A recent decision has exposed a loophole in the Bankruptcy Code. Will the House of Representatives pass the Bankruptcy Threshold Adjustment and Technical Corrections Act to fix it? | Thompson Coburn LLP

On April 28, 2022, California Central District Bankruptcy Judge Ernest M. Robles issued a decision concerning the eligibility of a debtor to act as a small business debtor under Subchapter V of the Bankruptcy Code. In the decision, Judge Robles determined that the debtor, Phenomenon Marketing & Entertainment, LLC (“Phenomenon”), was not eligible to act as a small business debtor since at least two of the debtor’s affiliates were “issuers” under the Securities Exchange Act. of 1934 (“Exchange Act”). The decision highlights an issue first identified by the authors in a cover story published in the February issue of the American Bankruptcy Institute Journal titled Not-so-technical: A loophole in the Cares Act ‘small business debtor’ fix.

SBRA and Technical Issue with Subchapter V Eligibility

The Small Business Reorganization Act of 2019 (the “SBRA”) prevents publicly traded companies from proceeding under Subchapter V by excluding from the definition of small business debtor “any debtor that is a company subject to the reporting requirements under Section 13 or 15(d) of the Securities Exchange Act of 1934.”[1] The Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) amended SBRA to further limit Subchapter V eligibility by excluding “any debtor affiliated with an issuer.”[2] By using the phrase “an issuer”, which the Exchange Act broadly defines as “any person who issues or proposes to issue a security”, without any reference to the issuer being subject to the “reporting requirements” of the Exchange Act, the Bankruptcy Code not only ineligibles publicly traded Subchapter V companies and affiliates of publicly traded companies, but also facially disqualifies non-public companies simply because they have an affiliate who issued a security.

Legislative language problem and attempts to solve the problem

In the article, we proposed a solution whereby Congress could mitigate the potential over-exclusion of debtors from Subchapter V by deleting the phrase “of an issuer” and inserting “any debtor that is an affiliate subject to the reporting requirements under Section 13 or 15(d) of the Exchange Act of 1934 (15 USC 78m, 78o(d))”[3], which is the language used in § 101(51D)(B)(ii) and §1182(1)(B)(ii). Seemingly spurred on by our article, on March 14, 2022, Senator Charles Grassley (R-Iowa) introduced the bipartisan Senate Bill 3823, entitled “The Bankruptcy Threshold Adjustment and Technical Corrections Act” (the “Technical Corrections Act”). Senators Richard J. Durbin (D-IL), Senator Sheldon Whitehouse (D-RI) and Senator John Cornyn (R-TX) co-sponsored the bill. On April 7, 2022, the bill passed the Senate by unanimous consent. On April 11, 2022, the bill was introduced in the House of Representatives, which to date has taken no further action.

The most notable aspect of the Technical Corrections Act is to reinstate the debt limit for small businesses choosing to file a Subchapter V claim at $7.5 million for an additional two years (this higher debt limit provision was originally included in the CARES ACT but expired on March 27, 2022).[4] The initial version of the Technical Corrections Act, as introduced, would have made this increased debt limit permanent, but the bill was later amended in the Senate to only provide for a two-year extension. from the date of promulgation. The bill also included other technical amendments to the Bankruptcy Code, including the technical correction we suggested in the ABI Journal article.

Decision of Phenomenon Marketing & Entertainment, LLC

In his decision, Judge Robles conducted a careful analysis of the SBRA, as amended by the CARES Act, and, as suggested in our article, concluded that the Bankruptcy Code, as currently written, Prohibits obligors if they or an affiliate (an entity that owns 20% of the obligor) is an “issuer”, whether the obligor or its affiliate is a public company. Specifically, Judge Robles determined that at least two of the Debtor’s affiliates were “issuers” under the Exchange Act. Judge Robles also addressed our article at length in his ruling. However, Judge Robles did not conclude that the overbroad language was the product of a drafting error or represented the actual intent of Congress. Judge Robles raised the possibility that Congress intended to exclude any company that is either an “issuer” or a subsidiary of an “issuer” because Congress directed SBRA to “mum-businesses”. and-pop” and ruling out an entity with “sophisticated ownership structures” was a plausible policy move by Congress. Judge Robles concluded:[t]o To the extent that Congress intended entities such as the debtor to benefit from Subchapter V, it is for Congress, not this Court, to amend the law accordingly.


Judge Robles’ ruling highlights the very issue we raised in the ABI newspaper article. The authors believe that Congress did not intend to prevent small businesses from using the powerful tools of SBRA to rehabilitate their businesses just because they have a subsidiary that is an “issuer.” Our belief is reinforced by the fact that the Senate passed the Technical Corrections Act, which would specifically correct the overbroad language used in the definition, thus avoiding the result in Phenomenon. Ultimately, we agree with Justice Robles that it is up to Congress to decide whether to amend SBRA and whether the Technical Corrections Act passes the House and is signed into law by the President, Congress will have resolved the problem we identified in the ABI. newspaper article, and effectively ensure that the hard result achieved in Phenomenon should not be repeated.

[1] 11 USC § 101(51D)(B)(ii). [2] 11 USC § 101(51D)(B)(iii) prior to the passage of this bill. [3] Companies that are subject to reporting requirements under §§ 13 or 15(d) of the Exchange Act are primarily publicly traded companies. These companies are excluded from Subchapter V pursuant to 11 USC § 101(51D)(B)(ii). [4] Without the proposed increase, the current debt limit for Subchapter V debtors is $3,024,725, subject to adjustment for inflation every three years.

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