon appointment of a trustee under § 1104(a) for fraud or other cause:

• debtor immediately and automatically loses all those rights, powers, functions and duties of a trustee—because the trustee appointment also removes the debtor from possession; and
• bestows all those lost rights, powers, functions and duties of a trustee upon the newly appointed trustee.

Question: What statutory language authorizes a different result, upon removal of a Subchapter V debtor from possession? 

Answer: There isn’t any.

Accordingly, the same rules for reversion of trustee rights, powers, functions and duties of a trustee in regular Chapter 11 also apply to the corresponding trustee rights, powers, functions and duties in Subchapter V upon removal of debtor from possession.

–“Cause” is the Same

Moreover, the legal descriptions of “cause” are nearly identical for both, (i) appointing a trustee in regular Chapter 11, and (ii) removing a debtor from possession in Subchapter V:

• “cause” for removing a debtor from possession in a Subchapter V case (under § 1185) is described as:
  • “cause, including fraud, dishonesty, incompetence, or gross mismanagement of the affairs of the debtor, either before or after the date of commencement of the case”;
• “cause” for appointing a trustee in a regular Chapter 11 case (under § 1104(a)) is described as:
  • “cause, including fraud, dishonesty, incompetence, or gross mismanagement of the affairs of the debtor by current management, either before or after the commencement of the case”; and
• the only difference in these two descriptions is inclusion of the words “by current management” in § 1104(a)—otherwise, the descriptions are identical.

Accordingly, the legal standard of “cause” for removing a debtor from possession in both regular Chapter 11 cases and Subchapter V cases is the same.

–Statutory Rights, Powers & Functions

The statutory rights, powers and functions that revert to the trustee, upon removal of a debtor from possession (in both regular Chapter 11 and Subchapter V cases), are exactly the same.  They include:

• the right/power/function to sell estate assets under § 363 (“the trustee . . . may use, sell or lease . . .”);
• the right/power/function to obtain credit for the estate under § 364 (“the trustee may obtain unsecured credit and incur unsecured debt . . .”);
• the right/power/function to enforce turnover obligations under § 542 (“shall deliver to the trustee . . .”) and § 543 (“shall . . deliver to the trustee . . .”);
• the right/power/function to abandon property of the estate under § 554 (“the trustee may abandon . . .”);
• the right/power/function to avoid transfers under:
  • § 544 (“The trustee shall have . . . the rights and powers of, or may avoid any transfer of property of the debtor that is voidable by . . .”);
  • § 545 (“The trustee may avoid the fixing of a statutory lien . . .”);
  • § 547 (“the trustee may . . . avoid any transfer of an interest . . .”);
  • § 548 (“The trustee may avoid any transfer . . .”); and
  • § 549 (“the trustee may avoid a transfer . . .”).

Accordingly, there is no statutory distinction for the exercise of statutory rights/powers/functions between, (i) a regular Chapter 11 trustee, and (ii) a Subchapter V trustee after removal of the debtor from possession.

–Statutory Duties

Additionally, the statutory duties of a trustee in a regular Chapter 11 case and of a trustee with a removed from possession debtor in a Subchapter V case differ in only minor degrees.  Specifically:

• both § 1106(a)(1) and § 1183(b)(1),(5)&(6) incorporate the same duties identified in subparts (2), (5), (7), (8), (9) & (10) of § 704;
• as to differences in the incorporated § 704 duties:
  • only § 1183(b) includes subpart (6) on objecting to debtor’s discharge; and
  • only § 1106(a)(1) includes subpart (11) on performing ERISA obligations and subpart (12) on transferring health care patients; and
• § 1106(a) identifies only one duty that is not included in § 1183(b):
  • subpart (5) on filing a plan.

Accordingly, there is no substantive or material difference in duties between a regular Chapter 11 trustee and a Subchapter V trustee after removal of debtor from possession, beyond the right to file a plan.  The few other differences are limited in scope.

–Reinstating Debtor to Possession

In both regular Chapter 11 and Subchapter V, a debtor that’s removed from possession can be reinstated:

• § 1105 says for a regular Chapter 11 debtor, “the court may terminate the trustee’s appointment and restore the debtor to possession and management of the property of the estate and of the operation of the debtor’s business”; and
• § 1185(b) says for a Subchapter V debtor, “the court may reinstate the debtor in possession.”

Practice: Never-Never Land

Never-Never Land is a imaginary place that’s unhinged from reality.

And that’s precisely what the Ideal is, of a Subchapter V trustee (after removal of a miscreant debtor from possession) who:

• may operate debtor’s business for a while; but
• has no other expanded rights, powers, functions or duties.

Under the Ideal, a debtor removed from possession for fraud or other “cause” holds the entire bankruptcy case hostage:

• the Ideal fails to require that debtor promptly put-up or shut-up by filing a confirmable plan; and
• the Ideal empowers a miscreant debtor to, by doing nothing, scuttle any and all efforts at maximizing value of debtor’s assets for the bankruptcy estate.    

Under the Ideal, the only alternatives available to creditors, the court and other constituencies are:

• conversion to Chapter 7, which means, (i) a bankruptcy liquidation of debtor’s assets, or (ii) abandonment of debtor’s assets for liquidation by secured creditors in a race to the courthouse;
• dismissal of the bankruptcy, which also results in a liquidation by creditors in a race to the courthouse; or
• relief from automatic stay for secured creditors to liquidate their collateral by foreclosure processes under state law.

And consider this anomalous distinction created by the Ideal.  A Subchapter V trustee operating debtor’s business will:

• need to obtain credit, using the right/power/function granted by § 364; but
• will not have the right/power/function to do other things like:
  • sell assets under § 363;
  • enforce turnover obligations under § 542 or § 543;
  • avoid transfers under §§ 544, 547, 548, 549; or
  • abandon property under § 554.  

Question: Upon what statutory language can such an anomalous distinction be made? 

Answer: There is none.

Conclusion

Statutory language, on what happens in a Subchapter V case after removal of debtor from possession, creates this competitive reality:

• debtor still has the exclusive right to file a plan; but
• debtor had better exercise that exclusive right quickly—by getting a plan on file that has a fighting chance at confirmation; or
• Subchapter V trustee will exercise the expanded rights, powers, functions and duties of a trustee to administer the bankruptcy estate toward the goal of maximizing value for the bankruptcy estate.

As to practicalities, the Ideal of a trustee with no expanded rights, powers, functions or duties after removal of debtor from possession, beyond operating debtor’s business, is in Never-Never Land.

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