Subchapter V Eligibility Requirements Under Chapter 11 Clarified

Tyler Manger

St. John’s University School of Law

American Bankruptcy Institute Law Review Staff

One of the requirements a debtor must meet in order to be eligible for Subchapter V of Chapter 11 of title 11 of the United States Code (the “Bankruptcy Code”) is that it must be "engaged in commercial or business activities."[1]Additionally, the specific commercial or business debt at issue must have arisen from commercial or business activities of the debtor and have accounted for at least half of the debtor’s aggregate debt.[2] In In re Hillman, the U.S. Bankruptcy Court for the Northern District of New York held that: (1) the debtor’s defense of a state court lawsuit which involved a defaulted commercial lease agreement qualified as a commercial or business activity under section 1182(1)(A) of the Bankruptcy Code; and (2) fifty percent (50%) or more of a debtor’s total debt must be related "to the specific commercial or business activity (or activities) being relied upon . . . for Subchapter V eligibility purposes."[3]

On March 4, 2022, Michelle Corbin Hillman ("Hillman") filed a voluntary bankruptcy petition and elected to proceed as a small business debtor under Subchapter V of Chapter 11 of the Bankruptcy Code.[4] Hillman claimed to own a fifty percent (50%) equity interest in two unrelated businesses: (1) Tom Murray USA Inc. ("Tom Murray"); and (2) Corbin-Hillman Communications Ltd. ("CHC").[5] Hillman’s petition reflected total liabilities of $957,038.00, none of which stemmed from her interest in Tom Murray.[6] Hillman’s largest creditor, ULM I Holding’s Corp. ("ULM"), filed a general unsecured claim in the amount of $671,398.91, which related to a prepetition state court lawsuit alleging that CHC defaulted on a commercial lease agreement.[7] Notably, Hillman’s petition reflected that CHC is "closed" and the value of her ownership in CHC was $0.00.[8] Both Hillman and CHC had separately responded to that complaint in state court, but Hillman verified CHC’s answer by claiming therein that she was its president.[9]Accordingly, in the bankruptcy case ULM argued that Hillman was not an eligible Subchapter V debtor, because she was not engaged in "commercial or business activities" with respect to CHC or Tom Murray. ULM pointed to the fact that Hillman had acknowledged that CHC was closed and that her activities associated with Tom Murray were better characterized as a hobby rather than commercial or business activities.[10] In response, Hillman argued that ULM conflated the term "business activities" as "business operations" and that courts have interpreted the statute broadly.[11]

The bankruptcy court found that Hillman was eligible for Subchapter V because Hillman’s involvement in CHC’s lawsuit qualified as an engagement in a "commercial or business activity."[12] A majority of courts apply a "totality of the circumstances" approach to determine whether a debtor is engaged in "commercial or business activities" under section 1182 of the Bankruptcy Code.[13] Courts have largely interpreted section 1182 broadly due to Congress’ intent to provide wide availability for debtors under Subchapter V.[14] With respect to determining eligibility, courts have noted that it is irrelevant whether the debtor was making a profit, actively operating, or intending to operate in the future.[15]

The second issue addressed in Hillman is whether a nexus is required between the qualifying "commercial or business activities" and the related debt of the debtor.[16] The bankruptcy court held that Hillman was an eligible Subchapter V debtor because her debt arose from CHC and accounted for more than fifty percent (50%) of her total debt.[17] The language of section 1182 has created a split among bankruptcy courts.[18] Some courts hold that the total debt may relate to any commercial or business activity, while others like the bankruptcy court here require that the total debt must relate to the specific commercial or business activity being relied upon for eligibility.[19] The bankruptcy court relied upon the In re Ikalowych decision, which held that the word “the” in the statutory text is critically important because it infers that the debtor’s debt must have arisen from the particular activity that ultimately led them to file for Subchapter V.[20]

The holding in In re Hillman seems to go against Congress’ intent to apply section 1182 of the Bankruptcy Code broadly because the requirement of a nexus limits the possible debt a debtor can rely upon. Accordingly, there is a limit to how far courts will go to give effect to Congress’ intent to have this statute applied broadly.