"Just enough" is an undeniable — if informal — legal precept. The concept finds its way into canon from adequacy of pleading to application of equity.[1]

Recent rulings from bankruptcy courts throughout the United States confirm that "just enough" has now found a home in the nascent jurisprudence of Subchapter V eligibility. Among Subchapter V's eligibility requirements, a debtor must be engaged in and have more than 50% of its debts from commercial or business activity.

The U.S. Bankruptcy Court for the Middle District of Florida's July 23 decision in In re: Vertical Mac Construction LLC[2] expands the scope of "just enough" commercial or business activity to include a nonoperating debtor that merely maintains bank accounts, works with insurance adjusters and defense counsel, and prepares for the sale of its assets.

The Statutory Requirements for Subchapter V Eligibility

In 2019, Congress passed the Small Business Reorganization Act, or SBRA.[3] The addition of Subchapter V to the Bankruptcy Code is one of the principal features of the SBRA. Generally, Subchapter V affords small business debtors a new avenue of Chapter 11 relief with truncated procedures intended to decrease the time and expense of bankruptcy.

A debtor is eligible for relief under Subchapter V of the Bankruptcy Code if it satisfies the eligibility requirements under Section 1182(1)(A) of the Bankruptcy Code. As temporarily modified by the Coronavirus Aid, Relief and Economic Security Act,[4] a Subchapter V debtor:

Must be a person, which includes a corporation;

Must be engaged in commercial or business activity, excluding single asset real estate debtors;

May not have more than $7.5 million in debt on the petition date; and

Must have more than 50% of its debt from commercial or business activities.

Section 1182(1)(B) of the Bankruptcy Code excludes a debtor that otherwise meets these requirements if the debtor is (1) one of a group of affiliated debtors that exceed the $7.5 million debt cap on the aggregate, (2) subject to certain reporting requirements under the Securities Exchange Act, or (3) considered an issuer under Section 3 of the same act.

At least two of the eligibility requirements are as straightforward as drafters can hope. "Person" and "corporation" are defined terms in Section 101 of the Bankruptcy Code and the aggregate cap for petition date noncontingent liquidated secured and unsecured debts presents a simple calculation.

By contrast, the terms "commercial or business activities" featured in the remaining two requirements afford greater room for interpretation.

The Broad Category of "Commercial or Business Activity"

The debtor has the burden to establish eligibility to file under a particular chapter — or subchapter in this case — of the Bankruptcy Code if a party challenges the debtor's election. The debtor must establish eligibility as of the date it filed its bankruptcy case.

In the Vertical Mac Construction case, the bankruptcy court recently addressed the U.S. trustee's objection to a nonoperating debtor's Subchapter V election.[5]

The debtor was a stucco installation contractor for residential property. In 2017, homeowners began filing construction defect claims against the debtor for improper stucco installation. Ultimately, in October 2020, the debtor ceased operations after being unable to obtain either renewal or replacement insurance coverage.

The debtor filed its Subchapter V case after it ceased operations and filed a motion to sell substantially all of its assets under Section 363 of the Bankruptcy Code. The U.S. trustee objected to the sale and argued that the debtor was impermissibly using the case to liquidate its assets rather than reorganize — the debtor had no operations, did not pursue receivables or litigation and had no intention to resume operations.

The debtor focused on its prepetition activities and argued its former business operations satisfied the statute.

The court charted its own course and approved the sale after conducting a plain reading analysis of the terms "engaged" and "commercial or business activity" in Section 1182(1)(B) of the Bankruptcy Code. The court adopted the following definitions:

Engaged: Involved in activity; occupied, busy.

Commercial: Occupied with or engaged in commerce or work intended for commerce; of or relating to commerce; viewed with regard to profit.

Commerce: The exchange or buying and selling of commodities on a large scale involving transportation from place to place.

Business: A usually commercial or mercantile activity engaged in as a means of livelihood; dealings or transactions especially of an economic nature.

Activity: The quality or state of being active; behavior or actions of a particular kind.

The court concluded that the phrase "commercial of business activity" is broad and not limited to operations. As the court explained, "'[o]perations' insinuates a fully functioning business, but 'activities' encompasses acts that are business or commercial in nature but fall short of an actual operating business."

With this broad definition in mind, the court held that the debtor satisfied the "commercial or business activity" standard after considering the totality of the circumstances.

Although it was no longer operating, the debtor was still maintaining bank accounts, working with insurance adjusters and insurance defense counsel to resolve the construction defect claims, and preparing for the sale of its assets. Each of these constituted activities that were commercial or business in nature.

Additional Cases Interpreting "Commercial or Business Activities" for Subchapter V Debtors

The Vertical Mac Construction case joins a growing chorus of bankruptcy court decisions interpreting "commercial or business activities." Other cases[6] with similar holdings include In re: Ikalowych, In re: Offer Space, In re: Blue, and In re: Port Arthur Steam Energy LP.

In Ikalowych,[7] the U.S. Bankruptcy Court for the District of Colorado held on April 15 that an individual debtor met Subchapter V eligibility requirements because he (1) was an insurance salesperson earning wages from his sales; (2) personally guaranteed the debt of a repair business of which he was a part equity owner; (3) was the direct or indirect owner of two active LLCs and the manager of both; (4) continued to have corporate responsibility; and (5) performed limited services to wind down one business.

The U.S. Bankruptcy Court for the District of Utah held on April 22 in Offer Space[8] that maintaining a bank account, holding accounts receivable, exploring claims against a third party, managing the stock of the seller and "winding down its business and taking reasonable steps to pay its creditors and realize value for its assets" sufficient engagement in commercial or business activities.

In Blue,[9] the U.S. Bankruptcy Court for the Middle District of North Carolina found on May 7 that the debtor was engaged in commercial or business activity as the sole proprietor of a consulting business — even though she consulted only part-time for two clients and was employed full time by another business — because "consulting is clearly the delivery of services in exchange for a profit" that required her to provided "various business services" that "provide a material contribution to Debtor's income."

The U.S. Bankruptcy Court for the Southern District of Texas in its July 1 published decision in Port Arthur Steam Energy LP[10] held that a debtor that formerly operated a waste heat facility was still engaged in commercial or business activity on the petition date because it: (1) was managed by two principals of its limited partner under a management agreement and an independent contractor; (2) was litigating a multimillion dollar lawsuit against a flue gas provider; (3) was pursuing collection remedies on a $163,000 account receivable; (4) actively maintained its nonoperating facilities and related vehicles, including running technical parts of the facility and repairing storm damage; (5) proceeding to sell its assets in the bankruptcy case; (6) sold a $350,000 asset prepetition; and (7) filed reports and tax returns as required by state and federal agencies.

Courts are less likely to find sufficient commercial or business activities where the debtor is an individual who owns a nonoperating business, particularly where the business has been dissolved under applicable state law, including In re: Thurmon and In re: Johnson.

In Thurmon,[11] the U.S. Bankruptcy Court for the Western District of Missouri held on Dec. 8, 2020, that individual debtors who were retired and did not intend to return to business were not engaged in commercial or business activity where they merely owned the majority equity interest in the empty shell of a pharmacy business that sold its assets prepetition.

In its March 1 decision in Johnson,[12] the U.S. Bankruptcy Court for the Northern District of Texas found that an individual debtor was not engaged in commercial or business activity where he was the president of an oil and gas company owned by his mother because he was nothing more than an employee and was not conducting his mother's business for his own profit.

Key Takeaways for Liquidating and Nonoperating Subchapter V Debtors

Potential debtors should consider the evolving state of play as courts continue to delineate the boundary of just enough commercial or business activity to satisfy Subchapter V eligibility.

The considerations include whether the potential debtor is an individual or a corporation, whether the entity is active or dissolved under state law, whether the entity has sold substantially all of its assets prepetition and the remaining activities in which a nonoperating entity is involved.

The calculus becomes more complex for individual debtors, where courts have expressed a particularly divergent view of sufficient commercial or business activity that ranges from narrow interpretations to virtually all private sector wage earners with capital at risk or debts arising from their work.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] See, e.g., K-Tech Telecommunications, Inc. v. Time Warner Cable, Inc ., 714 F.3d 1277, 1284 (Fed. Cir. 2013) (A complaint "must give just enough factual detail to provide 'fair notice of what the . . . claim is and the grounds upon which it rests.'") (emphasis added); Highway Cruisers of Cal., Inc. v. Sec. Indus., Inc., 374 F.2d 875, 876 (9th Cir. 1967) ("Equity has many reeds. A characteristic of it is that one may not get all of the reeds. One may get just enough relief to stop the evil where it is apparent no great damage was done[.]") (emphasis added).

[2] See In re Vertical Mac Constr., LLC , Case No. 6:21-bk-01520-LVV, 2021 WL 3668037 (Bankr. M.D. Fla. July 23, 2021).

[3] Pub. L. No. 116-54, § 5, 133 Stat. 1079 (2019).

[4] Pub. L. No. 116-136, 134 Stat. 281, 310-12 (2020).

[5] See Vertical Mac Constr., LLC , Case No. 6:21-bk-01520-LVV, 2021 WL 3668037.

[6] Another line of cases holds that the phrase "engaged in commercial or business activities" should not be limited to the petition date. See, e.g., In re Wright , Case No. 20-01035-HB, 2020 WL 2193240 (Bankr. D.S.C. Apr. 27, 2020); In re Blanchard , Case No. 19-12440, 2020 WL 4032411 (Bankr. E.D. La. July 16, 2020); In re Bonert , 619 B.R. 248 (Bankr. C.D. Cal. 2020). However, the cases discussed below in this article disagree. See, e.g., In re Blue, — B.R. —, 2021 WL 1964085, at *6 (Bankr. M.D.N.C. May 7, 2021) (discussing rejection of Wright-Blanchard-Bonert petition date analysis). These cases hold that the debtor must be engaged in commercial or business activities as of the petition date and explore the scope of activities that may constitute engagement in commercial or business activities.

[7] In re Ikalowych , Case No. 20-17547 TMB, 2021 WL 1433241 (Bankr. D. Colo. Apr. 15, 2021).

[8] In re Offer Space , Case No. 20-27480, 2021 WL 1582625 (Bankr. D. Utah Apr. 22, 2021).

[9] In re Blue , — B.R. —, 2021 WL 1964085 (Bankr. M.D.N.C. May 7, 2021).

[10] In re Port Arthur Steam Energy, L.P. , 629 B.R. 233 (Bankr. S.D. Tex. 2021).

[11] In re Thurmon , 625 B.R. 417 (Bankr. W.D. Mo. 2020).

[12] In re Johnson , Case No. 19-42063-ELM, 2021 WL 825156 (Bankr. N.D. Tex. Mar. 1, 2021).

Reprinted with permission from Law360(c) 2021 Portfolio Media. Further duplication without permission is prohibited. All rights reserved.