Before the Court were jointly administered Chapter 11 cases, consisting of a corporate debtor and the principal of the same. First, in an issue of first impression, the Court considered whether the debtors, whose cases were filed prior to the enactment of the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) and the effective date of the Small Business Reorganization Act of 2019 (“SBRA”), could retroactively elect to proceed under Subchapter V when their respective debts on the petition date exceeded $2,725,625 but were less than $7.5 million.
The Court noted that there is no statutory prohibition to applying SBRA to cases that were pending prior to its effective date. Thus, citing In re Body Transit, Inc., 613 B.R. 400 (Bankr. E.D. Pa. 2020), the Court found that an eligible pre-SBRA debtor may generally amend its petition to elect to proceed under Subchapter V, subject to providing notice and an opportunity to object to all parties-in-interest under Fed. R. Bankr. P. 1009(a) and 1020(b) and, in the event of an objection to such election, a finding that the level of prejudice to the objecting party does not override the debtor’s right to amend its petition under Rule 1009(a). However, under the principles of statutory construction, the Court concluded that the increased debt limit provided for by the CARES Act to qualify as a debtor under SBRA unambiguously applied only to debtors whose cases were filed on or after the date the CARES Act was enacted. Accordingly, the Court held that because the debtors’ cases were filed prior to the enactment of the CARES Act, and their respective debts exceeded $2,725,625 on the petition date, the debtors were not eligible to proceed under Subchapter V.
Second, the Court weighed the debtors’ alternative request to dismiss both cases to refile under Subchapter V, against their largest creditor’s request to appoint a Chapter 11 trustee in both cases. Notably, the debtors and the creditor were embroiled in pre-petition district court litigation which culminated in a five-day bench trial and a fifty-six-page opinion and judgment in favor of the creditor and against the debtors for federal trademark infringement, Colorado common law trademark and trade name infringement, misappropriation of trade secrets, and breach of fiduciary duty. At the time of this Court’s ruling, the district court judgment was on appeal.
In the corporate case, the Court noted that the creditor advanced a multitude of arguments as to why the Court should order the appointment of a Chapter 11 trustee. In the interest of brevity, the Court focused its analysis on the five arguments which the Court found were most compelling and unrefuted by the debtors. First, the Court found that, pre-petition, the principal of the corporate debtor had admittedly undertaken a series of dishonest actions in the formation of the corporate debtor. Second, the Court found that, by virtue of the principal’s former role as employee and director of the creditor, the principal had admittedly breached his fiduciary duties to the creditor in the formation of the corporate debtor. Third, the Court found that the corporate debtor had mislabeled several lots of product pre-petition and sold the mislabeled, adulterated product to customers at the cost of unadulterated product. The Court further concluded that, post-petition, the corporate debtor failed to take any action to determine whether the mislabeled product was still in use by customers and, if so, to recall the mislabeled product. Fourth, the Court found that the corporate debtor’s monthly operating reports were perpetually inaccurate and untimely amended. Finally, the Court found that the corporate debtor’s monthly operating reports reflected continuing losses, and that certain projected future revenues which could render the corporate debtor profitable, were highly speculative.
For the above reasons, and due to the resulting mistrust, acrimony, and deadlock between the parties, the Court held that there was cause to appoint a Chapter 11 trustee under 11 U.S.C. § 1104(a)(1), and that such appointment was in the best interests of the estate and its creditors under 11 U.S.C. § 1104(a)(2).
In the principal’s case, the Court noted that the same mistrust and acrimony that was present between the parties in the corporate case, was also present between the parties in the principal’s case. However, the Court found that the creditor presented little additional, unrefuted evidence to compel the appointment of a Chapter 11 trustee in the principal’s case. The Court noted that the principal exemplified the purest example of an individual Chapter 11 debtor in that he was not a sole proprietor, did not manage any significant amount of real property, and generated no income outside of his relationship with the corporate debtor. Thus, the Court concluded that, because there would be little for a Chapter 11 trustee to manage in the principal’s case, the costs associated with the appointment of such trustee would outweigh any benefit derived by the estate. In fact, the Court believed that many of the creditor’s concerns regarding the principal’s case were adequately addressed by the appointment of a Chapter 11 trustee in the corporate debtor’s case.
For the above reasons, the Court held that the creditor failed to establish cause for the appointment of a Chapter 11 trustee in principal’s case, or that such appointment was in the best interests of the estate and its creditors. Instead, the Court found that the debtors had established cause to dismiss the principal’s case.
The Court noted that cause may exist to grant a debtor’s motion to voluntarily dismiss his Chapter 11 case when there has been a material change in circumstances post-petition. Here, the Court found that changes in the law ushered in by both SBRA and the CARES Act constituted such a material change in circumstances. Citing low success rates and obstacles frequently faced by individual Chapter 11 debtors, Court noted that Chapter 11 has historically been a poor fit for many individual debtors. The Court noted why Subchapter V may be a better fit for individual debtors but explained that Subchapter V also affords no shortage of protections for creditors.
The Court ultimately concluded that creditors would not be prejudiced by the dismissal of the principal’s case to refile under Subchapter V. Rather, in light of the streamlined provisions of Subchapter V, intended to achieve a timely and cost-effective reorganization, the Court held that dismissal of the principal’s case under 11 U.S.C. § 1112(b) was in the best interests of the estate and its creditors.