Appellate court rules that subchapter V small business debtors don’t need to be for profit businesses

By Zev Shechtman

In re RS Air, LLC, __ B.R. __, 2022 WL 1288608 (B.A.P. 9th Cir. April 26, 2022)

Case Synopsis

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.

Introduction

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.

Facts

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.

BAP Ruling

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.

 

Bankruptcy Appellate Decision Subordinates Judgment Liens Under Section 510(b)

By Eric P. Israel and Alphamorlai “Mo” Kebeh

Recently, the Bankruptcy Appellate Panel for the Ninth Circuit (the “BAP”) issued a ruling on an important issue.  In Kurtin v. Ehrenberg (In re Elieff), 637 B.R. 612, 2022 WL 832417 (B.A.P. 9th Cir. March 21, 2022), the BAP ruled that, when a claim is subordinated under Section 510(b), any judgment and other liens and encumbrances securing said claim are subordinated as well.  The BAP analyzed this issue in the context of a dispute between Todd Kurtin and Bruce Elieff, two former business partners embroiled in litigation.

Before the bankruptcy filing, the two parties reached a settlement agreement whereby, in relevant part, Kurtin would transfer his ownership interest in their business entities and, in exchange, Elieff would effect a series of settlement payments from the funds of such entities.  Elieff ultimately breached the settlement agreement, and Kurtin initiated a lawsuit against Elieff, alleging a breach of contract and other causes of action.  A jury returned a verdict on the breach of contract claim in favor of Kurtin, who subsequently recorded two abstracts of judgment against Elieff.  Elieff then filed a chapter 11 petition for bankruptcy and commenced an adversary proceeding against Kurtin, alleging subordination of claims under section 510(b).  The bankruptcy court granted summary judgment on the section 510(b) claims in favor of the plaintiff, and appeal was taken to the BAP.

The BAP determined that Kurtin’s claim for breach of the settlement agreement arose from the purchase or sale of securities, per section 510(b) of the Bankruptcy Code.  In doing so, the BAP noted that “[t]he Ninth Circuit broadly interprets the scope of § 510(b)” and that a claim arises from the purchase or sale of securities “whenever it shares a ‘nexus or causal relationship’ with the purchase or sale of securities.”  Because Kurtin’s claim indisputably originated from the breach of the settlement agreement which contemplated the transfer or sale of securities, the BAP found no material difference between the matter before it and other cases in which the Ninth Circuit had found that subordination was appropriate under Section 510(b).

After an in-depth analysis, the BAP in Elieff concluded that Kurtin’s judgment liens also should be subordinated under section 510(b).  First, turning to the definition of “claim” under section 101(5), the BAP determined that subordination of a “claim” within the meaning of Section 510(b) encompasses the entirety of a right to payment, “whether personal or in rem,” meaning that Kurtin would not be entitled to “any right to payment from any means until the unsecured creditors in the case were paid in full.”  It noted that the definition of “claim” in section 101(5) included any right to payment, “secured or unsecured.”  From a policy perspective, the BAP found that interpreting the word “claim” differently would lead to incongruous results, primarily because doing so “would permit a former equity investor to elevate its lien rights ahead of the unsecured creditors § 510(b) was enacted to protect.”  For these reasons, the BAP found that subordination of Kurtin’s claim was required under section 510(b), and that “once the claim has been subordinated, the lien automatically follows the debt.”

In re Elieff is a BAP decision with a clear ruling on an otherwise murky issue in bankruptcy law:  whether section 510(b) applies to subordinate judgment liens or only the underlying unsecured claim.  This subordination applies regardless of the date of creation or perfection of the judgment liens, which might otherwise be limited to a 90 day preference window.  Additionally, it provides considerable insight as to the type of claims that are subject to mandatory subordination under 11 U.S.C. § 510(b).  While we understand that Elieff has been appealed to the Ninth Circuit Court of Appeals, bankruptcy practitioners should be aware of this decision and its potential implications in their practice.

John N. Tedford, IV

We are proud of our partner and colleague John Tedford for being recognized by the Los Angeles Business Journal for this prestigious list.

Infowars Tries New Bankruptcy Section for Managing Litigation

Danning Gill Partner John N. Tedford, IV was quoted in The Deal in an article discussing the Subchapter V bankruptcy cases of three entities related to Alex Jones’ conspiracy-oriented website, Infowars.  Among other streamlined relief available as a result of the Subchapter V filings for small business debtors, unless the court orders otherwise, the creditors will not be able to form a creditors’ committee and the debtors won’t need to file a disclosure statement.

Stephanie Gleason
The Deal
April 20, 2022

Three entities associated with Infowars, the controversial, conspiracy-oriented website owned by Alex Jones, filed for Chapter 11 protection on Monday, April 18, using a new section of the code meant for small business — Subchapter V.

Infowars is the first company to attempt to use this new part of the code to manage tort liabilities.  Because the filing is under Subchapter V, there’s no guarantee that claimants — in this case families of victims of the 2012 Sandy Hook school shooting — will receive official committee representation.

In Subchapter V, “the default rule is that there is no committee,” John Tedford of Danning Gill Israel & Krasnoff LLP said.  He added, however, that a court can order one appointed.  There’s nothing to prohibit an official committee.

To read the entire article, click here.  Free trial subscription available.

Danning Gill Partner Zev Shechtman Appointed Mediator

Zev Shechtman, Partner
Zev Schechtman, Partner
Danning, Gill, Israel & Krasnoff, LLP is pleased to announce that Zev Shechtman has been appointed to the Panel of Mediators of the United States Bankruptcy Court for the Central District of California, for matters arising in Los Angeles, Orange, San Bernardino, Riverside, Ventura, Santa Barbara, and San Luis Obispo counties.  Zev completed his mediation training at the Pepperdine Law Straus Institute for Dispute Resolution.

L.A. Times Names Danning Gill Attorneys ‘Visionaries’
in Banking & Finance Issue

Danning, Gill, Israel & Krasnoff partners Eric P. Israel, John N. Tedford, IV, and Zev Shechtman have been recognized as visionaries in banking and finance by L.A. Times B2B Publishing.  According to the publication, the leaders profiled “were all nominated by their colleagues and peers and selected by our B2B Publishing stakeholders. Each of these senior-level executives has demonstrated successes and accomplishments during the last 24 months as well as leadership in their organizations while impacting change within their communities.”  We are honored to be recognized along with other accomplished professionals who serve the community. See the online version of the magazine here: https://www.latimes.com/b2b/finance.

Subchapter V Debt Limit Likely to Sunset at the End March

The subchapter V debt limit is likely to revert to $2,725,625 on March 28, 2022. Hope remains that Congress will soon restore it to $7.5 million.

By Aaron E. de Leest, Danielle R. Gabai, and Zev Shechtman

On March 28, 2022, the provision in the Coronavirus Aid, Relief, and Economic Security Act or the “CARES Act,” which increased the eligible debt limit for subchapter V debtors to $7,500,000 will sunset, and the debt limit will revert to $2,725,625.  The Senate has made efforts to remove the sunset provision in the CARES Act and thereby permanently increase the debt limit to $7,500,000.  However, the Senate’s bill, which was introduced on March 14, 2022, is stalled in the Senate Judiciary Committee.  Because the House is not in session this week, it does not appear that the Senate’s bill will make it through Congress and onto the President’s desk before the March 28, 2022 sunset.  Therefore, it is likely that, at least for the short term, the debt limit for subchapter V debtors will be substantially reduced to $2,725,625.

 

What does this mean for small businesses? 

Subchapter V provides a streamlined, less expensive, chapter 11 reorganization process for small business debtors.  See our prior blog post: https://danninggill.com/the-small-business-reorganization-act-of-2019-sbra/.   When Congress created subchapter V, it made $2,725,625 the maximum amount of debt that a debtor could owe and be eligible for subchapter V.  In response to the Covid-19 pandemic, in March 2020, Congress increased the limit to $7.5 million, but the limit expired after one year.  In 2021, Congress extended the higher debt limit to March 27, 2022.  When the higher cap expires, businesses will be ineligible to file subchapter V if they have more than $2,725,625 in debt.  To seek reorganization in bankruptcy, those debtors will need to file for regular chapter 11.

Aaron E. de Leest Promoted to Senior Counsel

Aaron de Leest, Attorney at Law

Danning, Gill, Israel & Krasnoff, LLP, is pleased to announce that effective January 1, 2022, Aaron E. de Leest was elevated to Senior Counsel.  Congratulations to Aaron for his advancement and for all of his accomplishments, which accomplishments this year include prevailing in a published Ninth Circuit decision and confirming two chapter 11 plans.

To read more about Aaron, click here.

ILC publishes write-up by Danning Gill Partner John N. Tedford, IV on Perryman v. Dal Poggetto (In re Perryman), 631 B.R. 899 (9th Cir. BAP 2021)

December 16, 2021

Dear constituency list members of the Insolvency Law Committee:

The following is a case update written by John N. Tedford, IV, a partner at Danning, Gill, Israel & Krasnoff, LLP, analyzing a recent decision of interest.

In Perryman v. Dal Poggetto (In re Perryman), 631 B.R. 899 (9th Cir. BAP 2021), the U.S. Bankruptcy Appellate Panel of the Ninth Circuit (the “BAP”) held that continuances of a hearing in a prepetition, nonbankruptcy action against the debtor, whether ordered by the state court, done by the clerk, or requested by a creditor, merely maintains the status quo and does not violate the automatic stay.

Here’s a link to the write-up on the CLA website:  click here.

To read the full published decision, click here.

 

ILC publishes write-up by Danning Gill Partner John N. Tedford, IV on Amendments to the Federal Rules of Bankruptcy Procedure and the Federal Rules of Appellate Procedure

December 7, 2021

Dear constituency list members of the Insolvency Law Committee:

The following is an update written by John N. Tedford, IV, a partner at Danning, Gill, Israel & Krasnoff, LLP, highlighting December 1, 2021 Amendments to the Federal Rules of Bankruptcy Procedure and the Federal Rules of Appellate Procedure.

In April 2021, the Supreme Court submitted to Congress proposed revisions to the Federal Rules of Bankruptcy Procedure (“FRBP”) and the Federal Rules of Appellate Procedure (“FRAP”). Because Congress did not reject or defer the proposed amendments, the proposed revisions went into effect on December 1, 2021.

The entire package of materials transmitted to Congress may be accessed here.  Some of the proposed revisions are listed below.

      • Amended FRBP 3007(a)(2)(A)(ii) – Service of Claim Objections on Insured Depository Institutions
      • Amended FRBP 9036 – Service by Electronic Transmission
      • Other Conforming Amendments to the FRBP
      • Amended FRAP 3(c)(1)(B) and New FRAP 3(c)(4) and (6) – Contents of the Notice of Appeal (Generally)
      • New FRAP 3(c)(5) – Contents of the Notice of Appeal (Summary Judgment Orders Resolving Remaining Claims, and Orders on Motions for Reconsideration)
      • Amended FRAP 3(c)(7) (formerly (c)(4)) – Notices of Appeal that Designate Only Interlocutory Orders

Here’s a link to the writeup on the CLA website:  click here.