The following is a case update written by Monique D. Jewett-Brewster, an attorney with Hopkins & Carley, ALC, analyzing a recent decision of interest:

SUMMARY

Analyzing matters of first impression, a New York bankruptcy court has held that a debtor may amend her chapter 11 petition to proceed under subchapter V of the Small Business Reorganization Act of 2019 even when her case has been pending for over fifteen months and a creditor’s proposed plan of reorganization has been scheduled for a hearing on confirmation. [In re Ventura, 2020 WL 1867898 (Bankr. E.D.NY. Apr. 10, 2020).]

To view the entire opinion, click here.

FACTS

In 2007, debtor Deirdre Ventura (Debtor) purchased a six-bedroom historic mansion. The acquisition of the property was financed in part by a $1 million dollar loan secured by a mortgage on the property from Wells Fargo Bank, N.A. The note and mortgage were eventually assigned to Gregory Funding, as servicer for U.S. Bank National Association, as Indentured Trustee (Gregory). Debtor eventually registered the property as a bed and breakfast, but she continued to reside there at all times as an “owner operator.”

After Debtor defaulted on the mortgage, Gregory commenced foreclosure proceedings against the property. In August 2018, Gregory obtained a judgment of foreclosure and sale in its favor. One day before the scheduled foreclosure sale, Debtor filed a voluntary petition under chapter 11. A few months into the case, and with the consent of the parties, the bankruptcy court entered an order directing Debtor and Gregory to participate in the Loss Mitigation Program with respect to the property. After several months, the parties agreed to terminate loss mitigation discussions; thereafter, Debtor effectively waived her exclusivity period to file a plan of reorganization by failing to file her plan by the court-appointed deadline to do so.

In December 2019, Debtor and Gregory each filed a proposed plan and disclosure statement pursuant to court order. Gregory’s proposed plan provided for an auction sale of the property subject to higher and better offers and a carve out from the sale proceeds to pay all other creditor classes in full. In contrast, Debtor’s proposed plan sought to bifurcate the mortgage into a secured and unsecured claim and only pay Gregory’s secured claim in full. The court later determined that Debtor’s proposed plan was unconfirmable on its face because it violated 11 U.S.C. § 1123(b)(5)’s prohibition against modification of claims secured by a debtor’s principal residence. The court then approved Gregory’s disclosure statement and set February 26, 2020 as the date for a hearing on the confirmation of Gregory’s proposed plan.

At the confirmation hearing, the court advised the parties about the Small Business Reorganization Act of 2019 (SBRA) that became effective on February 19, 2020. The court then offered Debtor the opportunity to proceed with the hearing as scheduled or adjourn the hearing for a short time to allow Debtor to determine whether she wished to amend her petition. On March 6, 2020, Debtor amended her petition to designate herself as a small business debtor under the newly amended definition and to elect to proceed as a subchapter V debtor. The court entered a scheduling order, setting a status conference on April 1, 2020 and setting Debtor’s deadline to file a plan on June 8, 2020. Shortly thereafter, Gregory filed a motion objecting to Debtor’s eligibility to proceed under subchapter V of the SBRA on the ground, among others, that the designation was prejudicial to Gregory based on the history of the case. The U.S. Trustee also objected to Debtor’s election to be treated as a subchapter V debtor, raising several timing and technical issues. After carefully analyzing the SBRA and the purpose behind the new law, the bankruptcy court denied Gregory’s motion and overruled the objections to Debtor’s eligibility to proceed under the SBRA.

REASONING

The SBRA is codified in 11 U.S.C. §§ 1181-1195; certain Code sections that existed prior to the SBRA have also been modified. Citing to the Report from the House Committee on the Judiciary, the court began its analysis by noting that the SBRA is intended to allow small businesses and individuals to take advantage of a chapter 11 process that would be less costly and time consuming than the current process. H.R. REP. No. 116-171, at 2 (2019). As the court observed, the goal of the legislation is to allow small business debtors “to file bankruptcy in a timely, cost-effective manner, and hopefully allows them to remain in business” which “not only benefits the owners, but employees, suppliers, customers, and others who rely on that business.” Newly amended 11 U.S.C. § 101(51D)(A) defines a “small business debtor”, in part, as “…a person engaged in commercial or business activities … that has aggregate noncontingent liquidated secured and unsecured debts as of the date of the filing of the petition … in an amount not more than $2,725,625… not less than 50 percent of which arose from the commercial or business activities of the debtor.”

The court then acknowledged that SBRA imposes several requirements in subchapter V cases, including the requirements that appeared to be time sensitive: (i) the U.S. Trustee must appoint an SBRA trustee charged with the development of a consensual plan; (ii) the court must hold a status conference with the SBRA trustee within 60 days of entry of the order for relief; (iii) the subchapter V debtor must submit a status report 14 days prior to the status conference detailing efforts to reach a consensual plan; and (iv) the subchapter V debtor must file a plan within 90 days of entry of the order for relief. See, e.g., 11 U.S.C. §§ 1183(b)(7), 1188(a), (c), 1189(b).

Observing that the SBRA is silent as to whether it applies to pending cases, or only to cases commenced after the effective date, the court noted that the Code affords bankruptcy courts with the discretion to extend subchapter V deadlines “if the need for the extension is attributable to circumstances for which the debtor should not be justly held accountable.” 11 U.S.C. §§ 1188(b), 1189(b). Citing to a bankruptcy court decision in the Central District of California, In re Progressive Solutions, Inc., No. 8:18-bk-14277, the court soundly rejected the U.S. Trustee’s objections based on timing and scheduling issues arising from Debtor’s SBRA designation in the pending case:

Given that the Debtor’s case was filed over fifteen months ago, the Court finds that to argue the Debtor should have complied with the procedural requirements of a law that did not exist is the height of absurdity. The Debtor is not required to comply with deadlines that clearly expired before the Debtor could have elected to proceed as a subchapter V debtor.

The court then considered Gregory’s argument that retroactive application of the SBRA to Debtor’s case is impermissible because it would be prejudicial to Gregory’s “vested rights.” In particular, Gregory interpreted “vested rights” to mean the court’s prior orders permitting Gregory to file its own plan and approving Gregory’s disclosure statement, along with the court’s finding that the Debtor’s proposed plan was patently unconfirmable. However, the court disagreed with Gregory’s analysis of the SBRA’s purportedly prejudicial impact on its vested rights:

While Gregory speaks in terms of damage to its vested rights resulting from the progress made in the Debtor’s bankruptcy case, Gregory is focused on the wrong question. The correct question to ask is whether designation of the Debtor as a subchapter V debtor will impair Gregory’s rights as they existed prior to the effective date of the SBRA. Clearly, the amendment to the definition of “small business debtor” does not amount to a taking of property…. ¶ Gregory may still avail itself of all rights granted to a secured creditor under the Code that have not been amended by the SBRA.

The court then considered, and rejected, Gregory’s argument that applying the SBRA to Debtor’s case would be prejudicial based on the history of the case, “including the fact that the Court had previously rejected the Debtor’s proposed plan and was poised to rule on whether to confirm Gregory’s proposed plan.” Reasoning that Gregory still will retain many of the rights it had at the inception of the case, the court concluded that any delay caused by permitting Debtor to proceed under subchapter V would not be sufficiently prejudicial to Gregory given the “current economic conditions.”

AUTHOR’S COMMENT

The President signed the SBRA into law on August 23, 2019 and it became effective on February 19, 2020—shortly before the widespread business disruptions caused by the coronavirus pandemic. The court’s thoughtful decision in this case highlights its concern that “family–owned businesses and other ‘Main Street’ businesses that are currently in such dire need of relief” be permitted to avail themselves of the SBRA’s less costly and time-consuming path to reorganization. The court further expressed its belief that “[small business] debtors who are willing to risk everything to start and maintain their own businesses … should be applauded,” rather than penalized by not letting them elect to proceed under the SBRA in cases pending when the new law took effect.

In reaching this decision, the court clearly considered the tremendous difficulties that small debtors are facing due to Covid-19. It does not appear, however, that the court gave equal weight to the detrimental impact that allowing a small debtor to effectively restart its case fifteen months postpetition might have on a creditor, especially where that creditor has already incurred the cost of preparing its own plan that was scheduled for a confirmation hearing. Certainly, small business debtors are not the only ones suffering due to Covid-19’s unprecedented impact on the economy. In any event, creditors objecting to a debtor’s election to proceed under the SBRA in a case pending at the time the new law took effect should focus their arguments on actual economic prejudice—i.e., the real economic, monetary costs of litigating a case under one set of rules for months and then having to relitigate it under a different set of rules—rather than the “rights” they may have had under the prior law.

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.