The following is a case update written by Monique D. Jewett-Brewster, an attorney with Hopkins & Carley, ALC, analyzing a recent decision of interest:
A Georgia bankruptcy court has held that a chapter 11 debtor is ineligible for relief under Subchapter V of the Small Business Reorganization Act pursuant to 11 U.S.C. § 1182(1)(B)(iii), because 20% of the debtor’s voting stock is held by a publicly traded company qualified as an “issuer” under the Securities Exchange Act. [In re Serendipity Labs, Inc., 2020 WL 6557675, Case No. 20-68124 (Bankr. N.D. GA. Oct. 19, 2020).]
To view the order, click here. A copy of this order is also accessible on the court’s docket.
Serendipity Labs, Inc. (Debtor) is the parent company of a group of affiliated entities that franchise, manage, and in some cases own, 35 co-working spaces. Due in part to the Covid-19 health emergency, Debtor filed a voluntary petition under chapter 11 electing to proceed under Subchapter V of the Small Business Reorganization Act of 2019 (SBRA). Debtor’s disputed secured lender, Hall Los Angeles WTS, LLC, objected to Debtor’s Subchapter V election, arguing that Debtor was ineligible to proceed because its affiliate Steelcase, Inc. (Steelcase), a publicly traded company and qualified “issuer” under the Securities Exchange Act of 1934 (Securities Act), holds more than 20% of Debtor’s voting shares. In response, Debtor argued that Steelcase is not an “affiliate” as defined by section 101(2)(A) of the Code because it owned only 6.51% of the shares authorized to vote on Debtor’s bankruptcy filing. The court concluded that, pursuant to 11 U.S.C. § 1182(1)(B)(iii), Debtor is ineligible to be a debtor in a SBRA case. The court then entered its order sustaining Hall’s objection and revoking Debtor’s Subchapter V election.
The court began its analysis by reviewing section 1182 of the Bankruptcy Code, which governs Subchapter V eligibility. As the court observed, section 1182(1)(B)(iii) provides that “any debtor that is an affiliate of an issuer” as defined in the Securities Act is ineligible to be a SBRA debtor. Noting Congress’s enumeration of specific eligibility requirements under section 1182, the court expressly declined to examine Debtor’s motives for electing to proceed under Subchapter V or the potential effect of the election on the bankruptcy estate.
In next determining whether Steelcase is an “issuer” as contemplated in section 1182(1)(B)(iii), the court looked to section 78c of the Securities Act which, with certain inapplicable exemptions, defines “issuer” as “any person who issues or proposes to issue any security” including stock. 15 U.S.C. §§ 78c(a)(8), (10). Pointing to evidence in the record, the court noted that Steelcase is a publicly traded company on a stock exchange, thereby establishing that Steelcase is an issuer for the purposes of analyzing Debtor’s Subchapter V eligibility.
The court then examined section 101(2)(A) of the Code, which defines “affiliate” as an “entity that directly or indirectly owns, controls, or holds with power to vote, 20 percent or more of the outstanding voting securities of the debtor.” 11 U.S.C. § 101(2)(A) (emphasis added). Noting that Steelcase owns more than 27% of Debtor’s voting securities, the court concluded that the company is an affiliate of Debtor. In doing so, the court rejected Debtor’s argument that only those shares “with power to vote” on the matter before the Court—Debtor’s bankruptcy filing—should count. Instead, analyzing the split of authority from courts examining affiliate status in the context of insider status and venue, the court concluded that it should consider only whether Steelcase: (1) owns 20% or more of Debtor’s voting securities; (2) controls 20% or more of Debtor’s voting securities; or (3) holds 20% of more of Debtor’s voting securities with the power to vote those securities. Finding that Steelcase owns 27.36% of Debtor’s voting securities, the court opined that Steelcase was an affiliate of Debtor, rendering Debtor ineligible to proceed under Subchapter V.
The SBRA is still relatively new, signed into law on August 23, 2019, and taking effect on February 19, 2020. The bankruptcy court in Serendipity Labs observed that its analysis of affiliate status in the context of determining Subchapter V eligibility appears to be a matter of first impression. The court’s careful analysis on this novel issue therefore provides substantial value to the bar, particularly as case law develops on issues including a debtor’s eligibility to proceed under Subchapter V. This guidance is even more important because the Coronavirus Aid, Relief, and Economic Security (CARES) Act temporarily raises the SBRA debt ceiling from $2.7 to $7.5 million, thereby expanding the pool of small business debtors potentially eligible to proceed under Subchapter V through March 2021. Given this increased access to the streamlined benefits that SBRA provides, I anticipate that we will see more Subchapter V eligibility disputes such as the one in this case.
These materials were authored by Monique D. Jewett-Brewster, an attorney with Hopkins & Carley, ALC, a member of the ad hoc group and 2018-19 Chair of the CLA Business Law Section. Editorial contributions were made by the Hon. Meredith Jury (United States Bankruptcy Judge, C.D. Cal, Ret.), also 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.