Nat’l Loan Invs., L.P. v. Rickerson (Bankr. W.D. Pa.)
The following is a case update written by Robert G. Harris, a partner in Binder & Malter, LLP, analyzing a recent decision of interest:
A Bankruptcy Court in the Western District of Pennsylvania (the “Court”) recently upheld challenges to the eligibility of a physician to proceed as a debtor in Subchapter V. The Court concluded that the debtor had failed to prove that she was presently engaged in commercial or business activity because her business entities and practice had been completely inactive for several years, and she was, at the petition date, a salaried employee of an entity in which she had no ownership interest. The Court also found that the debtor failed to prove that more than 50% of her debts arose from business or commercial activity owing to a lack of evidence in the record as to whether her State and Federal income tax obligations were consumer or business in nature. Nat’l Loan Invs., L.P. v. Rickerson (In re Rickerson), 2021 WL 5905974 (Bankr. W.D. Pa. Dec. 14, 2021).
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Ruthellen W. Rickerson, the debtor herein (the “Debtor”) is a physician who specializes in Obstetrics and Gynecology. The Debtor was the owner of three legal entities created in 1997 relating to her Titusville Pennsylvania medical practice.
Ruthellen D. Weeks, P.C., a professional corporation (the “Professional Corporation”), was formed to serve as the vehicle to provide the Debtor with revenue from her practice. The Debtor was the 100% owner and president of the Professional Corporation.
The Women’s Health Association of Titusville (the “Medical Company”) was formed to conduct the actual medical practice itself. The Debtor owned 50% of the Medical Company, and the Debtor’s partner in the practice, Dr. Leonard A. Ferreira, owned the other 50%. The Debtor provided medical services at the practice for the Professional Corporation, which paid her from the revenues it received from the Medical Company.
The Women’s Health Organization of Titusville, a/k/a Women’s Health Association of Titusville (the “Real Estate Company”) owned 602 W. Central Ave., Titusville, Pa. (the “Medical Building”) where the Medical Company operated and paid rent to the Real Estate Company. The ownership of that entity was held 50% by the Debtor and her husband, Alfonso Rickerson, and 50% by Dr. Ferreira and his wife, Hillerinee Ferreira.
The Real Estate Company financed its acquisition of the Medical Building with a loan of $475,000 from PNC Bank in late-1997. That loan was secured by a mortgage against both the Medical Building and the Debtor’s residence located at 12348 North Perry Rd., Titusville, Pa. (“the Debtor’s Residence”).
In 2014, the medical practice was sold to OB/GYN Associates of Erie, an unrelated entity. The buyer employed the Debtor as a treating physician for several months after the sale. The Debtor then took a job with an entity named OPTUM, a part of the United Health Group. The Debtor does not hold an equity or ownership interest in OPTUM and is not a manager or officer of her employer.
In 2017 there was a foreclosure and sheriff’s sale of the Medical Building property that was not sufficient to pay off the PNC Bank loan. The assignee of the PNC mortgage, National Loan Investors, L.P. (“NLI”), obtained a judgment in mortgage foreclosure against the Debtor’s Residence. The impending foreclosure prompted Debtor’s personal bankruptcy filing.
The Debtor’s total obligations at filing amounted to $1,095,439.63; $151,194.13 of this amount was scheduled as consumer debt. The Debtor asserted that the remainder was business debt consisting of (1) $352,578.77 owed to NLI; (2) $556,991.01 owed to the IRS; and (3) $48,503.37 owed to the Pennsylvania Department of Revenue.
The Debtor filed her voluntary Chapter 11 petition on June 3, 2021, identifying herself as a small business debtor and electing to proceed under Subchapter V. Within 30 days of the filing, NLI filed a Motion to Dismiss Chapter 11, Subchapter V Bankruptcy Case, and the United States Trustee filed a Motion to Strike Designation of Chapter 11 Case as Subchapter V under 11 U.S.C. § 1182. NLI requested dismissal or the case or conversion to a “conventional” Chapter 11 case. The U.S. Trustee requested that the Subchapter V designation be stricken. The motions were granted in part: the Debtor’s designation of the case as being under Subchapter V of Chapter 11 was stricken, and the case was allowed to proceed as one under Chapter 11, but not under Subchapter V.
The Court followed the majority view and held the burden of proof in establishing eligibility for Subchapter V relief lies with the debtor, citing In re Blue, 630 B.R. 179, 187 (Bankr. M.D.N.C. 2021) and In re Wright, 2020 Bankr. LEXIS 1240, 2020 WL 2193240, at *2 (Bankr. D.S.C. Apr. 27, 2020).
The Court then addressed whether the Debtor was a “person engaged in commercial or business activities” as set forth in 11 U.S.C. § 1182(1)(A). The Court first concluded, based on plain language, that the words “engaged in” “import … a condition of contemporaneity into the definition.”
Moving beyond plain language, the Court cited In re Johnson, 2021 Bankr. LEXIS 471, 2021 WL 825156 (Bankr. N.D. Tex. March 1, 2021) for two propositions: first, “… the small business debtor provisions of the Bankruptcy Code are designed to identify and help currently active businesses to successfully reorganize as a going concern, something which is ‘not essential to a small business that is no longer occupied with/busy in any commercial or business activities.’”; and, second, “Congress was not writing on a blank slate when Subchapter V was created because the Bankruptcy Code already included the same “engaged in” phrase in other contexts and it had been interpreted to include a present tense requirement, such that a debtor’s past engagement in commercial or business activity was not sufficient.” The Court also analyzed and applied as binding precedent In re Pittsburgh & Lake Erie Properties, Inc., 290 F.3d 516 (3d Cir. 2002)(“PLE”), a Railroad Reorganization case under Subchapter IV of Chapter 11 in which the term “engaged in” was applied to disallow administrative claims in a case filed after the railroad had ceased operating.
The Court noted the majority of cases had applied the condition of contemporaneity to the term “engaged in” citing In re Thurmon, 625 B.R. 417 (Bankr. W.D. Mo. 2020), In re Offer Space, LLC, 629 B.R. 299, 306 (Bankr. D. Ut. 2021) and even In re Ikalowych, 629 B.R. 261, 281 (Bankr. D. Col. 2021). The Court dismissed In re Wright, 2020 Bankr. LEXIS 1240, 2020 WL 2193240 (Bankr. D.S.C. Apr. 27, 2020), and In re Blanchard, 2020 Bankr. LEXIS 1909, 2020 WL 4032411 (Bankr. E.D. La. July 16, 2020) as unpersuasive on the point and rejected them without discussion.
The Court then reviewed case law interpreting the term “engaged in commercial or business activities.” The Court started with the basic proposition from In re Johnson that “a person engaged in the exchange or buying and selling of economic goods or services for profit” is engaged in commercial or business activities. The Court accepted that “even after the cessation of buying and selling of goods and services for profit as of the time of the filing of the petition it can still be found to be presently engaged in commercial or business activities based on a totality of circumstances approach if it is still in the process of concluding the business.” The Court conceded, citing In re Offer Space, LLC andIn re Port Arthur Steam Energy, L.P., 629 B.R. 233 (Bankr. S.D. Tex. 2021) that a business without employees or operations, even with no intention to reorganize, could nevertheless be engaged in commercial or business activities if it had, for example, active bank accounts, accounts receivable, was analyzing and exploring counterclaims in a pending lawsuit, was managing remaining assets, was winding down its business. was actively pursuing litigation against a third party, seeking to collect on outstanding accounts receivable, selling an asset, preserving asset value or having managers oversee the company while an independent contractor maintained its facility.
The Debtor offered no evidence of any such activities by the Debtor, the Professional Company, the Medical Company, or the Real Estate Company or any intent by Debtor to ever reactivate any of these entities or to resume her medical practice. Instead, the Debtor relied solely on employment with OPTUM as support for her claim that she was presently engaged in commercial activity at the time of her filing. The Court, noting that the debtor was simply a W-2 employee of OPTUM, not an owner, officer, director or in a managerial position, found that the Debtor’s employment by OPTUM did not constitute engagement in commercial or business activities within the meaning of Section 1182(1)(A).
The Court then examined Debtor’s debts to assess whether more than $547,719 (50% of the total of $1,095,439.63) arose from business or commercial activity. The Debtor had conceded that $151,194.13 was consumer debt. The Court found that the Debtor proved that $340,900.53 of her debt to NLI (the non-real estate portion net of advances to pay real estate taxes on Debtor’s Residence) arose from her commercial or business activities.
The parties disputed whether the taxes of $556,991.01 owed to the IRS and $48,503.37 owed to the Pennsylvania Department of Revenue were business or personal in nature. Citing In re Brashers, 216 B.R. 59 (Bankr. N.D. Okl. 1998)(question of whether income tax debt owed by the debtor constituted consumer debt within the meaning of Section 707(b)) and In re Stovall, 209 B.R. 849 (Bankr. E.D. Va. 1997) the Court concluded that the tax debt was neither consumer nor business debt. For purpose of analysis, the Court nevertheless assumed all IRS tax debt was business debt and divided the taxes into pre- and post-sale periods. The Court ruled that all amounts owed for periods after the medical practice was sold must be deducted, since commercial or business activity had by then ceased. The Court’s conclusion that less than 50% of Debtor’s obligations had arisen from business or commercial activity provided a second basis for the finding that the Debtor was ineligible to proceed under Subchapter V.
Eligibility for Subchapter V remains a hot topic. Objections to designation have naturally moved on from retroactivity to challenges to whether the debtor is at the time of filing engaged in commercial or business activity and the nature and composition of the debt stack. Adding an element of contemporaneity into section 1182(A), along with the words “engaged in,” appears merited and uncontroversial. Differences in interpretation among courts appear in the application of the totality of circumstances test and what is or is not viewed as a commercial or business activity at the time of filing. In re Rickerson, In re Offer Space, LLC, andIn re Port Arthur Steam Energy, L.P., among other cases, suggest that Subchapter V may only be available where there is evidence of a business to be or being wound down: an active bank account, receivables to be collected, assets to be sold, or pending or contemplated litigation. Intent to reorganize is a factor but clearly not dispositive, at least as to a business, as Subchapter V seems to be employed for liquidation as often as it is for reorganization.
Individuals filing to get relief from business debts on which they are jointly liable, or that they have guaranteed, may well find it harder to defend their eligibility without some aspect of their business still needing to be wound up at the time of filing. Statements by the courts in In re Wright and In re Blanchard that “…nothing [in the Small Business Reorganization Act] therein, or in the language of the definition of a small business debtor, limits application to debtors currently engaged in business or commercial activities” will likely not be followed by all courts. Counsel may wish to identify what remains to be done in the business early in the representation and explain how progress in a pre-bankruptcy wind-down may complicate or at least advance the timing of a personal Subchapter V filing.
This review was written by Robert G. Harris, a partner in 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.