In an individual Chapter 11 Subchapter V case, a group of creditors (“Creditors”) filed a motion to convert the case to Chapter 7. Finding cause for conversion under 11 U.S.C. § 1112(b) because Debtor filed the case in bad faith, the Court converted the case to Chapter 7.

Debtor filed his bankruptcy petition while he was incarcerated for civil contempt of the state trial court. The state court had adjudicated Debtor as having breached his fiduciary duties through a fraudulent scheme by which he took Mexican beachfront property from a Colorado LLC (of which he was a member and manager) for himself. During the state court litigation, Debtor lied under oath, hid his assets, and disobeyed orders of the court. His actions prompted the state court to sanction him on multiple occasions, including by granting Creditors a writ of attachment on Debtor’s assets. Debtor filed his bankruptcy petition on the eve of a state court damages hearing that had been continued twice. Debtor’s bankruptcy petition secured his release from jail without purging his contempt and further delayed the damages hearing against him for several months.

Postpetition, after the Court granted relief from stay, the state court held the damages hearing and liquidated over $21 million in damages against Debtor and in favor of Creditors. Due to the comparatively small amounts of his other debts (which were largely legal fees incurred from state court litigation), Debtor’s bankruptcy case was essentially a two-party case between himself and Creditors. Despite his dishonest prepetition conduct, Debtor filed a proposed Subchapter V plan that relied on him reinvesting funds and making $2 million in payments over five years, followed by a $22 million balloon payment at the conclusion of the plan. The Court questioned whether the proposed plan was feasible and proposed by means not forbidden by law.

Significantly, throughout the pendency of his Subchapter V case, Debtor knowingly held investments in cannabis companies. Because of these investments, Debtor argued that the Court must dismiss his case rather than have a Chapter 7 trustee administer illegal cannabis assets. The Court disagreed with Debtor, finding that based on the scant facts in the record—and because United States Trustee took no position on whether the case must be dismissed—Debtor’s seemingly attenuated connections to cannabis did not require dismissal instead of conversion.

In two jointly administered Chapter 11 Subchapter V cases, Creditor, a former insider of the two entity Debtors, objected to plan confirmation. Both Debtors were in the food/restaurant industry and experienced a significant downturn with the onset of the COVID pandemic in 2020. Prior to the bankruptcy case, Creditor helped start the businesses in 2012 and sold his ownership interests in 2018, with purchase price payments due to him over eight years. When the bankruptcy case was filed, Debtors had defaulted on the purchase price payments and the parties had failed to reach a corresponding settlement.

Creditor was the only party to object to plan confirmation. He claimed that the plan was not proposed in good faith, was not fair and equitable, and was not in the best interest of the creditors. He also disputed the accuracy of Debtors’ financial projections and liquidation analysis. He proffered his own competing plan.

After holding an evidentiary hearing on confirmation, the Court confirmed Debtors’ plan over Creditor’s objection. The Court found that, considering the totality of the circumstances, Debtors’ plan was proposed in good faith because Creditor’s buyout was not forced upon him, Debtors have been forthright throughout the bankruptcy process, the other creditors either accepted or did not oppose the plan, and because Subchapter V does not allow the Court to consider competing plans like Creditor’s. Although Creditor took issue with Debtors’ liquidation analysis, he did not offer any contradictory evidence. Finally, the plan was fair, equitable, and feasible because Debtors would pay the secured creditor in full and make payments above their projected disposable income to the unsecured creditors, and would have the cash to do so.

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.

In a case of first impression in the Tenth Circuit, the Court considered whether a Chapter 13 plan may be confirmed, notwithstanding that it fails to provide for payment of net proceeds from an exempt personal injury claim to creditors.

The debtor scheduled and claimed a 100% exemption in an unliquidated pre-petition personal injury claim. The debtor proposed a Chapter 13 plan which provided for payment of priority tax debt and the cure of arrearages on the debtor’s home mortgage over 5 years. The plan further provided for a 3.24% distribution to unsecured creditors but failed to provide for payment of any of the net proceeds of the personal injury claim to creditors. The Chapter 13 trustee objected to confirmation, arguing that under 11 U.S.C. § 1325(b)(2), the net proceeds of the personal injury claim should be included in the debtor’s disposable income for purposes of determining his payments under the plan. The Chapter 13 trustee also objected to the debtor’s claim of exemption in the personal injury claim, arguing that such claim should not re-vest in the debtor at confirmation because the net proceeds should be included in his disposable income calculation.

The parties submitted trial briefs, and the Court held an evidentiary hearing on the matter. The following facts were undisputed: the debtor was a below-median income debtor with a required plan commitment period of 3 years; the statute of limitations on the personal injury claim would run during the required 3-year plan commitment period; the debtor was injured during the automobile accident that gave rise to the personal injury claim; the debtor’s injuries required ongoing medical treatment; the debtor would be required to pay at least some of the costs of his ongoing medical treatment; and none of the debtor’s medical debts associated with the automobile accident were scheduled in his bankruptcy case because they had been paid by himself and/or his insurer as they came due.

The debtor made several legal and policy arguments against requiring debtors to include proceeds of exempt assets in the calculation of their disposable income under 11 U.S.C. § 1325(b)(2). The debtor’s primary arguments were threefold: (i) the plain language of 11 U.S.C. § 522(c) expressly shields exempt assets from pre-petition creditors; (ii) the “ability-to-pay test” in 11 U.S.C. § 1325(a)(4) compels a debtor to pay unsecured creditors the value of his non-exempt assets, therefore the debtor should not be required to pay the value of his exempt assets; and (iii) a personal injury recovery is not “disposable income” as that term is defined in 11 U.S.C. § 1325(b)(2), therefore it cannot be “projected disposable income” under 11 U.S.C. § 1325(b)(1).

The Chapter 13 trustee conceded that the personal injury claim was exempt but argued that courts generally hold that proceeds of exempt assets are disposable income under 11 U.S.C. § 1325(b)(2), regardless of a claimed exemption. The Chapter 13 trustee proposed to treat the net proceeds of the personal injury claim in this case in a manner consistent with his ordinary practice: (i) he would not object to the personal injury claim re-vesting in the debtor upon confirmation, so long as the plan provided that the net proceeds of such claim would be turned over to the Chapter 13 Trustee once received; and (ii) after the proceeds were turned over, the Chapter 13 Trustee would confer with the debtor to assess the debtor’s needs and reach an agreement as to what portion of the proceeds, if any, should be considered disposable income.

The Court noted that under 11 U.S.C. § 1325(b)(1), where a Chapter 13 plan does not provide for full repayment of unsecured claims and the Chapter 13 trustee or an allowed unsecured creditor objects to confirmation, the debtor must commit all of his projected disposable income to the plan. The Court observed that the Bankruptcy Code does not define “projected disposable income.” Post-BAPCPA, courts have determined that the starting point for calculating a debtor’s projected disposable income under 11 U.S.C. § 1325(b)(1) is the calculation of his disposable income under 11 U.S.C. § 1325(b)(2), which is calculated using his current monthly income under 11 U.S.C. § 101(10A). However, in cases where significant changes in a debtor’s financial circumstances are “known or virtually certain at the time of confirmation,” the Supreme Court concluded in Hamilton v. Lanning, 560 U.S. 505 (2010) that a forward-looking approach is the correct method of calculating a debtor’s projected disposable income.

The Court addressed each of the debtor’s arguments but focused the majority of its analysis on the interplay between 11 U.S.C. §§  522(c) and 1325(b)(2). The Court noted the pre-BAPCPA split of authority regarding whether exempt property must be included in the disposable income analysis. The majority of courts, relying on a distinction between the importance of exemptions in Chapter 7 and Chapter 13 cases and the plain language of 11 U.S.C. § 1325(b), held that exempt income must be included in the calculation. Whereas courts that adopted the minority view read 11 U.S.C. § 1325(b) in conjunction with 11 U.S.C. § 522(c) to protect exempt property from pre-petition debt and exclude exempt income from the calculation. The Court expounded upon the majority and minority views in the context of personal injury recoveries and ultimately agreed with the majority view.

The Court then analyzed the changes that BAPCPA made to 11 U.S.C. § 1325(b) and its addition of 11 U.S.C. § 101(10A) and determined that they did not warrant deviation from the pre-BAPCPA majority view. More specifically, 11 U.S.C. §§ 1325(b) and 101(10A) expressly exclude certain items from the respective definitions of “disposable income” and “current monthly income,” yet exempt personal injury recoveries are not among the enumerated exclusions. Thus, the Court found that a plain language reading of 11 U.S.C. §§ 1325(b) and 101(10A) generally requires that proceeds from an exempt personal injury claim be included in the calculation of a debtor’s projected disposable income. The Court noted that a plain language reading accords with the overarching policy behind BAPCPA of maximizing payments to creditors, and the Lanning Court’s forward-looking approach to calculating a debtor’s projected disposable income where changes in his financial circumstances are known or virtually certain at the time of confirmation.

However, the Court acknowledged that the debtor credibly testified at the evidentiary hearing regarding his need for ongoing medical treatment and the costs associated therewith. Thus, it was clear to the Court that at least some portion of the proceeds will be reasonably necessary for the maintenance or support of the debtor and, therefore, be carved out of his disposable income under 11 U.S.C. § 1325(b)(A)(i).  Accordingly, the Court denied confirmation of the debtor’s plan and ordered the debtor to file an amended plan which provided that all net proceeds of the personal injury claim, once received, shall be turned over to the Chapter 13 trustee, pending a determination of what portion of the proceeds are reasonably necessary for the maintenance and support of the debtor.