Subchapter V Role of the Trustee in Chapter 11 Bankruptcy


Chapter 11 Subchapter V cases are relatively new to the bankruptcy world. Subchapter V was added to Chapter 11 of the Bankruptcy Code in February 2020 to provide an efficient and cost-effective alternative process for small businesses wishing to organize under Chapter 11.

Unlike regular Chapter 11 corporate reorganizations, Subchapter V provides for the appointment of a trustee. However, sub-chapter V provides few details on the role of these trustees. This article explains how a court dealt with this ambiguity.

Background

In a regular Chapter 11 reorganization, no trustee is appointed. The debtor retains control of the business and takes on a new title of “debtor in possession”. The appointment of trustees has historically been limited to Chapter 7 liquidation cases. If the Chapter 7 debtor is a business, the trustee manages its affairs until its assets are liquidated and the business is liquidated.

Like Chapter 7 cases, the appointment of a trustee in a Subchapter V case is made by the US Trustee’s Office. Unlike Chapter 7 administrators, however, a Subchapter V administrator is a “non-operational” administrator. In other words, the Subchapter V trustee does not take control of the business. Like a normal Chapter 11 reorganization, the debtor retains control. Thus the question arises: What exactly is the role of the syndic of sub-chapter V?

‘Honest Brokers’

In a recent case, a bankruptcy court explained that the role of the subchapter V trustee is to provide oversight of the debtor in possession and to help facilitate negotiations between the parties who will vote on the plan of reorganization in order to to reach a consensus. In re Corinthian Commc’ns, Inc., 642 BR 224 (Bankr. SDNY 2022). The court dubbed them “honest brokers” and explained that they provide “credibility in assessing the prospects of the debtor’s business for a successful reorganization and facilitate[] negotiation of a reorganization plan with the debtor’s stakeholders, thus enabling small businesses to reorganise.

Allowing a small business owner to remain at the helm and direct the business increases an organization’s chances of success. Small business owners often have built their business and maintain personal relationships with their customers, employees and suppliers. Withdrawing the owner from the bankruptcy process can torpedo a successful reorganization. The drafters of Sub-Chapter V took this into account when they decided not to make the trustee in the present proceedings operating trustees.

But what if small business owners present obstacles to a successful reorganization? In Corinthian communications, the owners filled out fraudulent loan applications and engaged in gross mismanagement of the business. Their conduct included failure to comply with corporate formalities and the transfer of funds between the debtor company and the owners’ other businesses.

They also demonstrated a lack of credibility and transparency by failing to disclose material corporate and financial information in the bankruptcy filings, including insider ownership of a trust controlling the owner of the company. debtor company. They further failed to include copies of significant checks in the required monthly operating reports filed with the court. The court decided to extend the functions of the trustee of subchapter V.

Extension of the powers of the trustee of sub-chapter V

Section 1185(a) of the Bankruptcy Code permits the eviction of a debtor in possession “for cause, including fraud, dishonesty, incompetence, or gross mismanagement of the debtor’s affairs, either either before or after the date of commencement of the Case.” Further, if the debtor is removed as a debtor in possession, Section 1185(b)(5) provides that the Subchapter V duties of the trustee will be extended to business operations.

Thus, the debtor could be ousted for its problematic behavior and the sub-chapter V trustee replaced as the “operating trustee”. However, the court of Corinthian communications worried about how this would affect the likelihood that a small business would be able to reorganize. Given the personal relationship dynamics involved with so many small businesses, removing the owner could prevent a successful reorganization.

The court opted for a medium term. Section 1183(b)(2) permits a court “for cause and upon application by an interested party, the Trustee or the United States Trustee” to order that the powers of a Trustee of the Subchapter V be extended to include powers “to inquire into the acts, conduct, assets, liabilities and financial condition of the debtor, the operation of the debtor’s business and any other matter relevant to the case or the formulation of a plan » of reorganization Once the investigation is completed, the trustee reports to the court on the conclusions of the investigation.

The court found that there is a basis for sub-chapter V trustee powers when there are “significant issues such as the true financial position of the debtor, what assets belong to the estate, the management of the succession by the debtor as debtor in possession, and the accuracy and completeness of the debtor’s declarations and reports. The court also determined that a bankruptcy court may, on its own initiative, decide that the Subchapter V trustee’s powers should be expanded, even though Section 1183(b)(2) does not explicitly provide for an order. of sua spontaneous.

Conclusion

Takeaway meals from Corinthian communications is that the powers and responsibilities of the Sub-Chapter V trustee will generally be limited to those of a “non-operating” trustee, who merely provides oversight of the debtor company, provides an unbiased third-party assessment of the prospects for success of the debtor’s reorganization, and facilitates negotiations between the interested parties so that the debtor arrives at a consensual recovery plan. However, when matters involving the owners or management of the small business go badly, the bankruptcy court can intervene on its own or at the request of an interested party.

The court could start with a less aggressive approach, asking the subchapter V trustee to investigate and report. Or it can remove the owners from control altogether and place the debtor’s business in the hands of the subchapter V trustee.

While trustees in bankruptcy have been a long-standing staple in the field of bankruptcy, this expanded role puts the Subchapter V trustee in somewhat uncharted territory. Trustees have always been a creature of Chapter 7, whose purpose is to liquidate and distribute assets. Unlike Chapter 7, the purpose of a Sub-Chapter V proceeding is to reorganize and bring the business successfully out of bankruptcy. This can put a strain on trustees who typically handle a heavy caseload and will certainly be a factor in considering the full extension of powers to “operating trustee” status in Subchapter V cases.

See the original publication of this article on Bloomberg: Subchapter V Role of the Trustee in Chapter 11 Bankruptcy Where download pdf.

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