The following is a case update by Cathy Ta of a recent case of interest:
In In re Two Wheels Props. LLC, 2020 Bankr. LEXIS 3606 (Bankr. S.D. Tex. Dec. 30, 2020), the court found that a forfeited corporation for tax purposes under Texas state law would be eligible to seek chapter 7 relief but not chapter 11, subchapter v relief “to continue its business or affairs,” given that its forfeited corporate existence is limited to only “one option under Texas state law—to liquidate.” To view the memorandum, click here.
FACTS & ANALYSIS
On Nov. 2, 2020, the debtor Two Wheels Properties, LLC filed for chapter 11, subchapter v relief (small business debtor reorganization). However, about 9 months earlier, the debtor was dissolved due to a forfeiture of its corporate charter for failure to report and pay franchise taxes. According to the opinion, under Texas state law, the debtor’s charter could not be reinstated because the forfeiture occurred for tax purposes.
At the initial status conference, the court, sua sponte, raised whether the debtor had standing to file chapter 11 given its forfeited corporate charter. After the debtor, the U.S. trustee, and the subchapter v trustee (the “trustee”) submitted briefing on this issue, the court found the debtor lacked standing to seek chapter 11, subchapter v relief “to the extent” utilized “to continue its business or affairs” because the debtor’s post-forfeiture corporate existence “persists” for the limited purpose of “wind up” under Texas state law.
The court conducted an analysis of Texas state law, which provides that after forfeiture, a corporation continues in existence for three years for limited purposes such as “liquidating, applying or distributing property.” Drawing on In re ABZ Ins. Servs., 245 B.R. 255 (Bankr. N.D.Tex. 2000), which concluded that a forfeited Texas corporation for tax purposes is eligible for chapter 7 relief, the court determined that a forfeited Texas corporation for tax purposes could seek chapter 7 relief within three years of its forfeiture because such relief would be consistent with the liquidation purposes of its limited existence under Texas state law. By contrast, chapter 11, subchapter v relief is not an option “to the extent [the debtor] seeks to continue its business or affairs.”
The court dismissed the case, without prejudice.
The court characterized the debtor’s chapter 11, subchapter v reorganization case as an attempt to expand the debtor’s post-forfeiture limited corporate existence beyond Texas state law, which permits liquidation of assets and satisfaction of liabilities only. That characterization was consistent with the debtor’s amended status conference report, which indicated that the goals of the debtor’s reorganization plan were “to cure and maintain the mortgage on its commercial real estate and make its creditors whole.” Siding with the U.S. Trustee that Texas state law barred the debtor’s corporate reinstatement, the court called the debtor’s reorganization endeavor a “contravention of state law.”
The trustee disagreed with the contention that the debtor could not reinstate its corporate charter: in his brief, he pointed out that the Texas Secretary of State’s own website provides instructions for reinstatement of the debtor’s charter. The trustee also argued that the case was filed to stop a foreclosure, which he submitted would fall within two of the limited purposes of a dissolved corporation under Texas state law: “prosecuting or defending in its corporate name any action or proceeding by or against the dissolved corporation” and “settling any other affairs not completed before dissolution.” The trustee advanced the general position that the debtor could be eligible for subchapter v relief if its charter were reinstated within the three years of the company’s limited existence. However, that would be longer than the timeframes to confirm a plan under subchapter v: 90 days from the petition date to file a plan; 28 days’ notice for plan objections; and 28 days’ notice for plan confirmation hearing. The court rejected the trustee’s position.
The record does not provide why the debtor was unable to reinstate its corporate charter before the court dismissed the case. The debtor’s brief did not address its reinstatement efforts; rather, the brief focused on the debtor’s continued albeit limited corporate existence, despite its forfeiture. The only place where the debtor’s reinstatement efforts were mentioned was a footnote in the U.S. Trustee’s brief, which noted that the debtor’s representative testified at its 341 meeting that the debtor “was in the process of trying to reinstate its charter.” The footnote further provided, however, that the U.S. Trustee was otherwise “not aware” if the debtor had been successful.
Had the debtor reinstated its charter, the issue of the debtor’s eligibility for chapter 11, subchapter v relief would have become moot, given that its corporate existence would no longer be limited to “wind up” under Texas state law.
The main takeaway from this case would be to ensure that a debtor has good corporate standing before seeking chapter 11, subchapter v relief. In light of subchapter v’s quick plan confirmation-related timeframes, there may be insufficient time for any concurrent corporate reinstatement efforts.
These materials were authored by ILC member Cathy Ta, with editorial contributions from ILC member Jessica M. Simon, Ballard LLP.