Debtor Cannot Proceed Under Bankruptcy Subchapter V

(Parker Tax Publishing January 2022)

In a case of first impression, a bankruptcy court held that a debtor was not entitled to proceed under the Small Business Debtor Reorganizations provisions of Chapter 11, Subchapter V, because she did not meet the requirement of being a "debtor." The court concluded that the debtor (1) failed to meet her burden of proof to show that she is presently engaged in commercial or business activities, and (2) did not prove that 50 percent of her total debt, the majority of which was owed to the IRS, arose from commercial or business activities. In re Rickerson, 2021 PTC 391 (Bankr. W.D. Pa. 2021).

Background

Ruthellen Rickerson is a physician who specializes in obstetrics and gynecology. She filed a voluntary bankruptcy petition under Chapter 11 on June 3, 2021. In her petition, Rickerson checked the box indicating that she is a "small business debtor" who was choosing to proceed under Subchapter V of Chapter 11 of the Bankruptcy Code.

Rickerson is employed as a "physician adviser" by an entity named OPTUM, a part of the United Health Group. Her job duties with OPTUM include doing secondary admission reviews for hospital patients. Rickerson does not have any equity or ownership interest in OPTUM and is not a manager or officer of that company. She works there full-time and her current gross monthly income from OPTUM is $13,925.

Rickerson is also an owner in three different legal entities, all created in or around late-1997, that were related to her former active practice as a treating ob-gyn physician in Titusville, Pennsylvania. One of the entities was Ruthellen D. Weeks, P.C., a professional corporation of which Rickerson was the 100 percent owner and president (Professional Corporation). A second entity was formed for conducting the actual medical practice itself (Medical Company) and it was owned 50 percent by Rickerson and 50 percent by Dr. Leonard Ferreira, who was Rickerson's partner in the practice. The third entity was a general partnership that owned real estate at 602 W. Central Ave., Titusville, Pa. where the Medical Company operated its practice (Real Estate Partnership). The Real Estate Partnership was owned 50 percent by Rickerson and her husband, and 50 percent by Dr. Ferreira and his wife, with each pair of spouses holding their share as tenants by the entireties.

The 602 W. Center St. property was financed with a $475,000 loan that the Real Estate Partnership obtained from PNC Bank in late-1997. That loan was secured by a mortgage which included the Rickerson's residence and it was assigned to National Loan Investors (NLI) in 2002. In 2017, there was a foreclosure and sheriff sale on the 602 W. Center St. property but it was not sufficient to pay off the loan. As a result, NLI then obtained a judgment in mortgage foreclosure against Rickerson's residence in the amount of $339,201 which included real estate tax advances made by NLI on the residence in the amount of $11,678.

In 2014, the medical practice was sold to an unrelated entity and Rickerson's employment with the practice was terminated several months later. Rickerson subsequently went to work for OPTUM as a W-2 employee. By 2017, neither the Medical Company nor the Real Estate Partnership owned any assets or were conducting any business operations. Likewise, by 2017, the Professional Corporation had been defunct for a number of years. As the result of an impending sheriff sale scheduled on her residence, Rickerson filed for bankruptcy under the provisions of Subchapter V of Chapter 11 of the Bankruptcy Code.

Subchapter V of the Bankruptcy Code

The Small Business Reorganization Act of 2019 (SBRA) (Pub. L. 116-54) provides that a small business debtor applying for a discharge of debts may elect at the time of filing to proceed under Subchapter V of chapter 11 of the Bankruptcy Code. SBRA was enacted to provide a fast track for small businesses to confirm a consensual plan with the assistance of a private trustee. Filing for bankruptcy under SBRA increases a debtor's ability to negotiate a successful reorganization while retaining control of the debtor's business, reduces unnecessary procedural burdens and costs by eliminating the creditors' committee and disclosure statement requirements for the plan of reorganization, and ensures quick reorganizations.

To be eligible to file for bankruptcy under Subchapter V, 11 U.S.C. Section 1182(1)(A) provides that a debtor must be "a person engaged in commercial or business activities ... 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 $7,500,000 (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." Only individuals who fall within this definition are permitted to be bankruptcy debtors under Subchapter V.

Before a bankruptcy court, the bankruptcy trustee and NLI argued that Rickerson did not qualify under this definition. First, they said, she is not "a person engaged in commercial or business activities" within the meaning of the statute because her previous business ventures related to the medical practice that terminated and ceased any operations a number of years ago, and since then she has been only a W-2 employee of OPTUM, a company which she neither owns nor manages. Second, they argued that Rickerson could not show that at least 50 percent of her debt arose from her commercial or business activities. Rickerson conceded that $151,194 of her debt was consumer debt, but asserted that the remainder was business debt. That remainder consisted of: (1) $352,579 owed to NLI; (2) $556,991 owed to the IRS; and (3) $48,504 owed to the Pennsylvania Department of Revenue.

Analysis

The bankruptcy court held that Rickerson was ineligible to proceed under Subchapter V because (1) her employment by OPTUM did not constitute "engaging in commercial or business activities" within the meaning of Section 1182(l)(A), and (2) she did not prove that 50 percent of her total debt arose from her commercial or business activities.

The court noted that the key phrase "person engaged in commercial or business activities" may be broken down into three component parts: (1) person, (2) engaged in, (3) commercial or business activities. The court said that, while the term "person" is defined in the Bankruptcy Code as including individuals, partnerships, and corporations, and Rickerson clearly met that definition, the Bankruptcy Code does not provide any definitions for the remaining two components. The phrase "engaged in" seemed clear enough to the court on its face as requiring the person to be involved in or to take part in commercial or business activities. However, the court questioned whether a Subchapter V debtor must be engaged in commercial or business activities at the time the bankruptcy case is filed, or was it sufficient that the debtor was engaged in commercial or business activities at some time in the past though is no longer doing so at the time the petition is filed? The court concluded that the most natural and apt plain language reading of this term as written in the statute imports a condition of contemporaneity into the definition. In reaching its conclusion, the court agreed with the analysis set out by the bankruptcy court in In re Johnson, 2021 WL 825156 (Bankr. N.D. Tex. 2021) where that court noted that Congress was not writing on a blank slate when Subchapter V was created because the Bankruptcy Code already included the same "engaged in" phrase in other contexts and it had been interpreted to include a present tense requirement, such that a debtor's past engagement in commercial or business activity was not sufficient.

Observation: Other courts have found that even if the debtor has ceased any actual buying and selling of goods and services for profit as of the time of the filing of the bankruptcy petition, a debtor can still be found to be presently engaged in commercial or business activities based on a totality-of-circumstances approach if the debtor is still in the process of concluding the business.

With respect to the issue of whether Rickerson met the 50 percent debt requirement, the court noted that the parties vigorously disputed how Rickerson's IRS debt should be treated in this context. As neither side presented the court with any legal authority as to how a personal income tax obligation should be treated in the context of Subchapter V (i.e., as a business debt or something else), and because the court could not find any such authority, the court found this to be an issue of first impression. After evaluating similar questions that arose in other settings, the court looked at the portion of taxes that arose when Rickerson was an independent contractor, when it was her responsibility to pay her taxes but she failed to do so. Based on the confusion and lack of evidence in the record as to that portion of the tax debt, the court concluded that Rickerson failed to meet her burden of proof to show that any of the IRS tax debt should be treated as business debt. The court made a similar determination with respect to Rickerson's Pennsylvania tax debt. As a result, Rickerson had proven only that an amount well below 50 percent of her total debt arose from her commercial or business activities.

Finally, the court rejected NLI's motion to have the case dismissed for cause. While the court found that NLI's request had some merit, the court said it did not believe it was enough to dismiss the case this early in the process, especially since NLI offered little to show any bad faith in connection with Rickerson's bankruptcy filing.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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