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Federal Courts Broadly Construe Subchapter V Eligibility

In 2019, Congress passed the Small Business Reorganization Act. A major facet of the Act was the creation of Subchapter V, which provides a more streamlined and efficient reorganization process for small businesses.

A requirement of Subchapter V is that the Debtor must be engaged in commercial or business activities. Recent bankruptcy court holdings have interpreted this to allow broad eligibility.

In In re Offer Space LLC, No. 20-27480, 2021 Bankr. LEXIS 1077 (Bankr. D. Utah April 22, 2021), a soon-to-be Debtor sold the main operational asset of its business – its proprietary software. Thereafter, the Debtor filed for Subchapter V bankruptcy relief under Chapter 11 of the Bankruptcy Code. The Trustee, however, opposed the Debtor’s eligibility, alleging the Debtor was no longer an operational business when it filed for bankruptcy. Specifically, the Trustee sought to disqualify Debtor’s eligibility based on the facts that: 1) Debtor had no employees, 2) Debtor no longer conducted business in the manner it previously conducted business, and 3) Debtor had no intention to reorganize its business and instead intended to liquidate its assets. The Trustee concluded that because Debtor was no longer an operating business, it could not be “engaged in commercial or business activities.”

The Court reasoned that “activities” and “operations” are not interchangeable terms. Being engaged in business activities does not presuppose that those activities must relate to the core operation of the company. Had Congress used the term operations instead of activities, the Court indicated it would have to adopt the Trustee’s narrow reading. But neither a plain reading of the provision nor the legislative history supported this narrow reading in the Court’s view.

The Court rejected the Trustee’s position and held that the Debtor was engaged in commercial or business activities, satisfying the eligibility requirements of Subchapter V. Particularly, Debtor was engaged in commercial or business activities by: 1) maintaining active bank accounts, 2) maintaining accounts receivable, 3) managing a lawsuit, 4) managing its sock, and 5) winding down its business. The Debtor was, therefore, eligible to proceed under Subchapter V of Chapter 11 of the Bankruptcy Code.

Earlier this month, a bankruptcy court in Texas adopted this holding. In In re Port Arthur Steam Energy, L.P., No. 21-60034, 2021 Bankr. LEXIS 1793 (Bankr. S.D. Tex. July 1, 2021), the Court found that “actively pursuing litigation against a third party, seeking to collect on outstanding accounts receivable, selling an asset, and preserving value” are all commercial and business activities sufficient to support Subchapter V eligibility. The Court held, “[t]his Section . . . does not require a debtor to maintain its core or historical business operations on the petition date. It requires that the debtor was engaged in commercial or business activities.”

These broad holdings are welcome news for small business debtors because a common consequence of a bankruptcy filing is that the Debtor may suspend the core operational facet of its business.

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