The following is a case update written by Robert G. Harris (email@example.com), a partner in the Silicon Valley bankruptcy boutique, Binder & Malter, LLP, analyzing a recent decision of interest:
The United States Bankruptcy Court for the Southern District of New York (the “Court”), In re Corinthian Communications, Inc., 2022 WL 3051570 (Bankr. S.D.N.Y. August 3, 2022) recently found cause to expand the Subchapter V trustee’s powers under bankruptcy code section 1183(b)(2) to include an investigation of the debtor, operation of the debtor’s business, and to make a determination about the desirability of the continuation of such business pending further consideration of removing the Subchapter V debtor from possession for cause under section 1185(a) before removing the debtor notwithstanding the statutory requirement to do so before expanding the trustee’s powers.
To view the opinion, click here.
Corinthian Communications, Inc. (the “Debtor”) is an S corporation founded in 1974. It is 100% owned by Mr. Larry Miller, the Debtor’s President and sole director. The Debtor provides bookkeeping and payroll services for three of its non-debtor affiliates: Corinthian Trading Inc., Corinthian Media Inc., and Broadcast Buying Services (collectively, the “Affiliates”). The Affiliates earn revenue from outside sources that flow to the Debtor. The Affiliates’ expenses are shared with and paid by the Debtor, but there is no intercompany agreement setting forth what the shared liabilities are or regulating the monthly flow of funds from the Affiliates to the Debtor.
On April 4, 2022, the Debtor filed a voluntary petition and elected to proceed under Subchapter V of Chapter 11. Mr. Miller filed a general unsecured claim on his own behalf in the case for $1,236,350.
On June 7, 2022, after two Section 341(a) meetings had been conducted, the Debtor’s counsel informed the Court for the first time that the Debtor “provides payroll and accounting services” for other entities that have “common ownership with respect to the [D]ebtor’s principal.” The Debtor’s counsel also informed the Court that a trust owned by Mr. Miller’s children owns 20 percent of the building in which the Debtor leased its office space.
The U.S. Trustee moved for an order removing the debtor from possession. The U.S. Trustee alleged as cause that the Debtor had committed fraud by receiving almost one million dollars based on two PPP loan applications that incorrectly stated the Debtor did not have any common management with other businesses. The Debtor failed to disclose in the application not only the existence of the Affiliates, but some 40 other companies owned by Mr. Miller. Further cause alleged included claims of gross mismanagement based upon failure by the Debtor and its Affiliates to follow corporate formalities, sharing expenses without any formal agreement, and the absence of employment agreements fixing compensation for Mr. Miller or his employees. The US Trustee further alleged a lack of transparency and credibility and that the Debtor “has not been forthright” in responding to the U.S. Trustee’s and the Subchapter V Trustee’s inquiries, referencing the aforementioned non-disclosure of the Miller children’s partial ownership of the trust controlling the Debtor’s Landlord.
The Court first noted that Section 1185(a) provides for removal of the debtor in possession for cause and that, after removal, section 1183(b)(5) expands the Subchapter V Trustee’s duties to include, among other duties, “operating the business of the debtor.”
The Court then noted its power under section 1183(b)(2) to expand a Subchapter V Trustee’s powers to include the powers specified in sections 1106(a)(3) and 1106(a)(4) “. . . [to] investigate the acts, conduct, assets, liabilities, and financial condition of the debtor, the operation of the debtor’s business and the desirability of the continuance of such business, and any other matter relevant to the case or to the formulation of a plan; [and] (4) as soon as practicable— [to] (A) file a statement of any investigation conducted under paragraph (3) of this subsection, including any fact ascertained pertaining to fraud, dishonesty, incompetence, misconduct, mismanagement, or irregularity in the management of the affairs of the debtor, or to a cause of action available to the estate.” Critically, the Court confirmed its ability expand the powers of the Subchapter V Trustee sua sponte as section 1185 contains the phrase “on request of a party in interest,” citing In re Pittner, 638 B.R. 255, 259 (Bankr. D. Mass. 2022).
The Court then addressed the meaning of cause under sections 1183 and 1185, first citing Collier for the proposition that the standard should not be higher for the former than for the latter. 8 Collier on Bankruptcy ¶ 1183.03 (16th ed. 2022). Turning to the specific facts before it, the Court relied on In re AJEM Hosp., LLC, No. 20-80003, 2020 WL 3125276, at *1 (Bankr. M.D.N.C. Mar. 23, 2020) in which a bankruptcy court had expanded a Subchapter V Trustee’s duties owing to “the potential issue of intercompany claims.” The Court also cited Judge Paul Bonapfel’s treatise, A Guide to the Small Business Reorganization Act of 2019 with approval for the proposition that “[c]ause’ to expand a Subchapter V Trustee’s duties is also likely to exist where there are “significant questions such as the debtor’s true financial condition, what property is property of the estate, the debtor’s management of the estate as debtor in possession, and the accuracy and completeness of the debtor’s disclosures and reports.”
The Court, citing the issues surrounding intercompany claims between the Debtor and Affiliates, the lack of basis for the insider Miller Claim and potential for it to continue to be asserted against the Debtor and, the Debtor’s continued lack of disclosure to the Subchapter V Trustee, as cause to expand the trustee’s powers.
In re Corinthian Communications, Inc. represents a conservative approach to questions of removal of the Subchapter V debtor and the expansion of the Subchapter V Trustee’s powers. The most unique aspect of this case is the application of section 1183 to expand the Subchapter V Trustee’s powers before the debtor’s removal. Contrasted with the activist approach taken in In re National Small Business Alliance Inc., 2022 WL 2347699 (Bankr. D.D.C. June 29, 2022), in which the debtor’s seeming ineptitude and inability to present a confirmable plan led to removal and de-designation from Subchapter V so that a Chapter 11 trustee could be appointed, the Court in In re Corinthian Communications, Inc., exhibited expansive and somewhat puzzling patience under far more compelling and egregious circumstances. The key similarity between the decisions is that each Court acted to preserve and maximize the possibility of reorganization and return to creditors.
Practitioners may wish to take note of two points: first, filing a case with a large insider claim, without any intent to or mechanism to review or challenge it, raises a potential conflict. Alerting the Subchapter V Trustee to the issue early and seeking a neutral investigation and opinion may later prove invaluable. Second, notwithstanding the express language of Section 1183, it seems that courts are warming to the notion that the powers of a Subchapter V Trustee can be ordered expanded sua sponte. Counsel may be well-advised to monitor the record in Subchapter V cases closely to ensure that clients respond quickly and fully to requests for documents and information by the Subchapter V Trustee.
This review was written by Robert G. Harris (firstname.lastname@example.org), a partner in the Silicon Valley bankruptcy boutique, Binder & Malter, LLP, and a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.