“Just enough” is an undeniable—if informal—legal precept. The concept finds its way into canon from adequacy of pleading to application of equity. See, e.g., K-Tech Telecommunications, Inc. v. Time Warner Cable, Inc., 714 F.3d 1277, 1284 (Fed. Cir. 2013) (A complaint “must give just enough factual detail to provide ‘fair notice of what the . . . claim is and the grounds upon which it rests.’”) (emphasis added); Highway Cruisers of Cal., Inc. v. Sec. Indus., Inc., 374 F.2d 875, 876 (9th Cir. 1967) (“Equity has many reeds. A characteristic of it is that one may not get all of the reeds. One may get just enough relief to stop the evil where it is apparent no great damage was done[.]”) (emphasis added).
Recent rulings from bankruptcy courts throughout the United States confirm that “just enough” has now found a home in the nascent jurisprudence of Subchapter V eligibility. Among Subchapter V’s eligibility requirements, a debtor must be engaged in, and have more than 50% of its debts from, commercial or business activity. In the case of a liquidating or non-operating debtor, courts find that minimal activity may be sufficient to meet the “just enough” test for commercial or business activity.
The Statutory Requirements for Subchapter V Eligibility
In 2019, Congress passed the Small Business Reorganization Act of 2019 (“SBRA”). Pub. L. No. 116-54, § 5, 133 Stat. 1079 (2019). The addition of Subchapter V to the Bankruptcy Code is one of the principal features of the SBRA. Generally, Subchapter V affords small business debtors a new avenue of chapter 11 relief with truncated procedures intended to decrease the time and expense of bankruptcy.
A debtor is eligible for relief under Subchapter V of the Bankruptcy Code if it satisfies the eligibility requirements under Section 1182(1)(A) of the Bankruptcy Code. As temporarily modified by the Coronavirus Aid, Relief, and Economic Security Act, Pub. L. No. 116-136, 134 Stat. 281, 310-12 (2020), Subchapter V debtors must:
- must be a person, which includes a corporation;
- must be engaged in commercial or business activity;
- may not have more than $7.5 million in debt on the petition date; and
- must have more than 50% of its debt from commercial or business activities.
Section 1182(1)(B) of the Bankruptcy Code excludes a debtor that otherwise meets these requirements if the debtor is (i) one of a group of affiliated debtors that exceed the $7.5 million debt cap on the aggregate, (ii) subject to certain reporting requirements under the Securities Exchange Act of 1934, or (iii) considered an “issuer” under Section 3 of the same Act.
At least two of the eligibility requirements are as straightforward as drafters can hope of for a legal standard. “Person” and “corporation” are defined terms in Section 101 of the Bankruptcy Code and the aggregate cap for petition date noncontingent liquidated secured and unsecured debts presents a simple calculation. By contrast, the terms “commercial or business activities” featured in the remaining two requirements afford greater room for interpretation.
“Commercial or Business Activity” Is Broad and Can Include Maintaining Bank Accounts, Administering Claims, and Selling Assets.
The debtor has the burden to establish eligibility to file under a particular chapter—or subchapter in this case—of the Bankruptcy Code if a party challenges the debtor’s election. The debtor must establish eligibility as of the date it filed its bankruptcy case.
In In re Vertical Mac Construction, LLC, the United States Bankruptcy Court for the Middle District of Florida recently address the United States Trustee’s (the “UST”) objection to a non-operating debtor’s Subchapter V election. See In re Vertical Mac Construction, LLC, Case No. 6:21-bk-01520-LVV, 2021 WL 3668037 (Bankr. M.D. Fla. July 23, 2021). The debtor was a stucco installation contractor for residential property. In 2017, homeowners began filing construction defect claims against the debtor for improper stucco installation. Ultimately, in October 2020, the debtor ceased operations after being unable to obtain either renewal or replacement insurance coverage.
The debtor filed its Subchapter V case after it ceased operations and filed a motion to sell substantially all of its assets under section 363 of the Bankruptcy Code. The UST objected to the sale and argued that the debtor was impermissibly using the case to liquidate its assets rather than reorganize—the debtor had no operations, did not pursue accounts receivables or litigation, and had no intention to resume operations. The debtor focused on its prepetition activities and argued its former business operations satisfied the statute.
The court charted its own course and approved the sale after conducting a plain reading analysis of the terms “engaged” and “commercial or business activity” in section 1182(1)(B) of the Bankruptcy Code. The court adopted the following definitions:
Engaged. involved in activity: occupied, busy.
Commercial. occupied with or engaged in commerce or work intended for commerce; of or relating to commerce; viewed with regard to profit.
Commerce. the exchange or buying and selling of commodities on a large scale involving transportation from place to place.
Business. a usually commercial or mercantile activity engaged in as a means of livelihood; dealings or transactions especially of an economic nature.
Activity. the quality or state of being active: behavior or actions of a particular kind.
The court concluded that the phrase “commercial of business activity” is broad and not limited to “operations.” As the Court explained, “‘[o]perations’ insinuates a fully functioning business, but ‘activities’ encompasses acts that are business or commercial in nature but fall short of an actual operating business.”
With this broad definition in mind, the court held that the debtor satisfied the “commercial or business activity” standard. Although it was no longer operating, the debtor was still maintaining bank accounts, working with insurance adjusters and insurance defense counsel to resolve the construction defect claims, and preparing for the sale of its assets. Each of these constituted “activities” that were commercial or business in nature.
Additional Cases Interpreting “Commercial or Business Activities” to Liquidating or Non-Operating Subchapter V Debtors
The Vertical Mac Construction, LLC case joins a growing chorus of bankruptcy court decisions interpreting “commercial or business activities.” Other cases with similar holdings include:
- In re Ikalowych, Case No. 20-17547 TMB, 2021 WL 1433241 (Bankr. D. Colo. Apr. 15, 2021) (individual debtor met eligibility requirements because he (i) was an insurance salesperson earning wages from his sales, (ii) personally guaranteed the debt of a repair business of which he was a part equity owner, (iii) was the direct or indirect owner of two active LLCs and the manager of both, (iv) continued to have corporate responsibility, and (v) performed limited services to wind down one business).
- In re Offer Space, Case No. 20-27480, 2021 WL 1582625 (Bankr. D. Utah Apr. 22, 2021) (maintaining a bank account, holding accounts receivable, exploring claims against a third party, managing the stock of the seller, and “winding down its business and taking reasonable steps to pay its creditors and realize value for its assets” sufficient engagement in commercial or business activities).
Courts are less likely to find sufficient “commercial or business activities” where the debtor is an individual who owns a non-operating business, particularly where the business has been dissolved under applicable state law:
- In re Thurmon, Case No. 20-41400-can11, 2020 WL 7249555 (Bankr. W.D. Mo. Dec. 8, 2020) (individual debtors who were retired and did not intend to return to business were not engaged in commercial or business activity where they merely owned the majority equity interest in the “empty shell of” a pharmacy business that sold its assets prepetition).
- In re Johnson, Case No. 19-42063-ELM, 2021 WL 825156 (Bankr. N.D. Tex. Mar. 1, 2021) (individual debtor was not engaged in commercial or business activity where he was the president of an oil and gas company owned by his mother because he was “nothing more than an employee” and was not conducting his mother’s business for his own profit).
Key Takeaways for Liquidating and Non-Operating Subchapter V Debtors
Potential debtors should consider the evolving state of play as courts continue to delineate the boundary of “just enough” commercial or business activity to satisfy Subchapter V eligibility. The considerations include whether the potential debtor is an individual or a corporation, whether the entity is active or dissolved under state law, whether the entity has sold substantially all of its assets prepetition, and the remaining activities in which a non-operating entity is involved. The calculus becomes more complex for individual debtors, where courts have expressed a particularly divergent view of sufficient commercial or business activity that ranges from narrow interpretations to “virtually all private sector wage earners” with capital at risk or debts arising from their work.