The Restructuring Report

As has been widely reported, Congress recently reauthorized the $7.5 million debt threshold for subchapter V small business debtors, making subchapter V available to a significantly larger number of struggling businesses. With this change, the other requirements for a debtor to be eligible to elect subchapter V, takes on new importance.

A debtor is eligible to elect subchapter V if the debtor: (1) is a “person;” (2) is “engaged in commercial or business activities;” (3) does not have aggregate debts in excess of the debt limit on the petition date; and (4) at least 50 percent of the debtor’s debts arose from its commercial or business activities.

The second element — engaged in commercial or business activities — has been the subject of a growing body of case law.

The Ninth Circuit Bankruptcy Appellate Panel (BAP) recently joined a majority of courts in holding that, to satisfy this element, “a debtor need not be maintaining its core or historical operations on the petition date, but it must be ‘presently’ engaged in some type of commercial or business activities.” The court went on to apply a “totality of the circumstances” test to determine what types of activities satisfy this requirement when the debtor is no longer operational.

The case in which the Ninth Circuit Bankruptcy Appellate Panel heard, involved the bankruptcy of an entity that purchased or leased fractional interests in private aircraft. After the debtor got into a dispute with NetJets, it ended up in litigation and stopped operating. The debtor, however, claimed that it intended to resume operations and continue to engage in commercial or business activities. The BAP agreed, finding that under the totality of the circumstances, the debtor’s role in litigation, payment of aircraft registry fees, maintenance of good standing as a Delaware LLC, filing of tax returns, and payment of taxes were “commercial or business activities,” even though the debtor did not have a profit motive.

While a “totality of the circumstances” test creates as many questions as it answers, the BAP’s holding that a profit motive is not required, does help give contour to this element. Until further unfurled, we await developments in this area — all while more debtors seek to take advantage of the benefits of a subchapter V election.