Bankruptcy Court Expands Eligibility for Small Business Owners Under Subchapter V

Nicholas Hasbún

St. John’s University School of Law

American Bankruptcy Institute Law Review Staff

            The Small Business Reorganization Act of 2019 (“SBRA”) created a new subchapter V of chapter 11 of title 11 of the United States Code (the “Bankruptcy Code”).[1] Subchapter V provides “an expedited process for small business debtors to reorganize quickly, inexpensively, and efficiently.”[2] Under Subchapter V, an individual may be a debtor if they are a “person” with less than $7.5 million in aggregate debt, engaged in commercial or business activities, with at least 50% of their total debts arising from such activities.[3] In In re Blue, a bankruptcy court in North Carolina held that an individual that earned “material” income not related to her defunct business in which a “significant portion of [her] debts arose” was eligible to be a debtor under subchapter V.[4] In February 2021, Gwendolyn Charlene Blue (“Blue”), the “sole owner and president” of Wirecentric, an information transport (“IT”) consulting service, filed a voluntary petition for relief under subchapter V with the bankruptcy court to restructure her outstanding debt.[5] After closing Wirecentric, Blue worked full-time at a law firm and was a freelance IT consultant.[6]

         The bankruptcy administrator (“BA”) (the governmental entity entrusted with supervising the administration of bankruptcy cases in North Carolina) and the  Subchapter V Trustee (the representative of the bankruptcy estate appointed in every Subchapter V case) objected to Blue’s subchapter V election for two reasons.[7] First, the objecting parties argued that the debt related to Blue’s former residence did not arise from commercial or business activities, notwithstanding Blue incurring debt to finance the repairs of the property to “make the house rentable.”[8] The BA contended that the original mortgage was taken out for personal reasons and the residence was  “only temporarily rented.”[9] Second, the Trustee and BA argued that Blue is not personally liable for the debt owed on a Small Business Administration (SBA) loan because she signed the note “in her capacity as the president of Wirecentric” and not individually.[10]

         Under subchapter V, a debtor must establish that:

(1) she meets the definition of a “person”; (2) she is “engaged in commercial or business activities”; (3) she does not have aggregate debt exceeding $7,500,000 as of the date of petition; and (4) at least 50 percent of her debts arise from the commercial or business activities of the debtor.[11]

In addition, the BA and Trustee contended that Blue was not engaged in commercial or business activities because Blue’s consulting service does not fall within Congress’ intended definition of commercial or business activity.[12] The court disagreed and found Blue’s consulting service for RHA and Technology Express sufficient to satisfy the second prong of the statute because she was “currently” engaged in a business activity to make a profit, which contributed materially to her income.[13] Further, the court, relying on other court’s broad interpretation of § 1182(1), concluded that a “nexus between the qualifying debts and the Debtor’s current business or commercial activities” is not required.[14]

         The court then analyzed whether “not less than 50 percent of [Blue’s] debt arose from commercial or business activities.”[15] The court held that Blue’s refinanced mortgage on her former residence did not arise from commercial or business activities, but the debts owed to the three creditors for the purpose of renovating the property did.[16] Next, relying on North Carolina law,[17] the court found that the SBA loan did not arise from Blue’s commercial or business activities since the loan was signed “solely in her capacity as a corporate officer” for Wirecentric.[18] The court concluded that Blue’s debt satisfied the fourth prong of § 1182(1)(A) and thus was a “debtor” as defined under the statute.[19]

         In reaching its conclusion, the court emphasized that Congress “chose very broad language” when drafting the SBRA in effort to provide relief for small business debtors.[20] The court held that a “nexus” was not required between debts and current business activities, and reasoned that “such an implication” would be “far too limiting for the remedial purposes of subchapter V.”[21]