The debtor, Family Friendly Contracting LLC (the “Debtor”), filed a voluntary bankruptcy petition under Subchapter V of Chapter 11 of the Bankruptcy Code. The Debtor’s former owner, Stephen Lyons (“Lyons”), objected to the Debtor’s eligibility to proceed as a Subchapter V debtor. Lyons argued that a large portion of the Debtor’s debts arose from a loan transaction that was made for the benefit of the Debtor’s owners, and not the Debtor itself. Lyons therefore contended that the majority of the Debtor’s debts did not arise from the “commercial or business activities” of the Debtor as 11 U.S.C. § 1182(1)(A) requires.
Judge Catliota of the U.S. Bankruptcy Court for the District of Maryland overruled Lyons’s objections, concluding that the Debtor’s debts arose from “the commercial or business activities of the Debtor” under section 1182(1)(A); thus, the Debtor was eligible as a Subchapter V debtor.
The Debtor provides home improvement, restoration and contract management services to homeowners and commercial properties in Maryland, Washington D.C. and West Virginia. The Debtor also does remodeling, additions, basement finishing and service support for property management companies.
Lyons is the former 100% owner of both the Debtor and an affiliated entity that owned the real property where the Debtor’s headquarters are located. Under a Membership Interest Purchase Agreement, Lyons sold his 100% membership interest in the Debtor to an entity called FFC Holdings, LLC (“FCC Holdings”) for $4.65 million. After the transaction closed, FCC Holdings functioned solely as the holding company for the Debtor’s membership interest and the real property.
To obtain the funds to pay the purchase price to Lyons, the Debtor and Holdings borrowed $5.75 million from Live Oak Banking Company (the “Live Oak Loans”), secured by a lien on all assets of the Debtor and FCC Holdings. Both the Debtor and Holdings are the “Borrower” under the Live Oak Loans and are jointly and severally liable.
Only a “debtor” (as defined in Section 1182(1)(A) of the Bankruptcy Code) may elect to proceed under Subchapter V. That statute provides:
“subject to subparagraph (B), [debtor] means 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;”.11 U.S.C. § 1182(1)(A) (emphasis added).
The Debtor has the burden of establishing its Subchapter V eligibility.
In In re Family Friendly Contracting LLC, the issue was whether less than fifty percent of the Debtor’s aggregate non-contingent liquidated secured and unsecured debts as of the petition date “arose from the commercial or business activities of the debtor.” As Lyons argued, if the Live Oak Loans obligation of $5.75 million did not arise from the commercial or business activities of the Debtor, the Debtor would not have been eligible for Subchapter V.
Because this is a question of statutory interpretation, the Bankruptcy Court looked to the language of the statute. The Bankruptcy Court first analyzed the meaning of the phrase “commercial or business activities”, observing that virtually all courts have applied a liberal construction of that phrase, consistent with the purpose and language of Section 1182(1)(A) of the Small Business Reorganization Act. The Bankruptcy Court also relied on previous court decisions that used the dictionary definitions of the terms “commercial,” “business” and “activities.” See, e.g., In re Vertical Mac Constr., LLC, No. 6:21-BK-01520-LVV, 2021 WL 3668037, at *3 (Bankr. M.D. Fla. July 23, 2021); In re Ellingsworth Residential Cmty. Ass’n, Inc., No. 6:20-CV-1243-WWB, 2021 WL 3908525, at *3 (M.D. Fla. Aug. 19, 2021).
The Bankruptcy Court concluded that the Live Oak Loans arose from the commercial or business activities of the Debtor, because the Debtor entered into an integrated business transaction with Live Oak and Holdings, executed the notes thereunder, pledged all of its assets, and received loan proceeds and other benefits of the loan transaction.
The Bankruptcy Court then turned to, and ultimately rejected, Lyons’s argument that most of the Live Oak Loan debt did not arise from activities “of the debtor” because it primarily benefitted the owners of the Debtor, not the Debtor itself. Citing In re Ventura, 615 B.R. 1 (Bankr. E.D.N.Y. 2020), Lyons argued that the Court was required to make a “primary purpose” assessment of the transaction and determine that debt is “of the debtor” only if the “primary purpose” of the Live Oak Loans was to benefit the Debtor. The Bankruptcy Court rejected that argument, stating:
The primary purpose test is applied to resolve the binary question of whether a debt is commercial or consumer. A transaction can have both commercial and consumer attributes, and a court must determine whether it is one or the other by assessing why the debt was “primarily” incurred. § 101(8). The language of § 1182(1)(A) does not require, or even invite, this inquiry where the debt so clearly arose from the commercial or business activities of the debtor.
Focusing solely on the primary purpose of a business transaction to determine whether the debt is “of the debtor” ignores the reality that a business transaction can benefit more than one party, and generally does when the debt that arose from the transaction is mutual among more than one party. Stated otherwise, a debt can arise from the commercial or business activities of a debtor while, at the same time, also arising from the commercial or business activities of the joint obligor. Primacy is not included in the assessment once the debt is determined to be incurred through the debtor’s commercial or business activities.
Examining the substance of the loan transaction, the Bankruptcy Court observed that the Debtor (and FCC Holdings) incurred the Live Oak Loans as part of a fully integrated transaction that allowed FCC Holdings to acquire the Debtor and the real property on which it operated. The transaction also provided substantial direct and indirect financial and other benefits to the Debtor that were designed to strengthen its prospects post-sale.
The Bankruptcy Court concluded that section 1182(1)(A) of the Bankruptcy Code does not require courts to dissect the various benefits obtained by all the parties, nor does it exclude debt that directly benefits other parties. Therefore, the Debtor was eligible for Subchapter V.
The Bankruptcy Court’s statutory analysis of section 1182(1)(A) is consonant both with the language of the statute and with the purpose of the Small Business Reorganization Act – which is to give qualifying small businesses a greater opportunity to reorganize. Indeed, in many commercial loan transactions, there are multiple obligors (such as multiple borrowers, or a borrower and a guarantor). Those obligors are often jointly and severally liable for all of the loan obligations, and the proceeds of the loans often benefit all obligors to varying extents. Removing potential Subchapter V protections from one obligor under a commercial loan facility, on the grounds that other obligors are also liable or that other obligors more directly benefitted from the loan transaction, is not supported by the language of Section 1182(1)(A). Moreover, doing so makes little sense, because it would negatively affect many (if not most) debtors. The author believes that the Court was correct in its ruling.
These materials were written by Michael J. Riela at Tannenbaum Helpern Syracuse & Hirschtritt LLP (Riela@thsh.com). Editorial contributions were provided by Maggie E. Schroedter of Robberson Schroedter LLP (maggie@theRSfirm.com).