Maryland Bankruptcy Court Rules PPP Funds and Lease Rejection Damages Claims Not Considered for Purposes of Debtor Eligibility Requirements in Subchapter V Chapter 11 Case

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The Small Business Restructuring Act of 2019, Pub. L. 116-54, 133 Stat. 1079 (Aug. 23, 2019) (SBRA) became effective February 19, 2020. SBRA, among other things, created a new Subchapter V under Chapter 11 of Title 11 of the United States Code. Its purpose was to provide business debtors a more streamlined bankruptcy process for rehabilitating and restructuring debts when compared to a traditional Chapter 11 case. A further goal was to reduce the time and expense of small business reorganizations when compared to the current Chapter 11 process.

A debtor is required to elect to proceed under Subchapter V and must meet certain eligibility requirements. One requirement is the debtor must be a person or entity engaged in a commercial or business activity with “aggregate noncontingent liquidated secured and unsecured debts as of the date of the filing of the petition” in the amount of $2,725,625 or less, excluding debts owed to affiliates or insiders of the debtor. With the enactment of the Coronavirus Aid, Relief, and Economic Stability Act of 2020, Pub. L. 116-136, 134 Stat. 281 (2020) (CARES Act), the debt ceiling was temporarily increased through March 27, 2021, to $7,500,000.

Case law interpreting SBRA remains limited, and many reported decisions to date focus on the debtor’s ability to elect Subchapter V in a case pending at the time SBRA became effective or where a debtor attempts to elect Subchapter V after deadlines have past. In an unreported opinion, the United States Bankruptcy Court for the District of Maryland recently ruled on the debt threshold eligibility requirements under Subchapter V. In In re Parking Management, Inc., Case No. 20-15065, Doc. No. 224 (Bankr. D. Md., Aug. 28, 2020), the debtor filed amended schedules in its case to include funds it received pursuant to the Paycheck Protection Program (PPP) under the CARES Act. Inclusion of these funds in the debtor’s schedules increased the aggregate debts reflected in the schedules well above the $7,500,000 cap. Parties objected to the debtor’s eligibility to proceed under Subchapter V based on the foregoing and also asserted that claims arising from the rejection of certain leases post-petition further increased the aggregate debts beyond the debt eligibility cap. If either the PPP funds or the lease rejection damages claims were included in the calculation of the $7,500,000 debt limit, the debtor would not be eligible for Subchapter V relief.

The court found that neither the PPP funds nor the lease rejection damages were to be included in the calculation of the debt eligibility cap. The PPP funds, the court found, were both contingent and unliquidated as of the filing of the case. In support of the contingent nature of the liability, the court found that forgiveness is “the essential characteristic of the debtor’s obligation under the PPP Note and the PPP requirements” and any repayment obligation must be triggered by the debtor’s use of the funds for ineligible expenses or by the failure of the debtor to meet other employee-related criteria. The court further found the debtor’s obligations under the PPP Note were unliquidated because the amount of liability, if any, was undetermined as of the filing of the case and would not be determined until a later date depending on the debtor’s use of the PPP funds.

The court also found the lease rejection damages claims to be contingent as of the filing of the case. Reviewing the process of rejecting leases in a bankruptcy case, the court noted that lease rejection requires court approval and the act of rejection occurs after the petition date. Accordingly, any claim arising out of a lease rejection was a contingent obligation of the debtor until approval of the rejection, notwithstanding that many leases were rejected “as of” the petition date. All lease rejections, the court held, were post-petition events. Accordingly, the lease rejection claims were contingent as of the filing of the case and thereafter became non-contingent upon approval of rejection by the court post-petition.

This case provides guidance to debtors considering a Subchapter V election in Chapter 11 who may not appear, at first blush, to fall under the eligibility debt cap and provides them an opportunity to implement SBRA’s more cost-effective and streamlined process. Miles & Stockbridge continues to monitor the evolving landscape in the law under Subchapter V of Chapter 11.

Opinions and conclusions in this post are solely those of the author unless otherwise indicated. The information contained in this blog is general in nature and is not offered and cannot be considered as legal advice for any particular situation. The author has provided the links referenced above for information purposes only and by doing so, does not adopt or incorporate the contents. Any federal tax advice provided in this communication is not intended or written by the author to be used, and cannot be used by the recipient, for the purpose of avoiding penalties which may be imposed on the recipient by the IRS. Please contact the author if you would like to receive written advice in a format which complies with IRS rules and may be relied upon to avoid penalties.

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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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