by Craig B. Rule, Esq.
Orlans PC
USFN Member (DC, DE, MA, MD, MI, NH, RI, VA)
On February 19, 2020, the provisions of the Small Business Reorganization Act of 2019 became effective, thereby creating a new Subchapter V under Chapter 11 of the Bankruptcy Code. This Subchapter permits small businesses to avail themselves of the capability to reorganize, but without many of the costs and delays associated with regular Chapter 11 cases. Initially, Subchapter V had a debt limit (both secured and unsecured) of $2,725.625.00, but the CARES Act modified this limit, increasing the debt threshold to $7,500,000.00 (until March 27, 2021 unless further extended by Congress). Among the procedural benefits to debtors of Subchapter V are that only a debtor may propose a plan of reorganization, there is no need to file a disclosure statement, and a debtor is not required to allow creditors to vote on acceptance of the plan. Substantively, Subchapter Vpermits a debtor to “cram down” debts secured by a debtor’s principal residence to the value of the property, an option not afforded by a Chapter 13 or a regular Chapter 11 bankruptcy case, if the loan was not used to purchase the property and the property was primarily used in connection with the debtor’s small business. See 11 U.S.C. § 1190(3). This article will discuss how courts have interpreted the provisions of Subchapter V in the seven months since its provisions became effective.
Given its youth, it is not surprising that the greatest number of reported decisions interpreting Subchapter V have discussed the eligibility threshold for a debtor to proceed under the Subchapter. A common question raised has been whether an election to Subchapter V can be made if the bankruptcy case was pending prior to the February 19, 2020 effective date. A majority of the decisions have allowed for the election in case that were already pending prior to that date. See In re Bello, 613 B.R. 894 (Bankr. ED MI March 27, 2020); In re Body Transit, Inc., 613 B.R. 400 (Bankr. ED PA March 24, 2020); In re Twin Pines, LLC, 2020 Bankr. LEXIS 1217 (Bankr. D NM April 30, 2020); and In re Moore Props. of Person Cty., LLC, 2020 Bankr. LEXIS 550 (Bankr. MD NC February 28, 2020). On the other hand, at least two bankruptcy courts have ruled to the contrary. During the case of In re Seven Stars on the Hudson Corp., 2020 Bankr. LEXIS 2106 (Bankr. SD FL August 7, 2020), the bankruptcy court dismissed the case of a debtor who had filed before the effective date of Subchapter V.
The court determined that, even if the debtor was eligible under Subchapter V, he had not complied with 11 U.S.C. § 1188(a), which requires a status conference within 60 days of the original bankruptcy filing date, and 11 U.S.C. § 1189(b), which mandates the filing of a plan of reorganization within 90 days of that same date. Similarly, the bankruptcy court for In re Double H Transportation LLC, Case number 19-31830 (Bankr. WD TX March 5, 2020), struck the debtor’s election to Subchapter V and found that there was nothing in the Small Business Reorganization Act of 2019 that would give Subchapter V a retroactive effect. The Court ruled that as a result of the late election, the debtor could not comply with the status conference and plan filing deadlines, and that the election itself was defective because the debtor failed to file financial documents required by 11 U.S.C. §§ 1116(1) and 1187(a). In contrast, the Court for In re Trepetin, 2020 Bankr. LEXIS 1770 (Bankr. D MD July 7, 2020) allowed an extension of deadlines to hold a status conference and file a plan finding the debtor did not manipulate the timing of the filing of the bankruptcy case and no creditor asserted unfair prejudice from the delay. See also In re Bonert, 2020 Bankr. LEXIS 1783 (Bankr. CD CA June 3, 2020). Examining another threshold eligibility question, a bankruptcy court in the Eastern District of Louisiana permitted a debtor to proceed under Subchapter V in spite of the fact that the debtor was not presently engaged in commercial activities. See In re Blanchard, 2020 Bankr. LEXIS 1909 (Bankr. ED LA, July 16, 2020).
Of particular concern to secured mortgage creditors is the decision of the Bankruptcy Court for the Eastern District of New York in In re Ventura, which not only allowed for the election to Subchapter V for a bankruptcy case pending prior to February 19, 2020, but also found that the individual debtor could potentially “cram down” a residence that the debtor also used as a bed and breakfast. In re Ventura, 615 B.R. 1 (Bankr. ED NY April 10, 2020) (On appeal. Direct appeal to 2nd Circuit denied, September 17, 2020). The Ventura court reasoned that, although the original petition was filed before the effective date of Subchapter V, allowing cram down under 11 U.S.C. § 1190(3) would not prejudice any vested rights of the mortgagee as there had been no bankruptcy plan confirmed and the nature of the property as a business property was evident upon the original bankruptcy filing date. Id. at 15-18. The court also found that the debtor was not judicially estopped from asserting that her mortgage debt arose from commercial or business activities because this characterization was not at odds with her pre-election disclosures in her petition and schedules. Id. at 20-23.
Finally, the court made a preliminary determination that the cramdown provisions of 11 U.S.C. § 1190(3) could apply to her mortgage, although the mortgage was a purchase money mortgage used to acquire a property in which the debtor resided, because the primary purpose of the property was to be a bed and breakfast business, although the court reserved final determination for an evidentiary hearing during which it would employ a five-factor test to decide whether the mortgage could be modified. Id. at 23-25. The five factors provided for in that case are: (1) Were the mortgage proceeds used primarily to further the debtor's business interests? (2) Is the property an integral part of the debtor's business? (3) The degree to which the specific property is necessary to run the business; (4) Do customers need to enter the property to utilize the business? And (5) Does the business utilize employees and other businesses in the area to run its operations? Id. at 25.
In conclusion, based on the case law discussed above, bankruptcy courts appear to be applying a liberal reading of the provisions of Subchapter V in a manner that favors debtors seeking protection under its provisions.
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Fall 2020 USFN Report
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