The Small Business Reorganization Act And Its Evolving Case Law

Jim LaMontagne | July 21, 2021

On Feb. 19, 2020, the Small Business Reorganization Act was enacted. The SBRA amended the Bankruptcy Code to add Subchapter V, a new streamlined Chapter 11 process for small businesses and individuals. It has now been almost a year and a half since its enactment and indications are that the SBRA is a success. According to the American Bankruptcy Institute’s SBRA Resource Page, as of June 2021, 2,130 Subchapter V cases have been filed in the United States and the 2021 filings are outpacing the 2020 filings. As the Subchapter V cases have increased in number, the case law interpreting Subchapter V has also evolved, providing guidance to debtors, creditors and attorneys.

To date, many of the decisions entered in Subchapter V cases have tackled the issue of whether a debtor is eligible to be in Subchapter V but there have also been some interesting decisions addressing conversion to Subchapter V.

The cases that address debtor eligibility commonly revolve around the issue of whether a debtor is “engaged in commercial or business activities.”

In In re Blue, a North Carolina bankruptcy court ruled that to be “engaged” requires a debtor to be presently participating in business or commercial activities as of the petition date. The court then ruled that the debtor was engaged in business or commercial activities because the debtor was a part-time IT consultant for two clients (a delivery of service for profit) and while the debtor had another full-time job, nothing in section 1182 of the Code required that such activities be the debtor’s only income. In re Blue, 2021 Bankr. LEXIS 1378 (Bankr. M.D.N.C. 2021).

In In re Offer Space, LLC, 2021 Bankr. LEXIS 1077 (Bankr. UT 2021), the bankruptcy court ruled that a company that sold its assets and had no intention of resuming or reorganizing its business was still engaged in commercial or business activities by having active bank accounts and accounts receivable, managing the debtor’s equity interests and winding down the business.

In contrast, the court in In re Thurman, 625 B.R. 417 (Bankr. W.D. MO. 2020), sustained the United States Trustee’s objection to debtors’ designation as a subchapter V small business debtor, as the debtor was not engaged in commercial or business activities on the petition date because the debtor had sold the business with no intent to return to it and was otherwise not active or involved in any commercial or business activities. The court ruled that keeping the empty shell of the former business entity open with the secretary of state’s office did not render the debtor “engaged” in business activities.

In a decision decided shortly after SBRA was enacted, the court in In re Wright, 2020 LEXIS 1240 (Bankr. S.C. 2020), ruled that the definition of “small business debtor” was not limited to debtors currently engaged in business or commercial activities and allowed the debtor to proceed under Subchapter V even though he was “addressing residual business debt” from businesses that had ceased operating more than a year earlier. While the Wright decision was later followed in In re Bonert, 2020 Bankr. LEXIS 1783 (Bankr. C.D. Cal 2020), the support for this line of cases is weakening significantly.

Finally, on the issue of eligibility, and specifically, the issue of debt limits within Subchapter V, the bankruptcy court in In re Parking Management, 620 BR 544 (Bankr. MD 2020), held that the Subchapter V debtor’s lease rejection claims (which caused the debtor to exceed the $7,500,00 Subchapter V debt limit) would not be considered in the debt limitation determination under section 1182 of the Code because the rejection claims were contingent claims as of the petition date.

Another issue that has garnered attention from the courts is whether or not to extend status conference and plan deadlines (60 and 90 days after the order for relief, respectively) (the “Deadlines”) when a debtor converts to Subchapter V after the Deadlines have expired. Under the Code, the Deadlines can only be extended if the need for the extension is attributable to circumstances for which the debtor should not justly be held accountable.

In In re Seven Stars on the Hudson Corp., 618 B.R. 333 (Bankr. S.D. Fl 2020), the court denied a debtor’s request to extend the deadlines after conversion, finding that where a debtor elects to proceed under Subchapter V after the statutory deadlines have passed, it cannot be said that the need for an extension of the deadlines is attributable to circumstances for which the debtor should not justly be held accountable. The court went on to write “that decision by a debtor should not foist upon creditors all of the added powers of a Subchapter V debtor without one of the most significant protections afforded to creditors — that the case proceed expeditiously.”

Not all courts are as rigid as Seven Stars however: In re Trepetin, 617 B.R. 841 (Bankr. MD. 2020) (extending deadlines because debtor acted timely in filing his requested extensions in connection with the conversion of his Chapter 7 and since a Chapter 7 debtor is not required or permitted to file a plan, the debtor has not been dilatory in the plan process itself and appears to have complied with all his obligations under Chapter 7 of the Code); See also, In re Ventura, 615 B.R. 1, 6 (Bankr. E.D.N.Y. 2020) and In re Twin Pines, LLC, 2020 Bankr. LEXIS 1217 (Bankr. NM 2020) (debtor, who commenced its Chapter 11 case as a small business case approximately one year before the SBRA went into effect, could amend its petition to elect subchapter V treatment 387 days after commencing the bankruptcy case, with the court exercising its discretion to grant an extension of the deadlines).

In conclusion, with an increasing number of Subchapter V cases will come good court decisions allowing debtors, creditors, attorneys and judges to better administer Subchapter V cases for the benefit of small business and individual debtors.

This article was originally published in the Bar News and can be found here.