"engaged In": the Rocky Marriage Between Commercial and Business Activity and Subchapter v Eligibility

• Publication year: 2023
• Citation: Vol. 39 No. 2

"Engaged In": The Rocky Marriage Between Commercial and Business Activity and Subchapter V Eligibility

Blake Clevenger

"ENGAGED IN": THE ROCKY MARRIAGE BETWEEN COMMERCIAL AND BUSINESS ACTIVITY AND SUBCHAPTER V ELIGIBILITY Abstract

The Small Business Reorganization Act of 2019, which created subchapter V bankruptcy relief for eligible small business debtors, is a step towards a small-business-friendly bankruptcy environment. The legislative history of subchapter V stated the goal of this new statute was to provide a cost-effective and streamlined path to reorganization to allow financially distressed small businesses to remain in business. To be eligible for subchapter V relief, a debtor must, among other requirements, be "engaged in commercial or business activities." However, courts have continuously disagreed on the meaning of "engaged in commercial or business activities." Courts have taken different stances on whether the debtor must be presently engaged in commercial or business activities, and what conduct satisfies the "activities" prong.

This Comment proposes a revision to subchapter V's eligibility requirements to alleviate the confusion caused by inconsistent judicial interpretation, correct legislative drafting mistakes, and harmonize legislative intent and application, and proposes that the phrase "engaged in commercial or business activities" should be replaced with "presently engaged in the operation of, as of the petition date, a trade or business." The term "trade or business" is a term of art commonly used in the Tax Code. The test set out by the Supreme Court in Commissioner v. Groetzinger should be used to determine if unregistered business forms, like sole proprietorships, are engaged in a trade or business. However, registered business forms are inherently a trade or business. These changes will remedy existing confusion by implementing a clear framework that accurately reflects legislative intent.

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Table of Contents

Introduction..........................................................................................375

I. Advantages Afforded to Subchapter V Debtors..................376

A. Reduced Cost to Debtors......................................................... 377
B. The Reorganization Plan: Exclusivity and Discharge .............. 379
C. Inapplicability of the Absolute Priority Rule............................ 380

II. Three Schools of Thought........................................................381

A. The First School of Thought: Wright and Blanchard's No Contemporaneity Requirement .......................................... 382
B. The Second School of Thought: Thurmon and Johnson's Narrow Stance on "Activities"................................................ 384
C. The Third School of Thought: Port Arthur Steam Energy, Offer Space, and Ikalowych's Lenient Construction of "Activities" ....................................... 386

III. Highlighting the Inconsistencies: the Third School's Take on the Second School...........................391

A. Broadening the Definition of "Activities" ............................... 391
B. Drawing a Distinction between Individuals and Entities: "Bridging the Gap" .................................................. 392

IV. Usage of "Engaged In" Throughout the Bankruptcy Code and Other Statutes....................................394
V. Legislative History...................................................................397
VI. The Case for Reform to 11 U.S.C. § 1182(1)(A).........................400
VII. Proposed Revision to Section 1182(1)(A).................................402

A. "Presently Engaged in, . . . as of the Petition Date "................ 403
B. "The Operation of" ................................................................ 404
C. A "Trade or Business." ........................................................... 405

Conclusion.............................................................................................407

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Introduction

The "engaged in commercial or business activities" requirement for subchapter V eligibility should be revised to better reflect legislative intent and narrow the scope of debtor eligibility. Congress passed the Small Business Reorganization Act of 2019 ("SBRA"), creating subchapter V, which established a new avenue of relief for eligible small business debtors to reorganize under chapter 11. A small business debtor is defined as:

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.¹

Representative Ben Cline of Virginia, the SBRA's sponsor, spoke during a hearing held by the Subcommittee on Antitrust, Commercial, and Administrative Law on June 25, 2019, at which the House version of the SBRA was considered.² During the hearing, Cline stated the legislation was intended to allow these debtors "to file bankruptcy in a timely, cost-effective manner, and hopefully allow them to remain in business" which "not only benefits the owners, but employees, suppliers, customers, and others who rely on that business."³ Proceeding under subchapter V offers unique advantages not typically afforded to standard chapter 11 debtors. However, the Bankruptcy Code fails to define "engaged in commercial or business activities," which has led to inconsistent rulings on eligibility among bankruptcy courts. The conflicting directives from bankruptcy courts have caused confusion among

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debtors, lawyers, and scholars. This Comment navigates and diagrams this uncertainty on eligibility and ultimately proposes a revision to 11 U.S.C. § 1182 that will better reflect legislative intent and permit easier application.

This Comment begins by highlighting key advantages uniquely afforded to subchapter V debtors to illustrate the importance of eligibility. Next, this Comment explores the seminal eligibility cases in early subchapter V jurisprudence. Ashley Champion has sorted the prevailing interpretations of "engaged in commercial or business activity" into three distinct schools of thought, each characterized by a few notable opinions.⁴ After discussing and expanding on her framework, I provide an overview of the inconsistencies between the different schools of thought. Before suggesting a proposed revision to subchapter V's eligibility requirements, this Comment examines the SBRA's legislative history and the usage of "engaged in" throughout the Bankruptcy Code and other federal statutes, such as the Tax Code. My proposed revision to subchapter V's eligibility requirements better captures legislative intent by requiring debtors to be actively operating a trade or business on the petition date. The term "trade or business" is a term of art commonly used in the Tax Code, and its established definition will be adopted in this context.

I. Advantages Afforded to Subchapter V Debtors

The SBRA and subchapter V provide a reasonable avenue for financially distressed small businesses to seek reorganization and avoid both the harsh realities of chapter 7 liquidation and the costs and complexities associated with traditional chapter 11 relief. Before the SBRA, small businesses had few choices for relief and often resorted to chapter 7 bankruptcy, which ends the debtor's business via liquidation.⁵ Although a successful chapter 11 case would allow continued operations, chapter 11's costs and procedural obligations are often too demanding for small businesses to satisfy.⁶ The significant procedural and reporting requirements can quickly accumulate substantial attorney's fees for the chapter 11 debtor.⁷ In addition to their own attorney's fees, chapter 11 debtors are also responsible for the attorney's fees of the unsecured creditors'

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committee, creating even more financial stress for already struggling small businesses.⁸ The SBRA aims to alleviate some of these concerns by implementing a streamlined and more affordable process which provides small businesses a previously unavailable opportunity to quickly reorganize.⁹

A. Reduced Cost to Debtors

Subchapter V provides several cost advantages to eligible debtors that are not otherwise available under chapter 11. Reorganization under subchapter V is typically less expensive than a traditional chapter 11 case because the debtor is not required to pay quarterly fees to the United States trustee.¹⁰ In a standard chapter 11 case, debtors must pay a quarterly fee to the United States trustee System Fund, which can range from $250 to $250,000, based on the amount of the debtor's total quarterly disbursements.¹¹ However, the statute outlining quarterly United States trustee fees explicitly excludes small business cases under subchapter V.¹² Although subchapter V debtors are not required to pay quarterly United States trustee fees, a "subchapter V trustee" is typically appointed to assist the reorganization process by handling many of the typical chapter 11 obligations.¹³ The subchapter V trustee does not assume management of the debtor's business but rather assists in creating a reorganization plan and examining proofs of claim from creditors.¹⁴ The termination of the subchapter V trustee's appointment is based on whether the plan is consensual or non-consensual.¹⁵ If the plan is consensual, the subchapter V trustee is relieved of their duties when the plan is "substantially consummated" under 11 U.S.C. § 1183(c)(1) and notice of substantial consummation is provided to the subchapter V trustee, the United States trustee, and all...