It’s the Wild West of “firsts” in these opening days of the Small Business Reorganization Act of 2019 (SBRA), which went live on February 19, 2020. We blogged about the first ever small business Subchapter V case here and provided some opening filing stats here. On Friday, Stone & Baxter even filed the first Sub V case in Georgia. More importantly, it appears that Judge Scott C. Clarkson, a bankruptcy judge in Central District of California, is the first judge to issue a substantive opinion about Sub V, and about one of its most talked-about issues no less:

Can a pre-Sub V small business debtor amend its petition to elect Sub V treatment?

In his late Friday opinion (8:10 EST for me), Judge Clarkson suggested (held?) that the SBRA does not, per se, prohibit retroactive Subchapter V designations. 

Background

The case is In re Progressive Solutions, Inc., a late 2018 (pre-Sub V) small business Chapter 11 case involving a Brea, California debtor who, among other things, licenses software solutions to municipalities for tracking and receiving licensing fees and penalties. Lewis Landau agreed to represent the debtor for an initial retainer of $25K. The debtor identified as a small business debtor on its November 2018 petition, with, according to the schedules, $556K in assets, $1.1M in liabilities, and revenues in 2017 of around $1M.

Approximately $977K of the liabilities represent disputed attorneys’ fees and costs awarded to the City of Oakland in a 2016 trade secret misappropriation lawsuit that the debtor had filed against the City and one of its employees. The Northern District of California awarded the fees to the City after it granted summary judgment in the City’s favor. The debtor appealed the fee award to the Ninth Circuit Court of Appeals, sought unsuccessfully a stay pending appeal, and filed the Chapter 11 in response to aggressive collection.

In April 2019, the debtor filed a preference action to avoid the City’s judgment lien, which action the parties dismissed in July 2019 on the condition that the City release its claim of lien. On May 20, 2019, the plan filing deadline, the debtor filed its Small Business Plan. The City objected to the Plan, including on the alleged bases of unfair discrimination of the City’s claim versus other claims and of violation of the absolute priority/new value rule.

In July 2019, the debtor filed an Amended Plan. In August, the City filed a competing Plan wherein it proposed to sell 100% of the equity interest in the debtor to Eckler Capital for at least $100,000, with an accelerated payment proposal for the City’s claim and other claims. In September, the Court considered the competing Plan on a preliminary basis and, unable to confirm the debtor’s Amended Plan, continued the September hearing to November, with a request for additional briefing on the two plans. 

The parties entered into a stipulation whereby the City withdrew its Plan and the parties agreed to continue the confirmation hearing on the debtor’s Amended Plan to January 9, 2020 to permit settlement discussions. Ultimately, the Court ordered that January 9 would be a status conference. Settlement discussions ensued in December, leading to a motion by the debtor to continue the January hearing to February 20, 2020, so as to permit further discussions and to give the debtor time to file three pleadings: 

• A motion for authority to amend its 2018 petition to elect Sub V treatment;
• A Second Amended Plan to comply with the SBRA-specific confirmation requirements and, in process, to eliminate the plan issues that prevented confirmation in September;
• A motion to have the Second Amended Plan confirmed under Subchapter V.

The debtor filed the pleadings on January 30, 2020, with the hearing set for February 20, 2020, one day after the SBRA effective date.

The United States Trustee and the City of Oakland objected to the pleadings. Judge Clarkson took them up on February 20 and ruled late on Friday.

Ruling

After considering the pleadings, hearing from the parties, and reviewing the docket, Judge Clarkson held that, despite practical issues that the United States Trustee might have to bear in accommodating retroactive Sub V Elections, there is “no legal reason to restrict a pending [pre-SBRA] Chapter 11 case to re-designate to a Subchapter V case.”

The first half of the Order contains a thorough summary of the SBRA’s legislative history, written with the precision and in the style of someone who previously spent 12 years on Capitol Hill and spent 1977-1982 as a legislative assistant to U.S. Congressman Harold L. Volkmer in D.C. Indeed, with the Congressman assigned to the House Judiciary Committee, Judge Clarkson found himself in his prior life working side by side for two years with Richard Levin and Ken Klee as the Committee created the 1978 Bankruptcy Code.

[Note: In reading the Order, it occurred to me that Sen. Amy Klobuchar, who Judge Clarkson quotes among others, could do a lot worse in her bid for the Presidency than trumpet her early support for the SBRA and desire that “Main Street have the same opportunities as big businesses” to enjoy bankruptcy protection.]

The second half of the Order addresses the two motions. Specifically, Judge Clarkson walks those of us who did not attend the hearing through the Court’s and the lawyers’ extensive conversation about whether the SBRA contains any explicit limitations on a pre-SBRA debtor’s ability to make a retroactive Sub V Election and, if it doesn’t, the procedural, practical, and substantive implications of permitting one:

• Does the SBRA contain such limitations? No, according to the Court and as “conceded” by the parties at the hearing, “nowhere in the SBRA are there stated limitations to the applicability of the SBRA (including new preference recovery provisions) to [already] pending cases.”
• Would a retroactive election disturb already-vested rights or other pre-election events in the case? Not only were the parties unable to provide examples of how vested rights would be disturbed by a retroactive election, but Judge Clarkson’s independent review of the docket didn’t reveal any. Of course, the Court focused in on the most obvious potential example, that being the City’s competing Plan. Given that Subchapter V doesn’t permit competing plans, the City’s prior withdrawal of its competing Plan was, to say the least, providential for the debtor.
• Would a retroactive election pose unworkable practical or procedural problems? Judge Clarkson paid serious attention to the United States Trustee’s “very good points regarding the practicality and scheduling issues arising from a SBRA designation of a pre-effective date pending case.” The Trustee’s concerns are what you’d imagine they would be, including concerns about accommodating Subchapter V’s demanding front-end deadlines for the IDI, 341, and Sub V Status Conference for a case that was already a year old. To the United States Trustee’s credit, the Trustee did not press for retroactivity limitations and conceded that the Court, in its discretion, could cut through those concerns with extensions and the like. 
• Do practical and procedural problems defeat the debtor’s right, if any, to make a retroactive election? Ultimately, Judge Clarkson held that, even if a retroactive election would result in “redundant” events in the case or be “procedurally awkward, there are no bases in law or rules to prohibit a resetting or rescheduling of these procedural matters.”
• Would it be better to just dismiss the case and file again? The United States Trustee made that suggestion and, to the Court’s surprise, no participating creditor objected. Nevertheless, the debtor declined to make an oral motion to dismiss and Judge Clarkson was “unwilling to dismiss the case, sua sponte,” without proper notice.
• Are there any other prevailing considerations? Judge Clarkson concluded by emphasizing that (i) the “primary purpose of the SBRA is to promote successful reorganizations using the tools that are now available under current law” and (ii), per U.S. Supreme Court authority, “it remains the Court’s duty to ensure that no vested rights have been altered by application of a changed law.” “In this instance,” he concludes, “that has not occurred.”

In short, Judge Clarkson explained that “arguments against the pending case being designated by the Debtor as a Subchapter V case all have to do with practicality and not legality.”

What About the Pending Motions?

Of course, bankruptcy courts only rule on the motions or prayers for relief that are pending before them. Thus, to be precise, Judge Clarkson had just two live issues before him.

First, per the debtor’s Sub V Petition Motion, should the Court enter an order “authorizing the amendment of Debtor’s chapter 11 petition regarding election of Subchapter V of chapter 11, extension of the § 1189(b) deadline [i.e., the Sub V’s 90 day plan filing deadline], and such other and further relief as the Court deems just and proper”? Honestly, in deference to the uncertainty surrounding the SBRA, I would have likely filed the same motion for one of my clients. It’s cautious and would seem to bring the uncertainty to a head. Nevertheless, Judge Clarkson ruled that the motion was “procedurally infirm.” There’s a certain elegance in his simple ruling about Rule 1009 (dealing with amendments to petitions, statements, etc.):

As there is no legal requirement to have a court grant leave to amend the petition or schedules, and there are clear procedures for parties to later object to any amendments or designations (including a designation as a Subchapter V debtor within the new federal rules for the SBRA), this Court finds that the Motion is unnecessary and not required by law. When and if there is a designation by amendment to the Petition, opposing parties may file objections on a timely basis, and the Court may undertake eligibility considerations.

And because the debtor had not yet amended its petition, and no Sub V case was then pending, Judge Clarkson held that extending the § 1189(b) deadline and any other SBRA-related deadlines would be premature.

Second, per the debtor’s Sub V Plan Motion, should the Court enter an order confirming the debtor’s pending Sub V Chapter 11 Plan under § 1191(b)? To start, if we’re recognizing SBRA firsts, then we must recognize Mr. Landau, the debtor’s counsel, as the first attorney to have filed a Sub V confirmation brief–it’s 31 pages long, has a proper table of contents and table of authorities, and addresses the Sub V plan requirements, one by one and extensively.  Nevertheless, Judge Clarkson held that the Plan Motion was “premature for the reasons stated above and is denied without prejudice.”

Conclusion

I could be off, but here’s my quick read of Judge Clarkson’s thoughtful opinion.

On the one hand, he has concluded that Subchapter V, itself, contains no explicit prohibitions on pre-SBRA debtors (including old fashioned small business Chapter 11 debtors and perhaps even Chapter 7 debtors) making a retroactive Sub V Election, whether by an amended petition, a conversion from Chapter 7 to Chapter 11, or otherwise.

On the other hand, he does not appear to have concluded that such debtors can always, per se, make that retroactive election and have it respected. Rather, such debtors can, for example, unilaterally amend their petitions under Rule 1009 without leave, notice those amendments out to impacted parties, and let impacted parties object. And then, under what I’ll call a “facts and circumstances” approach, the Court will make a ruling, with practical and procedural awkwardness providing the least pause and the disturbance of vested rights, prior final orders, and the like providing the most pause. Indeed, what if the City of Oakland had never withdrawn its competing Plan?

But perhaps Judge Clarkson would tell us that he hasn’t concluded anything–not yet, at least. After all, his ultimate decisions on the Sub V Petition Motion and Plan Motion did not depend at all on whether he believes that the SBRA limits retroactive Sub V Elections or that such elections are ever, under the appropriate circumstances, proper. Rather, he denied the first motion under a plain reading of Rule 1009 and denied the second one because, at the close of the hearing, no Sub V Election was even pending. As the Court alludes to in a parting footnote, the debtor only served out its Amended Petition under Rule 1009 after the hearing. 

Thus, we’ll wait for Rule 1009 to play out and for the Court to “undertake eligibility considerations” under Subchapter V. For now, I’d like to think that Judge Clarkson knew exactly what he was doing when he started the nationwide conversation about such a bleeding edge issue, all while reserving a ruling on the merits and protecting the debtor, its creditors, and other parties-in-interest until such time when due process has attached. 

As a bonus aside: Our favorite posts are those that address or expose us to personalities and biographies of those in the bankruptcy bar or those who might impact it, such as the late Justice Scalia, the late Harvey Miller, and others. Judging by the “clicks,” our readers enjoy those posts, too. With that in mind, I thoroughly enjoyed my background reading about Judge Clarkson. Did you know that, for the 9th Circuit B.A.P., he wrote the In re Friedman decision–the last bastion of hope on the absolute priority rule for debtor lawyers like us before the Ninth Circuit went a different direction? Did you know that he’s an accomplished, world traveling photographer? And if you’re interested in “the life and 1656 Bankruptcy of the Dutch artist Rembrandt van Rijn,” then look no further than here.

Here is a link to his California Lawyers Association profile and his interview for the ABI Journal’s Chapter 8 Humor column, including a great story about him serving six visiting Buddhist monks from Thailand his secret family guacamole recipe while cruising around on “Starry Decisis,” his 42-foot Grand Banks trawler. The lesson is to have hobbies and enjoy life outside of the profession. With that, little Kate and I are headed to Academy for a fresh bucket of softballs for the upcoming 2020 Vine Ingle Minor League 10 and Under Season.    

**A hat tip to Judge Catherine Peek McEwen, a bankruptcy judge in the Middle District of Florida, for first pointing the Twitter world to Judge Clarkson’s Order. By the way, her Orlando Division had the first Florida Sub V case. However, her Twitter profile is far too humble about her title and day job: https://mobile.twitter.com/catmcewen/status/1231219926834335745

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