The new Subchapter V of Chapter 11 of the Bankruptcy Code (Subchapter V) was enacted by legislation known as the Small Business Reorganization Act of 2019 (SBRA); and, came into force on February 19, 2020. Shortly thereafter, the COVID-19 pandemic impacted the country. In response, and on March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act (CARES Act) came into effect. This brief legislation, although now known to all, is important to consider in light of the time remaining for the increase in debt limits which is impacting small businesses seeking relief as small business debtor of sub-chapter V.
The Bankruptcy Code defines a “small business debtor” as follows,
(51D) The term “small business debtor”—
(A) subject to sub-paragraph (B), means a person carrying on business or trade (including any person affiliated with that person who is also a debtor under this title and excluding a person whose principal activity is the activity of owner of real estate with a single asset) that has aggregate unconditional liquidated secured and unsecured debts as of the date the petition is filed or the date of the relief order in an amount not to exceed $[7,500,000] (excluding debts owed to 1 or more affiliates or insiders) at least 50% of which arise from the business or commercial activities of the debtor; and
(B) not include-
(i) any member of an affiliated obligor group that has aggregate unconditional liquidated secured and unsecured debts in excess of $[7,500,000] (excluding debts to 1 or more affiliates or insiders);
. . . .
In In re 305 Petroleum, Inc., Pacific Pleasant Investments, LLC, Pleasant Point Investments, LLC, 2020 WL 6363718 (Bankr.NDMiss. 2020), 4 separate but affiliated entities sought relief as debtors of the Subchapter V. Three of 4 classified as a small business under 11 USC § 101 (51D). However, the fourth was a single-asset real estate debtor as defined under 11 USC § 101 (51B). The Court acknowledged that the SBRA was enacted to make small business reorganization “easier” by stating that the narrow question under 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 USC § 101(51D)(A) and (B) to qualify as a small business. The single-asset real estate business (Premier Petroleum Investment, LLC) was not considered a small business. But because it was an affiliate of the Other Obligors, its outstanding obligations (i.e. Premier Petroleum Investment, LLC) were included in the accounting for aggregate liabilities under 11 USC § 101 (51D) (B). Consequently, none of the 4 debtors was qualified as a “small business debtor”; and, each of the cases was reclassified as a standard Chapter 11 case.
It is also important to note that the parties to 305 Petroleum have stipulated that the single-asset real estate business (Premier Petroleum Investment, LLC) is an “affiliate”. Whether an entity is an affiliate will be determined on a case-by-case basis based on the facts of entities seeking to be classified as a “small business obligor”. 11 USC § 101(51D)(A) includes “affiliates” who 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 previous blog post”Common misunderstandings or oversights that members of a family business may experience when considering whether to file for bankruptcy” on November 9, 2020, the inclusion of non-debtor (but affiliated) entities becomes more sensitive to substantial consolidation. Therefore, could a litigant (or creditor) seek to substantially consolidate the affiliated entity in the bankruptcy for the purpose of disqualifying the otherwise qualified small business debtor from SBRA?
There are approximately 4 months left until the increased debt limit under the CARES Act expires, unless extended or otherwise 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. except for increased debt limits under the CARES Act. So the impact on what would be considered a small business debtor today will change significantly in 4 months. Especially if a related entity is considered an affiliate and blocks the small business from SBRA benefits.