NetJets Aviation, Inc. v. RS Air, LLC (In re RS Air, LLC) (9th Cir. BAP)

The following is a case update written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D. CA., Ret.), analyzing a recent decision of interest:

SUMMARY

In a ruling that affirmed the confirmation of subchapter V Chapter 11 plan, the Bankruptcy Appellate Panel for the Ninth Circuit (the BAP) made two significant rulings: (1) that a profit motive is not required to satisfy the requirement of Bankruptcy Code § 1182(1)(A) that a debtor must be “engaged in commercial or business activities” on the petition date to be eligible for subchapter V; and (2) that the burden is on the debtor to prove subchapter V eligibility. NetJets Aviation, Inc. v. RS Air, LLC (In re RS Air, LLC), 2022 WL 1288608 (9th Cir. BAP April 26, 2022).

To view the opinion, click here

FACTS

RS Air, LLC was formed in 2001 by its sole member and manager, Stephen Perlman, for the purpose of using and providing aircraft transportation services, acquiring and selling interests in aircrafts, and providing depreciation tax benefits to Perlman. From 2001 to 2017 RS Air earned revenue from providing flight services to Perlman, flying fragile technology prototypes to prevent damage from commercial baggage handling, and acquiring and selling fractional interest in aircrafts. As part of the latter business, RS Air entered into a series of agreements to purchase or lease fractional interests in private jets from NetJets Aviation and related entities. When one of NetJets aircraft was involved in a runway accident, RS Air ceased doing business with it and was still not engaged in its normal flight operations when it filed chapter 11 in 2020. Prior to the bankruptcy filing, RS Air and NetJets were involved in state court litigation and NetJets held 98% of the total non-insider debt against RS Air.

RS Air elected to proceed under subchapter V in its chapter 11 case. NetJets objected to the election, asserting that RS Air was not currently “engaged in commercial or business activities” as needed for eligibility under § 1182(1)(A) because it had had no flight operations, revenue or income for years and had no employees. It argued that in fact RS Air had never been revenue-generating and its sole purpose was to serve as the intermediary through which Perlman acquired interests in and used private jets, as well as receiving depreciation tax benefits. NetJets also asserted that the burden was on RS Air to establish eligibility for subchapter V. RS Air countered that ongoing operations, employees and profitability were not required for subchapter V eligibility and that it was currently engaged in business activities by litigating with NetJets; negotiating to sell its fractional jet interests back to NetJets; and paying aircraft registry fees, keeping tax obligations current, and otherwise maintaining good standing as a Delaware LLC. It argued that NetJets bore the burden of showing that RS Air was not eligible for subchapter V.

The bankruptcy court overruled the objections, finding that the burden was on NetJets, which had not met that burden because RS Air was engaged in sufficient business activities on the petition date by remaining in good standing, litigating with NetJets, and intending to resume fractional jet ownership with a different partner. RS Air subsequently filed a chapter 11 plan. NetJets raised similar arguments in opposition to the plan. At the plan confirmation hearing, RS Air presented an expert who opined that RS Air was set up primarily to create value as a tax benefit for Perlman and to provide him aircraft flight services, not to create value from profit on income. The bankruptcy court confirmed the plan, concluding that RS Air had no income but whether it generated income was not determinative for confirmation. It declined to revisit eligibility based on law of the case but noted that its interpretation of what were sufficient business activities for eligibility had been recognized by other courts and that those activities remained viable at confirmation.

NetJets timely appealed to the BAP, which affirmed.

REASONING

The BAP concluded that the bankruptcy court had erred by allocating the burden on eligibility to NetJets, but that the error was harmless because the record supported that RS Air could meet the burden. It recognized that the statute and rules were silent on burden and the issue was one of first impression in the Ninth Circuit. Looking at similar arguments regarding eligibility for chapter 9 and chapter 12 in the circuit, which placed the burden on the debtor, as well as subchapter V cases around the country which did likewise, the BAP held placing the burden on RS Air was consistent with those rulings.

Turning to whether a profit motive was necessary for a debtor to be engaged in business or commercial activity, the BAP did a comprehensive review of rulings on that issue in other jurisdictions, including all cases cited by NetJets. It found that the bulk of such rulings were consistent with the bankruptcy court’s findings that litigating, staying in good standing, keeping current on taxes obligations and paying registry fees, coupled with the intent to reengage in buying and selling fractionalized interests met the standards for commercial or business activities. The BAP saw no error in the bankruptcy court’s factual findings and held that a profit motive was not needed for eligibility.

Finally, the BAP found the application of law of the case was complex with many exceptions and that the trial court was entitled to revisit its interlocutory rulings when making final orders, such as confirming the plan. Again, that error was harmless since the plan confirmation record independently supported RS Air’s eligibility.

AUTHOR’S COMMENTS

The BAP’s holding on the burden makes sense and is consistent with what almost every bankruptcy court in the country has concluded: the debtor must establish its eligibility since it uniquely has the records and knowledge of the business operations to do so. Most significant here is the comprehensive review of the cases which have decided what operations are sufficient to satisfy the “engaged in commercial or business activities” requirement. Practitioners engaged in filing subchapter V cases would be well-served to read this opinion in detail as a short cut to reading the myriad of cases it analyzes. The definition has been broadly construed and the holding here is consistent with that trend.

This review was written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D. CA., Ret.), 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.