Debtors Not Required to Engage in Current Business Activities to be Eligible for Chapter 11 Relief Under Small Business Recovery Act

By Eric H. Horn and Heike M. Vogel

Continuing on our previous client update regarding changes to the Small Business Recovery Act (“SBRA”) imposed by the CARES Act, in a small business debtor’s Chapter 11 case, pending in the District of South Carolina, the Bankruptcy Court found that a Chapter 11 debtor’s business does not have to be currently operating in order to qualify for Chapter 11 relief under the SBRA.  See Charles Christopher Wright, Case No. 20-01035 (HB) (Bankr. D. S.C. April 27, 2020). So, why is this decision important, especially at this time? As addressed below, it further broadens the rights to seek bankruptcy protection not just by small businesses, but also by former owners of small businesses who continue to carry residual business debts.

Chapter 11 & the Small Business Recovery Act

On February 28, 2020, Charles Wright commenced a Chapter 11 case under the Small Business Recovery Act.  Mr. Wright listed that he was the sole member of Boiling Pot Investments, LLC, a Chapter 11 debtor that was dismissed on June 19, 2019.  Additionally, Mr. Wright listed that he was the 49% owner of Carolinas Custom Clad, Inc., another Chapter 11 case that was ultimately dismissed by the court on June 20, 2019.  At meetings held before the United States Trustee in those two Chapter 11 cases, Mr. Wright testified that both of those debtors ceased business operations in 2018.

In his present Schedules of Assets and Liabilities, Mr. Wright listed debts that were disclosed in both the Boiling Pot and Carolinas Custom Clad bankruptcy proceedings.  Indeed, Mr. Wright discloses a total of $395,816 in debt of which approximately $221,000 was listed as business debt (approximately 56% of the total debt) previously disclosed in the Boiling Pot and Carolinas Custom Clad bankruptcies.

U.S. Trustee’s Objection

On March 19, 2020, the United States Trustee filed an objection to Mr. Wright’s filing of the case as a small business case under the SBRA arguing that it does not qualify as a “small business”  since there are no current business operations. Indeed, both the Boiling Pot and Carolinas Custom Clad cases assets were sold and ultimately dismissed back in 2018.

Did the Owner have the Right to file under Chapter 11?

Considering the issue, the Court first analyzed the definition of “small business debtor” under Bankruptcy Code § 101(51D).  That section provides that

a person engaged in commercial or business activities (including any affiliate of such person that is also a debtor under this title and excluding a person whose primary activity is the business of owning single asset real estate) that has aggregate noncontingent liquidated secured and unsecured debts as of the date of the filing of the petition or the date of the order for relief in an amount not more than $2,725,625 (excluding debts owed to 1 or more affiliates or insiders) not less than 50 percent of which arose from the commercial or business activities of the debtor[.]

Considering the statutory language, the Court found that Wright met the definition of a small business debtor based only on the fact that Wright listed 56% of his total debt as residual business debt – which fell below the $2.7mm[1] cap set forth in the statute.  The Court determined that this was even the case where Wright did not currently conduct business operations – as the Boiling Pot and Carolinas Custom Clad cases were closed long before the filing of Wright’s Chapter 11 case.  In reaching that conclusion, the Court relied on an oft-cited bankruptcy treatise which states that:

The definition of a “small business debtor” is not restricted to a person who at the time of the filing of the petition is presently engaged in commercial or business activities and who expects to continue in those same activities under a plan of reorganization. That person may have incurred $2,725,625 in noncontingent, liquidated, secured and unsecured debts that arose from business activities before the date of the filing of the case, but as of the petition date may have discontinued those business activities. There is nothing in the legislative history to suggest that in this latter instance, the small business amendments should not apply to that person.

2 Collier on Bankruptcy ¶ 101.51D (16th ed. 2020).

What does this mean for Chapter 11 relief under the SBRA?

This decision is important because it expands the eligibility for Chapter 11 relief under the SBRA to entities that are no longer operating, but continue to carry business debts.  While this is one decision from a bankruptcy court, and it is not at all clear whether other bankruptcy courts faced with a similar issue will follow suit, nonetheless the findings by the South Carolina Bankruptcy Court could have tremendous implications and ultimately make SBRA Chapter 11 relief available even to parties or companies that are already out of business.

[1] Importantly, as discussed in our previous client alert, the statutory cap was increased to approximately $7.5 million for the next year.