When Is a Small Business Debtor Not a Small Business Debtor?

One of the changes that the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 made to small business bankruptcy cases was to eliminate the ability to opt in to treatment as a small business debtor. However, it appears that the Bankruptcy Rules may have given back the option which Congress intended to take away.

Under the 1994 bankruptcy reform legislation, special provisions for small business debtors were created. However, debtors were given the option to elect whether to be considered as a small business debtor and few did. The National Bankruptcy Review Commission recommended that this option be removed, stating:

The Commission recommends that choice of treatment as a "small business" debtor under the Bankruptcy Code should not be optional. If as a policy matter, Congress decides that small business debtors merit special treatment under the Bankruptcy Code, all debtors who meet the definition of "small business" should be subject to the same special track. Otherwise, the separate track will not likely be used.

Report of the National Bankruptcy Review Commission, Sec. 2.5.1.

BAPCPA added a new definition of "small business debtor" to the Bankruptcy Code. Under Sec. 101(51D), a debtor was a small business debtor if: (i) it was a person engaged in commercial or business activities (ii) but not a person whose primary activity was the business of owning or operating real property (iii) that has aggregate noncontingent liquidated secured and unsecured debts as of the date of the petition or the date of the order for relief in an amount not more than $2,000,000 (which has been adjusted for inflation to $2,190,000) and (iv) for which a creditor's committee has not been appointed or is not sufficiently active and representative to provide effective oversight of the debtor. Under this definition a debtor either is or is not a small business debtor. There is no choice in the matter.

If a person is a small business debtor, it is subject to added scrutiny designed to weed out nonviable cases. 11 U.S.C. Sec. 1116. It is also subject to more flexible provisions for proposing and confirming a plan. A small business debtor has an exclusivity period of 180 days (as compared to just 100 days for a small business debtor under the prior law). 11 U.S.C. Sec. 1121(e)(1). However, the outside date for any party to file a plan is 300 days. 11 U.S.C. Sec. 1121(e)(2). The debtor is allowed to file a combined plan and disclosure statement and receive conditional approval of its disclosures, thus eliminating the need for a separate disclosure statement hearing. 11 U.S.C. Sec. 1125(f). However, the plan proponent must obtain confirmation of a plan within 45 days after filing. 11 U.S.C. Sec. 1129(e).

Thus, the small business debtor provisions offer a series of carrots and sticks which are intended to be mandatory. However, Fed.R.Bankr.P. 1020(a) brings the right to elect in through the back door. Under this Rule, "the debtor shall state in the petition whether the debtor is a small business debtor." The U.S. Trustee and creditors may object to this statement within 30 days after the conclusion of the creditors' meeting. However, "the status of the case with respect to whether it is a small business case shall be in accordance with the debtor's statement . . . unless and until the court enters an order finding that the debtor's statement is incorrect."

Thus, a debtor can make an election not to be treated as a small business debtor by checking the wrong box and hoping that no one objects. One of the reasons that Congress eliminated the small business election was the perceived apathy of creditors in these cases. However, the provision in the rules allows debtors to make an incorrect designation and count on creditor apathy to allow it to pass unnoticed.

However, the fact that the debtor has a de facto election does not mean that the debtor can change status at will. In the case of In re Save Our Springs (SOS) Alliance, Inc., 393 B.R. 452 (Bankr. W.D. Tex. 2008), a debtor designated itself as a small business debtor. The debtor was arguably not eligible to be a small business debtor because it was an environmental advocacy group, which likely would not fall within the definition of a person engaged in commercial or business activities. The debtor proposed a plan which was hotly contested. By the time that the court denied confirmation, the debtor was beyond its 300 day window for proposing a plan. The debtor then amended its petition to revoke its designation as a small business debtor. The court found that having received expedited treatment based on its designation as a small business debtor, the debtor was judicially estopped to say that it wasn't. As a result, the court dismissed the case.

However, an incorrect designation may be corrected. In a case where I am involved, the debtor's previous counsel failed to check the box to indicate small business status. The debtor then proposed a combined plan and disclosure statement within the 300 day window given to a small business debtor. When the court noted that the debtor had not designated itself as a small business debtor, I filed a motion to designate the debtor as a small business debtor which the court granted. The difference in my case was that the debtor had never tried to obtain a benefit from not being a small business debtor and indeed had acted as if it were one from the beginning of the case. (Of course, it probably also helped that the designation in my case really was incorrect).

Thus, the small business election lives on in a practical sense, but is subject to challenge.