When Might a Court Remove a Subchapter V Debtor-in-Possession?
In a small business reorganization under Subchapter V of the U.S. Bankruptcy Code, the business owner is typically allowed to continue operating as a debtor-in-possession (DIP). This arrangement permits the owner to maintain control over the business under the auspices of the court-appointed trustee in order to facilitate the transition to financial solvency. However, there can be circumstances when DIP status may be revoked.
The court can remove a Subchapter debtor-in-possession and expand the role of the trustee upon finding DIP has engaged in fraudulent activities, dishonest practices or general mismanagement of the business and its assets. Removal also can occur if the debtor is found to be failing to meet obligations such as submitting required financial documents, maintaining transparency or following court orders.
The process of removing a debtor-in-possession begins with a motion filed by a creditor, a group of creditors, the U.S. trustee or other interested parties. This motion must be supported by evidence of the debtor’s mismanagement or misconduct. The DIP can respond with proof that the allegations are false, that the issues have been or are being rectified or that continued DIP management is in the best interest of creditors and the bankruptcy estate.
After a hearing, if the court decides to remove the debtor-in-possession, the role of the Subchapter V trustee is expanded. The trustee, who is usually limited to an oversight role, may be required to take over the day-to-day operations of the business. This is designed to protect creditors and ensure that the business is operated in a manner consistent with the reorganization plan.
However, this arrangement can present practical difficulties. Trustees, while knowledgeable in legal and financial aspects of bankruptcy, may not have familiarity with the company’s industry nor the operational expertise necessary to effectively run the business. What’s more, a Subchapter trustee has no authority to propose a new reorganization plan. This situation can hamstring the company’s ability to adhere to the existing plan and regain solvency.
If it becomes apparent that reorganization plan may no longer be feasible, other options may be considered. One is the sale of assets, which can be used to pay off creditors. Another option is converting the case to a traditional Chapter 11 proceeding, allowing creditors or other stakeholders to propose a new plan. A more extreme option is converting to a Chapter 7 bankruptcy, where the business ceases operations and its assets are liquidated to satisfy creditor claims.
These decisions can significantly impact the outcome of the Subchapter V case, the interests of creditors and the survival of the business. They often demand the input of major creditors. Assistance from an experienced Subchapter V bankruptcy attorney is also beneficial. The goal is to find the most effective and equitable solution that makes it possible for the business to remain in operation.
The Law Offices of Michael Jay Berger in Beverly Hills helps small businesses dealing with excessive debt obtain the benefits of bankruptcy protection and reorganization. Call 310-271-6223 or contact us online to schedule a free consultation.
