In re National Small Business Alliance, Inc. (Bankr. D. D.C.)

The following is a case update written by Robert G. Harris (rob@bindermalter.com), a partner in the Silicon Valley bankruptcy boutique, Binder & Malter, LLP, analyzing a recent decision of interest:

SUMMARY

The United States Bankruptcy Court for the District of Columbia (the “Court”), in a case of first impression, a year after having dispossessed a small-business membership association debtor, revoked its Subchapter V designation, then ordered the appointment of a Chapter 11 trustee and directed the case to proceed as a standard Chapter 11. In re National Small Business Alliance Inc., 2022 WL 2347699 (Bankr. D.D.C. June 29, 2022).

The opinion reported is the Memorandum of Law supplementing the Court’s April 18, 2022 Order Revoking Subchapter V and Small Business Designations and can be viewed by clicking here. 

FACTS

The Debtor operated a membership-based business that provided referrals, marketing assistance, and other support services to its 700-to-750 small business members (the “Members”). The Members paid their dues post-petition, and such dues contributed the only significant value to the Debtor’s business operations.

The Debtor was engaged in pre-petition litigation with holders of secured and unsecured claims, Venture Resources Consulting, LLC (“VRC”) and the Motiva Group, Inc. (“Motiva”). The Debtor filed bankruptcy on January 31, 2021, and elected in its original petition to proceed under Subchapter V. The bankruptcy case was dominated by VRC and Motiva attempting to litigate claims amongst themselves and against the Debtor, without regard to the Debtor’s estate as a whole or the Debtor’s Members. In the first fourteen months of the case, there were more than 300 docket entries.

Conversion of the case to Chapter 7 would have resulted in the immediate termination of membership services and little-to-no value distributed to creditors from the disposition of assets. Dismissal would have thrown the Debtor (and its Members) back into the fray of the state court litigation that existed before the case was filed.

The Debtor was removed from possession on April 30, 2021.

REASONING

The Court’s analysis begins with a statement of the question of first impression under Subchapter V before it: whether a court may revoke the Subchapter V designation made by a debtor in its petition.

The Court noted initially that the vast majority of case law pertains to whether and how a debtor already in Chapter 11 may proceed under Subchapter V if it did not elect to do so in its original petition. The Court surveyed the many cases on eligibility and concluded that, in general, courts find that an eligible debtor cannot “convert” to Subchapter V but can instead remain in Chapter 11 and amend its petition to elect to proceed under Subchapter V. Citing Hall L.A. WTS, LLC v. Serendipity Labs, Inc. (In re Serendipity Labs, Inc.), 620 B.R. 679 (Bankr. N.D. Ga. 2020), the Court held that “[t]he converse is applicable in this case. The Court cannot order that the Debtor convert to ‘standard’ chapter 11, but instead must order that the Debtor’s petition be amended to revoke the election to proceed under Subchapter V.”

The Court’s stated that Section 1185 specifically provides for the dispossession of a debtor in possession but that nothing in Subchapter V discusses the revocation of the election to proceed thereunder by a court. Nevertheless, drawing a parallel to the cases holding that a debtor may amend its petition and elect to proceed under Subchapter V after the filing, the Court looked to Chapter 11 and the Bankruptcy Code as a whole to determine whether the election may be revoked by a court post-petition.

The Court first considered the right of the debtor or another party to seek, and the court to order, a case converted from one chapter to another, referring to 11 U.S.C. §§ 706, 1112, 1208, 1307. Comparing revocation of the Subchapter V election to conversion, the Court noted that the treatment and requirements under chapter 11 and Subchapter V are materially different, much like the differences in chapters under the Bankruptcy Code. The Court reasoned that “… the ability to revoke a Subchapter V election is consistent with the Bankruptcy Code but also the Congressional goals of ensuring that Subchapter V cases provide a quicker reorganization process.”

The Court next turned to 11 U.S.C. § 105(a), stating that a court may rely on § 105(a) as authority where “the equitable remedy dispensed by the court is necessary to preserve an identifiable right conferred elsewhere in the Bankruptcy Code” and that § 105(a) “may be used to ensure that ‘a result that the Code clearly required’ is achieved,” citing Jamo v. Katahdin Fed. Credit Union (In re Jamo), 283 F.3d 392, 403 (1st Cir. 2002) and In re Red River Energy, Inc., 409 B.R. 163, 185 (Bankr. S.D. Tex. 2009). The Court then linked its conversion and section 105(a) analyses, stating that “… where a Debtor has elected Subchapter V status but is either (a) not eligible or (b) cannot meet the deadlines and requirements thereof, allowing for the revocation of the Subchapter V designation so that the debtor may proceed under standard chapter 11 is consistent with the right conferred to a debtor in the Bankruptcy Code to convert a case to another chapter therein.”

Finally, the Court applied a totality of the circumstances test to the facts before it. The case had been dominated by litigation involving VRC and Motiva without regard to the interests of the Members. After five attempts, the Debtor could not propose a confirmable plan and, having been removed from possession, the Debtor’s management could notbe repossessed with operational control. Yet, the Court found it to be “… clear that the Debtor has a committed client base with significant potential for growth, even in the internet-age.” The Court found the Debtor’s continuation in chapter 11 would preserve the only value currently held by the Debtor – the Members. Given the certainty of cessation of services to the Members in a Chapter 7 and the likelihood of little to no recovery to creditors, the Court found that it was in the best interest of creditors and the estate that the Debtor remain in chapter 11 rather than liquidate under chapter 7 or be dismissed. Under these facts, with the foregoing legal analysis, the Court found that it had the authority to order the revocation of the Debtor’s Subchapter V election, even where revocation is not specifically provided for in the Bankruptcy Code.

AUTHOR’S COMMENTS

The Small Business Reorganization Act of 2019 (the “SBRA”) contains limited remedies to deal with debtors who are unable to reorganize but have the potential to do so. Under § 1181(a), provisions for appointment of trustee under § 1104 are inapplicable in Subchapter V cases. While the Subchapter V debtor can be removed from possession and replaced by the Subchapter V trustee under § 1185(a), and § 1183(c)(5)(B) authorizes the trustee to operate the business of the debtor, the duties of a Subchapter V trustee upon removal of the debtor in possession do not include the duty to file a plan or recommend conversion or dismissal. See §1183(b)(5). As § 1121 does not apply in Subchapter V, the Subchapter V debtor is the only party who can file a plan under §1189(a).

In In re National Small Business Alliance Inc., the Court could have dismissed the case and forced the Debtor to refile or converted and allowed it to seek reconversion. However, in neither instance would the appointment of a Chapter 11 trustee have been certain or even likely. The business interruption and costs would have almost certainly doomed the Members and creditors to a complete loss. Given that the Debtor could not be reinstated, and the Subchapter V trustee could not by himself effectuate the Debtor’s reorganization, a Chapter 11 trustee’s appointment seems to have been the best option. Allowing bankruptcy courts to revoke the Subchapter V designation in cases where the debtor cannot or will not utilize the benefits of the subchapter for the benefit of the estate and creditors is entirely consistent with the goals and purposes of SBRA. Practitioners should expect courts to follow this decision, as it provides yet another tool to promote successful reorganization in Subchapter V.

This review was written by Robert G. Harris (rob@bindermalter.com), 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.

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