Frost Law
Highlights:
Small business owners keep our economy going—but not without exposing themselves to many risks and making significant sacrifices. Unfortunately, a high percentage of small businesses don’t make it, leaving some entrepreneurs with heavy business debts. Until subchapter V appeared, such individuals were left with little, if any, relief in the Bankruptcy Code.
Importantly, an individual may file a subchapter V bankruptcy to deal with personal liabilities arising out of obligations related to a failed business. Although subchapter V is still a relatively new process, it has already helped thousands of distressed small business owners find a more cost effective and efficient way to reorganize than via the traditional Chapter 11 path. Of course, as more judges meet subchapter V in their courtrooms, the process is increasingly refined as significant legal and interpretive issues are hammered out. Recently, the In re Hillman ruling from the United States Bankruptcy Court in the Northern District of New York, shed some light on two remaining eligibility inquiries:
(1) what actions are necessary for a debtor to be “engaged in commercial or business activities” and (2) does fifty percent or more of the debtor’s aggregate debt have to arise from the same commercial or business activities relied upon for subchapter V eligibility (“Nexus Requirement”).1
Facts
In March of 2022, Michell Hillman (Debtor) filed for bankruptcy under subchapter V of Chapter 11. In Debtor’s Schedule A/B, she claimed a 50% equity interest in two businesses: CHC (closed) and Tom Murray (ongoing). Debtor’s aggregate debt on the petition date was below the subchapter V threshold of $7,500,000.00 and not less than 50% of the debt arose form Debtor’s commercial or business activities.
Debtor’s only sources of income were Social Security and annuity distributions. Additionally, Debtor was defending a lawsuit (as state court action) brought by Creditor which involved “a defaulted commercial lease agreement by CHC and the Debtor's personal guaranty of same.”2 The lawsuit was pending as of the petition date.
Creditor contested Debtor’s subchapter V eligibility, stating “she is not a ‘person engaged in commercial or business activities … as of the date of filing the petition.’”3 Additionally, Creditor asserted that Debtor has no income from any alleged business venture and that the Tom Murray activities are better characterized as a “hobby.”
The court ultimately determined that Debtor was eligible for subchapter V of Chapter 11 and could move forward. In reaching this conclusion, the court began by introducing the four subchapter V eligibility requirements that a debtor must satisfy:
(1) meet the definition of a "person"; (2) be "engaged in commercial or business activities"; (3) have "aggregate noncontingent liquidated secured and unsecured debts as of the date of the filing of the petition . . . in an amount not more than $7,500,000 . . . "; and (4) "not less than 50 percent of which arose from the commercial or business activities of the debtor . . . ."4
Confident that no dispute existed regarding prongs 1 and 3, the court zeroed in on the remaining prongs 2 and 4, stating:
[T]his Court focuses on the following two remaining eligibility inquiries: (1) what actions are necessary for a debtor to be "engaged in commercial or business activities" and (2) does fifty percent or more of the debtor's aggregate debt have to arise from the same commercial or business activities relied upon for subchapter V eligibility ("Nexus Requirement")?5
First, the court noted that the majority of bankruptcy courts hearing subchapter V matters impose a “temporal restraint” upon the “engaged in” language in the first eligibility prong—meaning these courts look to a debtor’s activity as of the petition date. The court here promptly adopted the consensus view that Debtor was required to show that she was presently engaged in commercial or business activities as of the petition date.
Next, the court adopted the totality-of-circumstances approach to determine whether Debtor was engaged in commercial or business activities. The court explained that “a debtor can qualify for a subchapter V absent the company's traditional business operations where the company is winding down.”6 According to the court, there was enough winding down activity to satisfy the first prong since state court action was pending as of the petition date and involved commercial litigation between the parties. In other words, Debtor was engaged in commercial or business activities as required in 11 U.S.C. §1182(1)(A).
The court then moved on to consider whether 50% or more of the debtor’s aggregate debt had to arise from the same commercial or business activities being relied upon for subchapter V eligibility. As the court explained, this was viewed as the “Nexus Requirement,” which has created an existing split among the bankruptcy courts. Here, the court aligns itself with those courts that require the nexus and found:
As of the Petition Date, the Debtor was engaged in commercial or business activity in both Tom Murray and CHC. The Debtor has $671,398.91 of scheduled debt relating to the commercial or business activity of CHC. This debt is greater than 50% of the total $957,038.00 of liabilities reflected in the petition. Accordingly, the Court finds the Debtor has satisfied the Nexus Requirement because "not less than 50 percent of [the total debt] arose from the commercial or business activities of the debtor."7
In re Hillman is an important part of the emerging case law that is shaping how courts will apply subchapter V provisions in various situations. The decision clarifies that, in the subchapter V context, winding down activity includes the defense of a guaranty lawsuit which is pending as of the petition date. Moreover, the In re Hillman court joins other courts requiring that 50% or more of a debtor’s aggregate debt had to arise from the same commercial or business activities being relied upon for subchapter V eligibility (“Nexus Requirement”). It will be interesting to see how other courts do or do not follow In re Hillman.
Highlights:
Small business owners keep our economy going—but not without exposing themselves to many risks and making significant sacrifices. Unfortunately, a high percentage of small businesses don’t make it, leaving some entrepreneurs with heavy business debts. Until subchapter V appeared, such individuals were left with little, if any, relief in the Bankruptcy Code.
Importantly, an individual may file a subchapter V bankruptcy to deal with personal liabilities arising out of obligations related to a failed business. Although subchapter V is still a relatively new process, it has already helped thousands of distressed small business owners find a more cost effective and efficient way to reorganize than via the traditional Chapter 11 path. Of course, as more judges meet subchapter V in their courtrooms, the process is increasingly refined as significant legal and interpretive issues are hammered out. Recently, the In re Hillman ruling from the United States Bankruptcy Court in the Northern District of New York, shed some light on two remaining eligibility inquiries:
(1) what actions are necessary for a debtor to be “engaged in commercial or business activities” and (2) does fifty percent or more of the debtor’s aggregate debt have to arise from the same commercial or business activities relied upon for subchapter V eligibility (“Nexus Requirement”).1
Facts
In March of 2022, Michell Hillman (Debtor) filed for bankruptcy under subchapter V of Chapter 11. In Debtor’s Schedule A/B, she claimed a 50% equity interest in two businesses: CHC (closed) and Tom Murray (ongoing). Debtor’s aggregate debt on the petition date was below the subchapter V threshold of $7,500,000.00 and not less than 50% of the debt arose form Debtor’s commercial or business activities.
Debtor’s only sources of income were Social Security and annuity distributions. Additionally, Debtor was defending a lawsuit (as state court action) brought by Creditor which involved “a defaulted commercial lease agreement by CHC and the Debtor's personal guaranty of same.”2 The lawsuit was pending as of the petition date.
Creditor contested Debtor’s subchapter V eligibility, stating “she is not a ‘person engaged in commercial or business activities … as of the date of filing the petition.’”3 Additionally, Creditor asserted that Debtor has no income from any alleged business venture and that the Tom Murray activities are better characterized as a “hobby.”
The court ultimately determined that Debtor was eligible for subchapter V of Chapter 11 and could move forward. In reaching this conclusion, the court began by introducing the four subchapter V eligibility requirements that a debtor must satisfy:
(1) meet the definition of a "person"; (2) be "engaged in commercial or business activities"; (3) have "aggregate noncontingent liquidated secured and unsecured debts as of the date of the filing of the petition . . . in an amount not more than $7,500,000 . . . "; and (4) "not less than 50 percent of which arose from the commercial or business activities of the debtor . . . ."4
Confident that no dispute existed regarding prongs 1 and 3, the court zeroed in on the remaining prongs 2 and 4, stating:
[T]his Court focuses on the following two remaining eligibility inquiries: (1) what actions are necessary for a debtor to be "engaged in commercial or business activities" and (2) does fifty percent or more of the debtor's aggregate debt have to arise from the same commercial or business activities relied upon for subchapter V eligibility ("Nexus Requirement")?5
First, the court noted that the majority of bankruptcy courts hearing subchapter V matters impose a “temporal restraint” upon the “engaged in” language in the first eligibility prong—meaning these courts look to a debtor’s activity as of the petition date. The court here promptly adopted the consensus view that Debtor was required to show that she was presently engaged in commercial or business activities as of the petition date.
Next, the court adopted the totality-of-circumstances approach to determine whether Debtor was engaged in commercial or business activities. The court explained that “a debtor can qualify for a subchapter V absent the company's traditional business operations where the company is winding down.”6 According to the court, there was enough winding down activity to satisfy the first prong since state court action was pending as of the petition date and involved commercial litigation between the parties. In other words, Debtor was engaged in commercial or business activities as required in 11 U.S.C. §1182(1)(A).
The court then moved on to consider whether 50% or more of the debtor’s aggregate debt had to arise from the same commercial or business activities being relied upon for subchapter V eligibility. As the court explained, this was viewed as the “Nexus Requirement,” which has created an existing split among the bankruptcy courts. Here, the court aligns itself with those courts that require the nexus and found:
As of the Petition Date, the Debtor was engaged in commercial or business activity in both Tom Murray and CHC. The Debtor has $671,398.91 of scheduled debt relating to the commercial or business activity of CHC. This debt is greater than 50% of the total $957,038.00 of liabilities reflected in the petition. Accordingly, the Court finds the Debtor has satisfied the Nexus Requirement because "not less than 50 percent of [the total debt] arose from the commercial or business activities of the debtor."7
In re Hillman is an important part of the emerging case law that is shaping how courts will apply subchapter V provisions in various situations. The decision clarifies that, in the subchapter V context, winding down activity includes the defense of a guaranty lawsuit which is pending as of the petition date. Moreover, the In re Hillman court joins other courts requiring that 50% or more of a debtor’s aggregate debt had to arise from the same commercial or business activities being relied upon for subchapter V eligibility (“Nexus Requirement”). It will be interesting to see how other courts do or do not follow In re Hillman.
