Select Page

Debt from a debtor’s defunct business and employment in related field can help debtors qualify for Subchapter V eligibility

Bankruptcy Judge Benjamin A. Kahn of the United States Bankruptcy Court for the Middle District of North Carolina recently issued an opinion interpreting debtor income and eligibility under Subchapter V of chapter 11 in In re Blue, 21-80059 (Bankr. M.D.N.C. May 7, 2021).

In Blue, the debtor owned Wirecentric, Inc. (“Wirecentric”) a business that provided information transport consulting services such as wire installations, equipment and other infrastructure to enable data transport. The company went out of business in or around 2019 and had no assets. The debtor had no intention of reinstating the business. Following the failure of Wirecentric, the debtor took on several roles including a full-time position with the Lanier Law Group as a registered communications distribution designer as well as two independent contractor consulting roles with Roxboro Housing Authority (“RHA”) and Technology Express.  As an independent contractor the debtor did not hire any additional staff to assist with assignments and she received 1099s from both companies.

The debtor commenced her case by filing a voluntary petition under Subchapter V of chapter 11. The Bankruptcy Administrator and Trustee filed objections to the debtor’s Subchapter V election raising issue with whether the debtor’s debts arose from the commercial or business activities of the debtor and if the debtor met the eligibility requirements for Subchapter V.

There were two disputed categories of debt. The first was the debtor’s real property located in Fayetteville, North Carolina which originally served as the debtor’s personal residence (the “Original Residence”). The debtor later rented her Original Residence out until she had to evict the tenant in or around 2018. The Original Residence was encumbered by a refinanced mortgage as well as debts owed to certain creditors for funds borrowed by the debtor to make necessary repairs. The debtor claimed that the refinanced mortgage and home repair debts were business debts because the debtor previously rented the Original Residence, damages were caused by the rental and the debtor intended to rent the Original Residence again. In opposition, the Bankruptcy Administrator asserted that the Original Residence and the mortgage taken out was used by the debtor personally rather than as part of her business. The second category of disputed debt related to the debtor’s liability for a $60,000 United States Small Business Administration loan (the “SBA Loan”). There were inconsistencies at hearings and in the debtor’s schedules as to her liability on the SBA Loan. The Trustee claimed that the SBA Loan provided that Wirecentric was the borrower and the debtor signed in her capacity as the president of Wirecentric, rather than individually.

Judge Kahn examined the statutory eligibility requirements to determine if the debtor was in fact eligible to proceed under subchapter V. In order to be eligible to elect to proceed under subchapter V, a debtor must establish that: (1) she meets the definition of a “person”; (2) she is “engaged in commercial or business activities”; (3) she does not have aggregate debt exceeding $7,500,000 as of the date of petition; and (4) at least 50 percent of her debts arise from the commercial or business activities of the debtor. 11 U.S.C. § 1182(1)(A).

On the issue of whether the debtor engaged in commercial or business activities, because there is no statutory definition of “commercial or business activities” and “scant legislative history”, Judge Kahn looked to the plain language of the statute as well as opinions from other courts grappling with Subchapter V.  Judge Kahn adopted the majority view that the term “engaged” requires debtors to be presently participating in business or commercial activities as of the petition date. The debtor’s consulting work for RHA and Technology Express met the requirement of 11 U.S.C. § 1182(1)(A) as the debtor was a sole proprietor that delivered services in exchange for a profit that materially contributed to the debtor’s income. It did not matter that the debtor was no longer operating Wirecentric. Additionally, Judge Kahn found nothing in the plain language of 11 U.S.C. § 1182(1)(A) that required the debtor’s scheduled business debts to be related to the debtor’s current business activities. He emphasized that a narrow interpretation and “reading such language into the statute could have the effect of disqualifying meritorious small businesses from the remedial purpose of Subchapter V simply by having significant debts from former operations.”

The debtor also established that not less than 50 precent of her debt arose from commercial activities. As of the petition date the debtor’s total debts were $908, 494.87.  At least 50 percent of this amount $454,247.44, was the minimum amount of debt arising from commercial activities required to enable the debtor to proceed under Subchapter V. The Court carefully reviewed the debtor’s listed debts and categorized the debts to ensure compliance with statutory eligibility requirements for Subchapter V. The debtor owed about $60,000 on the refinanced mortgage on the Original Residence. However, the debtor now lived elsewhere and had rented the Original Residence continuously for almost 20 years. The debtor had been unable to rent the Original Residence for the last two years because she could not afford the necessary repairs to make the Original Residence habitable. Judge Kahn decided that the debtor could not count the mortgage on the Original Residence among her business debts because she had originally obtained the mortgage as her residence and therefore “did not arise from the debtor’s commercial or business activities”. In reviewing the debts, the Court held that the debtor’s activities in connection with repairing the Original Residence constituted commercial or business activity. When counting the business debts against the debtor’s personal debts, the Court found that just over half of the debtor’s debts were business debts, entitling her to proceed under Subchapter V.

With regard to the SBA Loan, Judge Kahn found that the debtor’s evidence failed to establish that she was personally liable. In examining the terms of the loan, the SBA note unambiguously stated that the debtor signed in her representative capacity as the president of Wirecentric and that the debtor was not individually liable based on the note’s terms. Citing to Keels v. Turner, 45 N.C. App. 213, 218, Judge Kahn noted that under North Carolina law, in order for an officer to be personally liable, the contract must contain two separate signatures– one on behalf of the company and one on behalf of the guarantor individually, or the officer must execute a separate guaranty. Here, the debtor signed the SBA Loan solely in her capacity as a corporate officer and there was no evidence in the record that would indicate that the debtor intended to personally guaranty the SBA Loan.

The Court held that the debtor met the eligibility requirements of Subchapter V and could proceed. This recent decision sheds light on the important due diligence required for individuals and businesses seeking relief under Subchapter V. A review of all debts is essential to ensure statutory compliance with the requirements of 11 U.S.C. § 1182(1)(A)– namely whether the debtor is engaged in commercial or business activities and whether at least 50 percent of the debt is attributable to commercial or business activities.

Thomas H. Curran Associates represents a broad range of businesses and corporate entities, private equity funds, as well as governmental agencies and other interested parties in all phases of the bankruptcy process and in bankruptcy related transactions and litigation. As advocates and trusted business advisors, our well-established foundation of knowledge and understanding of our clients’ business and professional interests, enables our attorneys to deliver unparalleled individualized attention to our clients of all sizes with their bankruptcy, litigation and corporate transactional needs.

Thomas H. Curran Associates Blog

Archives

Contact Us

Are You In Need of Legal Counsel for a Business Transaction, Commercial Litigation, Asset Recovery, or Bankruptcy Matter?

Contact our team today.

Call us at (617) 207-8670 or use the quick contact form below.

Austin Office

111 Congress Avenue
Suite 500
Austin, TX 78701

Boston Office

75 State Street
Suite 100
Boston, MA 02109

New York Office

17 State Street
40th Floor
New York, NY 10004

London Office

The Leadenhall Building
Level 30
122 Leadenhall Street
London EC3V 4AB

Pin It on Pinterest