This past February, the Small Business Reorganization Act of 2019 came into effect adding Subchapter V to the Bankruptcy Code’s existing Chapter 11 with the goals of expediting the restructuring process and allowing an easier path out of bankruptcy to qualifying debtors, defined as those with both secured and unsecured debts of less than $7,500,000.00.[1]

To proceed under Subchapter V, the debtor must make an election at the time of the bankruptcy filing and “designate” the case as one under Sub V. Quickly, the question arose, “Can an otherwise qualified Subchapter V debtor who filed for bankruptcy protection prior to the SBRA’s effective date take advantage of Subchapter V by redesignating a case retroactively?” Thus far, the answer is “Yes, if…”

[1] The debt limitation of a qualifying “small business debtor” was increased from $2,725,625.00 to $7,500,000.00 as part of the Coronavirus Aid, Relief, and Economic Security Act for a one-year period.

The Conversion Is Sought In “Good Faith”

Bankruptcy Judge Michelle M. Harner of Baltimore recently found a debtor who filed for protection under Chapter 7 of the Bankruptcy Code a mere nine days before the SBRA came into effect could convert his case from Chapter 7 to a Chapter 11 and designate it under Subchapter V. [1]

Examining the facts of the case, Judge Harner said the debtor: (1) acted as quickly as he could to convert / redesignate the case under Subchapter V; and (2) had previously complied with his obligations in Chapter 7. Accordingly, she allowed conversion because the debtor was not acting in bad faith and the need for extension of case deadlines as a result of the conversion was “fairly attributable to factors outside of [the debtor’s] control.” Judge Harner warned, however, that conversion might not been allowed for all Chapter 7 or Chapter 11 debtors; specifically, where a debtor had failed to comply with the obligations of the Code during the case or had missed a deadline to file a plan.

The Redesignation Was Sought Not Only To Extinguish An Existing Committee of Unsecured Creditors, i.e. Not In “Bad Faith”

Bankruptcy Judge Ernest M. Robles of Los Angeles allowed conversion / redesignation of a Chapter 11 case to a Sub V case even though: (1) the individual debtors had filed a “traditional” Chapter 11 prior to the SBRA and without designating themselves as a small business; (2) an official creditors’ committee had been formed and selected counsel; but (3) the court had not yet ruled on the committee’s retention application. [2]

In his opinion, Judge Robles noted the committee would not be “unduly prejudiced” by redesignation (even though the committee might come to an end because there ordinarily are no committees in SBRA cases), if the committee could demonstrate “cause” for continuation of the committee under Section 1102(a)(3). To show “cause,” Judge Robles said the committee would need to demonstrate its continued existence: (1) would improve recoveries to creditors; (2) assist in the prompt resolution of this case; and (3) is necessary to provide effective oversight of the debtors. Accordingly, Judge Robles permitted the redesignation of the case under Subchapter V, rejecting the idea that “the [d]ebtors’ Subchapter V election was motivated primarily by a desire to divest the [creditors’] committee of its role in this case.”

Redesignation Allowed If The Committee’s Counsel Is Paid

Finally, Bankruptcy Judge Frederick E. Clement of Sacramento, Calif., barred a corporate Chapter 11 debtor from redesignating its case under Subchapter V if redesignation would mean shortchanging counsel for the creditors’ committee.[3]

In this case, the committee had already retained counsel with court approval. However, the committee’s counsel had not been paid. The debtor asked the court to permit dismissal with an immediate refiling under Subchapter V. Further, the debtor intended to pay its counsel after dismissal but not committee counsel.

While Judge Clement dismissed the case, he retained jurisdiction to approve fee applications, gave the committee’s counsel a deadline for filing a fee application, and barred the debtor from paying any professionals, including its own, until all fee applications had been resolved and paid in full.

Bankruptcy can be complicated. If you need help navigating your rights in the bankruptcy process as a potential debtor-in-possession or as a secured or unsecured creditor, contact the experienced bankruptcy attorneys at Goosmann Law in our Sioux City, Sioux Falls, and Omaha offices.

[1] In re Trepetin, 20-11718 (Bankr. D. Md. July 7, 2020).

[2] In re Bonert, 19-20836 (Bankr. C.D. Calif. June 3, 2020).

[3] In re Slidebelts Inc., 19-25064 (Bankr. E.D. Calif. July 6, 2020).