Subchapter V Conversion for Existing Chapter 11 Debtors

By: Eric Silverstein

St. John’s University School of Law

American Bankruptcy Institute Law Review Staff Member


Congress passed the Small Business Reorganization Act of 2019 (“SBRA”) to give small businesses a better chance to successfully reorganize under Chapter 11 of title 11 of the United States Code (the “Bankruptcy Code”).[1] One of the SBRA’s most important amendments was the addition of subchapter V to Chapter 11 of the Bankruptcy Code, which is designed to reduce the cost and complexity of a small business reorganization.[2] The SBRA is silent as to its availability to small business debtors that had filed for bankruptcy relief prior to the effective date of the statute, February 19, 2020.[3] In In re Ventura, the Bankruptcy Court for the Eastern District of New York held that an individual debtor who had been in Chapter 11 for over a year could amend her petition and proceed as a “small business debtor” under  subchapter V.[4]  Deirdre Ventura (the “Debtor”) was the owner and operator of the Harbor Rose, a bed and breakfast located in New York.[5] In addition to being the Debtor’s sole source of income, the Harbor Rose was the Debtor’s primary residence.[6] On October 24, 2018, the Debtor filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code with the Bankruptcy Court for the Eastern District of New York.[7] In her petition, the Debtor claimed to be an individual Chapter 11 debtor, not a small business debtor, and “described her debts as primarily consumer debt.”[8] On November 19, 2019, the court directed the Debtor and her primary creditor, Gregory Funding (“Gregory”), to propose separate plans of reorganization.[9] Upon review, the court found the Debtor’s plan unconfirmable because it bifurcated the mortgage encumbering the Harbor Rose into secured and unsecured claims under 11 U.S.C. § 1123(b)(5), but this section of the Bankruptcy Code excludes claims secured by the debtor’s primary residence.[10] The court therefore scheduled a hearing to consider confirmation of Gregory’s proposed plan.[11] However, the SBRA went into effect before the confirmation hearing.[12] Consequently, the bankruptcy court adjourned the confirmation hearing and gave the Debtor the opportunity to amend her petition to proceed as a small business debtor under subchapter V, which would allow the Debtor to bifurcate a mortgage encumbering the Harbor Rose as she proposed under her first plan.[13]

Gregory and the U.S. Trustee both objected to the Debtor’s subchapter V election.[14] The U.S. Trustee claimed that the SBRA imposes procedural requirements that retroactive debtors must satisfy.[15] In the instant case, the Debtor could not comply with those requirements because she had already been in bankruptcy for fifteen months, and the SBRA’s 90-day deadline for the filing of a plan had expired.[16] Gregory argued that allowing the Debtor to retroactively elect subchapter V would be prejudicial because it would impair its rights if the Debtor was allowed to bifurcate the mortgage.[17] Gregory also claimed that the Debtor’s assertion in her schedules that her debt is primarily related to consumer activity places her outside of subchapter V’s definition of a small business debtor, and estoppel should prevent her from changing that assertion now.[18]

The bankruptcy court held that the Debtor could amend her petition and proceed as a “small business debtor” under subchapter V.[19] The court emphasized that its objective was to reach a result consistent with the SBRA’s intent to “keep small business owners in business.”[20] Initially, the court found that the SBRA’s silence regarding its application to existing debtors did not bar the Debtor from amending her petition, and gave no credence to the U.S. Trustee’s procedural objections to the conversion of the Debtor’s case, claiming that it would be the “height of absurdity” to hold the Debtor to the timing requirements of a law that did not exist at the time of her filing.[21] Gregory’s prejudice arguments were similarly dismissed because Gregory will retain many of the rights it had at the inception of the case in subchapter V, including the right to apply the proceeds of the sale to its debt.[22] Any delay that does result would not be sufficiently prejudicial given the inherent difficulty of selling the property due to the economic conditions resulting from the Covid-19 pandemic.[23] The Debtor’s amendment was also consistent with the SBRA’s definition of a “small business debtor” even though the schedules indicated that her debt was “primarily consumer debt” because the Debtor’s “primary purpose of purchasing the property” was to operate a business, the Harbor Rose bed and breakfast.[24]

In reaching its conclusion, the court emphasized that Congress enacted the SBRA in recognition of the hardships facing small businesses that file Chapter 11 petitions.[25] The court also noted the role of the SBRA and subchapter V against the backdrop of the COVID-19 pandemic, especially given the hardship many small businesses face due to its impact.[26] At a time when severe economic disruption threatens many small businesses, the court adopted an inclusive approach to subchapter V and effectuated Congress’ intention to provide small business debtors with the benefits that have largely eluded them in Chapter 11 by removing its associated cost and complication.[27]

[1] See In re Ventura, 615 B.R. 1, 6 (Bankr. E.D.N.Y. 2020).

[2] See id.

[3] See id. at 13.

[4] See id. at 7.

[5] See id.

[6] See id.

[7] See id. at 8.

[8] See id.

[9] See id. at 10.

[10] See id.

[11] See id.

[12] See id. at 11.

[13] See id.

[14] See id. at 11–12.

[15] See id. at 14.

[16] See id.

[17] See id. at 17.

[18] See id. at 18, 20.

[19] See id. at 7.

[20] See id. at 24.

[21] See id. at 15.

[22] See id. at 18.

[23] See id.

[24] See id. at 20.

[25] See id. at 12.

[26] See id. at 6.

[27] See id.