By Zev Shechtman
In order to qualify for small business reorganization under subchapter V of chapter 11 of the Bankruptcy Code, a debtor must be “engaged in commercial or business activities.” In this case, the Bankruptcy Appellate Panel of the Ninth Circuit determined that a debtor does not need to have a “profit motive” in order to be “engaged in commercial or business activities” within the meaning of the Bankruptcy Code.
In this case, the BAP affirmed the bankruptcy court’s order overruling the objection of appellant NetJets to subchapter V designation. NetJets argued that the debtor was not eligible for subchapter V relief because it was not “engaged in commercial or business activities” within the meaning of section 1182(1)(A) of the Bankruptcy Code. NetJets argued that the debtor was not “engaged in commercial or business activities” because it did not have “profit motive.” The bankruptcy court disagreed with NetJets, finding that a profit motive is not necessary to establish that a debtor is engaged in commercial or business activities. NetJets also argued that the bankruptcy court erred by determining that the objecting party had the burden of proof on subchapter V eligibility and by failing to consider exceptions to the “law of the case” doctrine. While the BAP generally agreed with NetJets on those issues, the BAP found that those errors were harmless.
RS Air was an LLC used by its sole member, Stephen Perlman, for personal benefits, such as aircraft transportation services, acquiring and selling interests in aircraft, and to depreciate taxes. RS Air had agreements with NetJets to purchase fractional interests in private jets. RS Air and NetJets had a falling out resulting in a lawsuit wherein NetJets alleged breach of contract and RS Air counterclaimed for breach of contract and fraud. As a result of these disputes, RS Air ceased normal flight operations and ended up filing for subchapter V chapter 11 bankruptcy prior to trial. NetJets was a creditor with 98% of non-insider debt.
NetJets objected to RS Air’s subchapter V designation. NetJets argued that RS Air was not engaged in “commercial or business” activities as of the petition date, as required for eligibility, because RS Air had no flight operations, no income or revenue, no employees, and its sole purpose was as a company through which Perlman could acquire interests in and use private jets. RS responded, arguing that it was engaged in commercial or business activities by: (1) litigation with NetJets, (2) negotiating transactions with NetJets, (3) paying aircraft registry fees, (4) remaining in good standing as a Delaware LLC, and (5) keeping current on state and federal taxes.
The bankruptcy court ruled that it was movant’s, not debtor’s, burden of proof on an objection to subchapter V eligibility. Then, the bankruptcy court found that RS Air was engaged in commercial or business activities, because RS Air: (1) was engaged in the business of litigation with NetJets, (2) intended to resume operations, (3) paid aircraft registry fees, (4) remained in good standing as a Delaware LLC, and (5) filed and paid taxes. The bankruptcy court therefore determined that NetJets failed to meet its burden of proof and overruled the objection.
NetJets later objected to plan confirmation, again arguing that the debtor was not eligible to be a subchapter V debtor. The bankruptcy court decided that the law of the case doctrine precluded re-litigation of eligibility. But, in any event, the bankruptcy court also noted that a growing body of case law supported the bankruptcy court’s early ruling. NetJets appealed.
The BAP ruled that the bankruptcy court did not err in determining that RS Air was engaged in commercial or business activities. The BAP cited a majority of courts which have determined that a debtor does not need to be “actively operating” in order to satisfy the requirement of being “engaged in commercial or business activities.” Rather, the BAP held that a debtor must be “presently” engaged in “some type of commercial or business activities to satisfy § 1182(1)(A).” The BAP cited approvingly cases that considered a “totality of circumstances” approach to the question of what constitutes commercial or business activities.
The BAP disagreed with NetJets that a “profit motive” is necessary to establish the existence of commercial or business activities. The BAP found that the tax beneficial aspects of the company constituted “business” within the common meaning of that term. Further, the BAP cited a number of cases of nonprofit entities, including churches, hospitals, and other nonprofits, which were eligible for subchapter V relief.
After dispensing with the appellant’s argument on the merits, the BAP addressed the burden of proof. The BAP found that the bankruptcy court erred when it determined that it was the movant’s, not the debtor’s, burden to establish eligibility. The BAP agreed with the majority of courts which have examined the issue and determined that it is the debtor’s burden to establish eligibility. However, the bankruptcy court’s error was harmless since RS Air demonstrated in opposition to the objection to eligibility that it was engaged in commercial or business activities as required by the Code.
Finally, the BAP acknowledged that the bankruptcy court failed to consider exceptions to the law of the case doctrine when it overruled the objection to eligibility when it was raised for a second time at plan confirmation. NetJets asserted that new evidence further established that the debtor never had any profits. The BAP held that any failure to consider such exceptions was harmless since all of the new evidence presented by NetJets related to its erroneous argument that a profit motive was necessary to establish subchapter V eligibility. Such evidence would not have changed the outcome.