Does my Business Qualify as a Small Business Debtor?

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The new Subchapter V of Chapter 11 of the Bankruptcy Code (Subchapter V) was enacted through legislation known as the Small Business Reorganization Act of 2019 (SBRA); and, went into effect on February 19, 2020. Shortly after, the COVID-19 pandemic impacted the nation. In response, and on March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act (CARES Act) became effective. This brief albeit now commonly known legislation is important to consider in light of the remaining time period for the increased debt limits that impact small businesses seeking relief as a small business Subchapter V debtor.

The Bankruptcy Code defines a “small business debtor” as follows,
(51D) The term “small business debtor”—
(A) subject to subparagraph (B), means a person engaged in commercial or business activities (including any affiliate of such person that is also a debtor under this title and excluding a person whose primary activity is the business of owning single asset real estate) that has aggregate noncontingent liquidated secured and unsecured debts as of the date of the filing of the petition or the date of the order for relief in an amount not more than $[7,500,000] (excluding debts owed to 1 or more affiliates or insiders) not less than 50 percent of which arose from the commercial or business activities of the debtor; and
(B) does not include—
(i) any member of a group of affiliated debtors that has aggregate noncontingent liquidated secured and unsecured debts in an amount greater than $[7,500,000] (excluding debt owed to 1 or more affiliates or insiders);
. . . .

In the matter of In re 305 Petroleum, Inc., Pacific Pleasant Investments, LLC, Pleasant Point Investments, LLC, 2020 WL 6363718 (Bankr.N.D.Miss. 2020), 4 separate, but affiliated, entities sought relief as Subchapter V debtors. Three of the 4 classified as a small business under 11 U.S.C. § 101(51D). However, the fourth was a single asset real estate debtor as defined under 11 U.S.C. § 101(51B). The Court recognized that SBRA was enacted to make reorganization for small business “easier” stating that the narrow issue presented for consideration was whether the debtors, collectively, met the definition of small business debtors.

The Court determined that a debtor must satisfy both provisions of 11 U.S.C. § 101(51D)(A) and (B) to qualify as a small business. The single asset real estate business (Premier Petroleum Investment, LLC) did not qualify as a small business. But since it was an affiliate of the other Debtors its (meaning Premier Petroleum Investment, LLC) outstanding obligations were included when accounting for the aggregate liabilities under 11 U.S.C. § 101(51D)(B). As a result, none of the 4 debtors qualified as a “small business debtor”; and, each of the cases were reclassified to a standard Chapter 11 case.

It is also important to note that the parties in 305 Petroleum stipulated to the fact that the single asset real estate business (Premier Petroleum Investment, LLC) was an “affiliate”. The determination of whether an entity is an affiliate will be on a case-by-case basis given the facts of the entities seeking to be classified as a “small business debtor”. 11 U.S.C. § 101(51D)(A) includes “affiliates” that are also a “debtor under this title”. Therefore, if Premier Petroleum Investment, LLC (the single asset real estate entity) had not filed for bankruptcy, would the Court have ruled the same? Probably not. To take the possibilities one step further, as mentioned in my prior blog post “Common Misunderstandings or Oversights that Members of a Family Business May Be Prone to as They Weigh Whether to File for Bankruptcy” on November 9, 2020, the inclusion of non-debtor (but affiliated) entities are becoming more susceptible to substantive consolidation. Therefore, could a contentious party (or creditor) seek to substantively consolidate the affiliated entity into the bankruptcy in an effort to disqualify the otherwise qualified small business debtor from the SBRA?

There are approximately 4 months until the increased debt limit provided for in the CARES Act expires, unless otherwise extended or changed by future legislation. Bloomberg Law recently reported that 18% of Chapter 11 cases filed from January 1, 2020, through October 31, 2020, were Subchapter V cases. A portion of these Subchapter V cases would not otherwise have been permitted except for the increase in debt limits provided for in the CARES Act. Thus, the impact on what would classify as a small business debtor today will significantly change in 4 months. Especially if a related entity is deemed an affiliate and blocks the small business from the advantages provided in SBRA.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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