Case Information
*1 FILED APR 26 2022 ORDERED PUBLISHED SUSAN M. SPRAUL, CLERK U.S. BKCY. APP. PANEL OF THE NINTH CIRCUIT UNITED STATES BANKRUPTCY APPELLATE PANEL OF THE NINTH CIRCUIT In re: BAP No. NC-21-1227-BGT RS AIR, LLC,
Debtor. Bk. No. 20-51604 NETJETS AVIATION, INC.; NETJETS
SALES, INC.; NETJETS SERVICES, INC.,
Appellants,
v. OPINION
RS AIR, LLC,
Appellee. Argued and Submitted on January 19, 2022 at Pasadena, California Appeal from the United States Bankruptcy Court for the Northern District of California M. Elaine Hammond, Bankruptcy Judge, Presiding Before: BRAND, GAN, and TAYLOR, Bankruptcy Judges.
APPEARANCES Kelly Singer of Squire Patton Boggs (US) LLP argued for appellants; Jennifer C. Hayes of Finestone Hayes LLP argued for appellee.
BRAND, Bankruptcy Judge:
INTRODUCTION Appellants NetJets Aviation, Inc., NetJets Sales, Inc., and NetJets Services, Inc. (collectively, "NetJets") appeal an order confirming the chapter *2 11 [1] plan of debtor RS Air, LLC ("RS Air"). Specifically, NetJets appeals the bankruptcy court's prior order denying its objection to RS Air's subchapter V election, and the court's later ruling upholding the eligibility decision in confirming the plan.
NetJets argues that the bankruptcy court erred in determining that RS Air was eligible for subchapter V relief. According to NetJets, since RS Air had no profit motive, it was not "engaged in commercial or business activities" on the petition date pursuant to § 1182(1)(A). [2] NetJets argues that the bankruptcy court further erred by allocating the burden of proof to NetJets to establish that RS Air was not eligible for subchapter V. Finally, NetJets argues that the bankruptcy court erred in ruling that the law of the case doctrine precluded the court from reconsidering RS Air's eligibility for subchapter V when new evidence at the final confirmation trial demonstrated that it was ineligible.
We hold that a profit motive is not required to satisfy § 1182(1)(A). We further hold that the burden is on the debtor to prove subchapter V eligibility. Although the bankruptcy court ruled otherwise on that issue, such error was harmless, because the record established that RS Air met its burden of establishing its eligibility to proceed under subchapter V. Finally, we conclude *3 that any error the bankruptcy court made regarding its law of the case ruling was harmless, because no new evidence was presented at the final confirmation trial that the court should have considered or that would have changed the outcome. Accordingly, we AFFIRM.
FACTS RS Air, a Delaware LLC doing business in California, was formed in 2001 by its sole member and manager, Stephen Perlman, for the purpose of using and providing aircraft transportation services, acquiring and selling interests in aircraft, and providing depreciation tax benefits to Perlman. From 2001 to 2017, RS Air's principal source of revenue from business operations was from providing flight services for Perlman and affiliated third parties and flying fragile technology prototypes to prevent damage from baggage handling on commercial flights. RS Air also obtained revenue from acquiring and selling fractional interests in aircraft.
Beginning in 2001, RS Air entered into a series of agreements to purchase or lease from NetJets fractional interests in private jets. NetJets is a private business jet charter company that sells fractional jet interests, charter jet flight time, and aircraft management services. NetJets actively marketed depreciation tax benefits as a key benefit to fractional jet ownership.
The parties had a good business relationship until July 2017, when one of the jets fractionally owned by RS Air was involved in a non-injury runway crash, which RS Air contends NetJets failed to disclose and was caused by a debt limits.
NetJets pilot. RS Air ceased doing business with NetJets after the accident and was still not engaged in its normal flight operations when it filed for bankruptcy in November 2020. RS Air attributed its lack of operations to NetJets not allowing RS Air to use or sell any jets after the accident and the parties' falling out. Ultimately, the parties ended up in litigation in Ohio, with NetJets filing suit against RS Air for breach of contract and RS Air asserting counterclaims against NetJets for breach of contract and fraud.
B. The bankruptcy case and litigation over subchapter V eligibility
Just before trial was to begin in Ohio, RS Air filed a chapter 11 bankruptcy case and elected to proceed under subchapter V. NetJets is RS Air's largest, non-insider creditor and holds approximately 98% of the total non-insider debt.
1. Objection to subchapter V designation NetJets objected to RS Air's election as a subchapter V debtor, arguing that RS Air was not eligible for subchapter V because it was not currently "engaged in commercial or business activities" pursuant to § 1182(1)(A).
NetJets argued that RS Air had no flight operations since at least 2017, no revenue or income since as early as 2012, and no employees. In fact, argued NetJets, RS Air had never been a revenue-generating business, and its sole purpose was to serve as the intermediary through which Perlman acquired interests in and paid for the availability and use of private jets. NetJets argued that it was RS Air's burden to establish eligibility for subchapter V.
In opposition, RS Air argued that ongoing operations, employees, or *5 historical profitability were not required for subchapter V eligibility. RS Air argued that it was currently engaged in business activities by (1) litigating with NetJets, (2) negotiating with NetJets to sell its fractional jet interests back to NetJets, (3) paying its aircraft registry fees, (4) remaining in good standing as a Delaware LLC, and (5) keeping its tax obligations current with the state of California and the federal government. RS Air also intended to resume normal flights operations with a different partner once able. RS Air argued that NetJets, as the movant, bore the burden of establishing that RS Air was not eligible for subchapter V.
The bankruptcy court overruled NetJets' objection to RS Air's subchapter V election ("Subchapter V Order"). First, it determined that NetJets, as the party challenging eligibility, had the burden to establish that RS Air was not eligible for subchapter V. Second, it found that RS Air was engaged in commercial or business activities on the petition date because RS Air: (1) transformed its business from flight services to investigation into and litigation with NetJets (its primary contractual party); (2) intended to resume fractional jet ownership with a different partner; (3) paid its aircraft registry fees; (4) remained in good standing as a Delaware LLC; and (5) filed its tax returns and paid taxes as required. The court rejected NetJets' argument that employees are required for eligibility, observing that many small businesses have no employees. Therefore, because NetJets did not meet its burden to establish that RS Air failed to satisfy the eligibility requirements of § 1182, RS Air would proceed as a subchapter V debtor.
2. RS Air's plan of reorganization At an earlier plan confirmation hearing, Perlman testified that, while some income is generated from providing flights to him or his related entities, RS Air would have no projected disposable income within the next five years, if ever. Instead, the primary financial benefit obtained is a tax deduction for aircraft depreciation that flows through Perlman. As a result, he would pay all administrative expenses and contribute new value of $50,000 (later increased to $100,000), which was more than the expected disposable income of $0.
At the final plan confirmation hearing, RS Air's financial expert testified that the net present value of RS Air's projected disposable income was $8,200. Because RS Air's value in a traditional disposable income analysis was projected to be a large negative number in the three- to five-year period postconfirmation, the financial expert created an alternative model to capture nontraditional kinds of value (e.g., tax benefits and aircraft flight services) that would not be included in a traditional analysis. The expert's alternative model recognized that RS Air was set up primarily to create value as a tax benefit from owning a fractional aircraft share and providing aircraft flight services, not to create value from profit on income.
In opposing confirmation, NetJets again argued that RS Air was not eligible for subchapter V, and therefore the Plan did not meet the good faith requirement of § 1129(a)(3). NetJets argued that RS Air was not a business with income, the expert's financial projections improperly included indirect items of value such as the depreciation tax benefit, and the expert's financial *7 projections were based on non-GAAP and never-before-seen methodologies. NetJets contended that the real purpose of RS Air's subchapter V bankruptcy was to sustain a facade business with no operations or income to protect Perlman and affiliates and provide him with valuable tax benefits.
In confirming RS Air's third amended plan of reorganization (the "Confirmation Order"), the bankruptcy court found that the disposable income projections of Perlman and RS Air's financial expert were consistent with NetJets' argument that RS Air was not a business with income, but that whether RS Air generated income was not determinative for confirmation.
The court decided that the law of the case doctrine precluded revisiting the issue of RS Air's subchapter V designation. However, the court noted that developing case law, which interpreted broadly the types of commercial or business activities that can satisfy § 1182(1)(A), supported its earlier decision that RS Air was engaged in commercial or business activities on the petition date. NetJets timely appealed the Confirmation Order, which included the prior Subchapter V Order. A motions panel granted NetJets' request for stay of the Confirmation Order pending appeal.
JURISDICTION The bankruptcy court had jurisdiction under 28 U.S.C. §§ 1334 and 157(b)(2)(L). We have jurisdiction under 28 U.S.C. § 158. [3]
*8 ISSUES
1. Did the bankruptcy court err in determining that RS Air was "engaged in commercial or business activities" on the petition date?
2. Did the bankruptcy court err by allocating the burden to NetJets to prove that RS Air was not eligible for subchapter V?
3. Did the bankruptcy court abuse its discretion in determining that the law of the case doctrine precluded its review of the Subchapter V Order?
STANDARDS OF REVIEW
The question of whether a particular activity constitutes "commercial or
business activities" under § 1182(1)(A) is a legal question we review de novo,
and the bankruptcy court's determination whether the debtor engaged in that
particular activity is a factual question we review for clear error.
See Int'l
Ass'n of Firefighters, Local 1186 v. City of Vallejo (In re City of Vallejo)
, 408 B.R.
280, 288-89 (9th Cir. BAP 2009) (we review questions of law and statutory
interpretation of the Code de novo and the bankruptcy court's factual findings
for clear error) (chapter 9 eligibility);
see also Watford v. Fed. Land Bank of
Columbia
,
Whether the bankruptcy court identified and applied the correct burden of proof is a question of law we review de novo. Boruff v. Cook Inlet Energy judgment and may be challenged on appeal).
LLC (In re Cook Inlet Energy LLC)
,
We review the bankruptcy court's decision whether to apply the law of
the case doctrine for an abuse of discretion.
See United States v. Lummi Indian
Tribe
,
DISCUSSION A. The bankruptcy court did not err in determining that RS Air was
"engaged in commercial or business activities" on the petition date. Under the Small Business Reorganization Act of 2019, commonly referred to as "subchapter V," Congress authorized eligible persons to avail themselves of streamlined chapter 11 bankruptcy relief designed to help small businesses. [4] Generally, a debtor is eligible to elect subchapter V if the debtor: (1) is a "person;" [5] (2) is "engaged in commercial or business activities;" (3) does *10 not have aggregate debts in excess of the debt limit on the petition date; and (4) at least 50 percent of the debtor's debts arose from its commercial or business activities. § 1182(1)(A).
The only question here is whether RS Air was "engaged in commercial or business activities" within the meaning of § 1182(1)(A). The Bankruptcy Code does not define the phrase and case law is sparse. With one exception, no appellate court has weighed in on the subject. The trial courts that have reviewed it are divided as to its meaning.
A majority of courts have held that a debtor need not be "actively
operating" on the petition date, but must be "presently" engaged in
commercial or business activities on the petition date to satisfy § 1182(1)(A).
See Nat'l Loan Invs., L.P. v. Rickerson (In re Rickerson)
,
2021);
In re Blue
,
283-84 (Bankr. D. Colo. 2021);
In re Johnson
, No. 19-42063-ELM, 2021 WL
825156, at *6-8 (Bankr. N.D. Tex. Mar. 1, 2021);
In re Thurmon
,
We agree with the majority, that the term "engaged in" is inherently contemporary in focus and not retrospective. Thus, a debtor need not be maintaining its core or historical operations on the petition date, but it must be "presently" engaged in some type of commercial or business activities to satisfy § 1182(1)(A).
The next question is, when a debtor is no longer operational, what types
of "activities" satisfy the requirement that the debtor be engaged in
commercial or business activities. In using the common meanings of the terms
and other statutory construction methods, courts generally have held that the
scope of commercial or business activities is very broad and apply a "totality
of the circumstances" standard.
See In re Rickerson
,
Suffice it to say, courts are less likely to find sufficient commercial or
business activities for purposes of § 1182(1)(A) where the debtor is an
*13
individual who owns a non-operating business, especially where the business
has been dissolved under applicable state law.
See In re Rickerson
, 636 B.R. at
425-26 (concluding that individual whose entities had been inactive for years
prepetition with no ongoing activity of any type and had no intent to
reactivate any of the entities was not engaged in commercial or business
activities);
In re Johnson
,
The bankruptcy court found that RS Air was engaged in commercial or business activities on the petition date by litigating with NetJets, paying its aircraft registry fees, remaining in good standing as a Delaware LLC, and filing its tax returns and paying taxes. In addition, RS Air intends to resume fractional jet ownership and flight operations with a different partner once able. We conclude that the activities identified by the bankruptcy court are "commercial or business activities" within the meaning of § 1182(1)(A). And the bankruptcy court correctly found that RS Air was "engaged in" these activities on the petition date. While NetJets wishes to split hairs about the *14 degree of RS Air's involvement in the Ohio litigation prior to and on the petition date, we do not view that factual issue as determinative.
NetJets argues that RS Air was not engaged in commercial or business activities either on or before the petition date because RS Air's activities lacked any motive to generate income or profit. NetJets contends that, to establish eligibility for subchapter V, the debtor must have a profit motive.
Thus, the question is whether engaging in commercial or business activities incorporates a "pursuit of profit" requirement.
NetJets cherry-picks cases which it argues support its position that an
eligible subchapter V debtor must have the intent to pursue profit.
In re
Vertical Mac Constr., LLC
,
In addition to discussing the definition for the word "commercial," the courts above went on to discuss the definition for the word "business," which is defined as "a usually commercial or mercantile activity engaged in as a means of livelihood," or "dealings or transactions especially of an economic nature ." Business , Merriam-Webster Online Dictionary, https://www.merriam- webster.com/dictionary/business (last visited Mar. 29, 2022) (emphasis added). Certainly, the depreciation tax benefits and the revenue generated by RS Air's flight operations or its acquiring and selling of its fractional aircraft interests are "dealings or transactions" of an "economic nature." Although NetJets tries to argue that no real tax benefit exists, that is contrary to its marketing strategy which touted tax benefits as a key advantage for fractional jet ownership.
Further, NetJets fails to note that the Ikalowych court went on to observe that § 1182(1)(A) speaks only to whether the debtor was engaged in commercial or business activities – "not whether the [d]ebtor was making a profit, actively operating, or intending to operate in the future." 629 B.R. at 285. That court further heeded:
Interpretation of statutory phrases can be aided by considering the definitions of each of the words in a phrase; but simply stringing separate dictionary definitions together is not enough and might lead in the wrong direction. Instead, the Court must consider context and purpose in applying definitions.
Id. at 278. The court in Blue was also careful not to limit the meaning of "commercial or business activities" to basic dictionary definitions. 630 B.R. at 188-89.
Finally, the issue of a "profit motive" was not directly addressed in these
cases. The few courts that have addressed it have held that § 1182(1)(A) does
not require a debtor to be engaged in for-profit business to qualify for
subchapter V. In
Ellingsworth Residential Community Association
,
On appeal, the district court affirmed.
Guan v. Ellingsworth Residential
Cmty. Ass'n
(
In re Ellingsworth Residential Cmty. Ass'n
), No. 6:20-cv-1243-
WWB,
The bankruptcy court in
Family Friendly Contracting LLC
also concluded
that the plain and ordinary meaning of "commercial or business activities"
does not require a profit motivation.
We note, and the
Ellingsworth
and
Family Friendly
courts observed,
Congress chose not to exclude nonprofits or other persons who lack a profit
motive from qualifying for subchapter V. And that makes sense, because
churches, hospitals, and other nonprofit businesses are allowed to file for
chapter 11 (or 7) relief.
See JBB Holdings, LLC v. Abundant Life Worship Ctr. of
Hinesville, GA, Inc. (In re Abundant Life Worship Ctr. of Hinesville, GA, Inc.)
, No.
20-40959-EJC,
Accordingly, we conclude that no profit motive is required for a debtor to qualify for subchapter V relief. To hold otherwise would wrongfully exclude nonprofits and other persons that lack such a motive. That RS Air had no profit motive did not render it ineligible for subchapter V.
B. The bankruptcy court erred by allocating the burden to NetJets to
prove that RS Air was not eligible for subchapter V.
The parties dispute who had the burden of proof as to RS Air's subchapter V eligibility: RS Air or NetJets. The Bankruptcy Code and Rules are silent on this issue. The bankruptcy court determined that NetJets, as the party challenging eligibility, had the burden. NetJets contends this was error. We agree.
The bankruptcy court rejected the Missouri bankruptcy case cited by
NetJets –
In re Thurmon
– as contrary to Ninth Circuit law.
Thurmon
held,
based on Eighth Circuit law, that the debtor has the burden to establish
subchapter V eligibility.
Neither this Panel nor the Ninth Circuit Court of Appeals has decided
the issue of who has the burden on subchapter V eligibility. However, in an
objection to the debtor's eligibility for chapter 9 relief, we held that the debtor
has the burden of establishing eligibility under § 109(c).
In re City of Vallejo
,
Cal. 2008)). Other circuit courts, as well as courts within this circuit, have held
that the debtor has the burden of establishing eligibility for chapter 12 relief
under § 109(f).
See First Nat'l Bank of Durango v. Woods (In re Woods)
, 743 F.3d
689, 705 (10th Cir. 2014) (citing cases);
Tim Wargo & Sons, Inc. v. Equitable Life
Assurance Soc'y of the U.S. (In re Tim Wargo & Sons, Inc.)
,
The reasoning of the courts placing the burden on the debtor to establish eligibility for relief in a chapter 12 case is persuasive for our purposes here, considering that chapter 12 contains the analogous requirement that a "family farmer" be "engaged in a farming operation" to be eligible. See § 101(18).
Nearly every court deciding the issue of who bears the burden of proving
eligibility for subchapter V has held that it is the debtor.
See In re Rickerson
,
*22 C. The bankruptcy court failed to recognize the exceptions to the law of
the case doctrine, but such error was harmless.
The doctrine of law of the case provides that a "court is generally precluded from reconsidering an issue that has already been decided by the same court, or a higher court in the identical case." Thomas v. Bible , 983 F.2d 152, 154 (9th Cir. 1993). To apply, "the issue in question must have been decided either expressly or by necessary implication in the previous disposition." Id. (cleaned up). But there are exceptions to this discretionary doctrine. A court may revisit a previously resolved question when: (1) the first decision was clearly erroneous; (2) an intervening change in the law has occurred; (3) the evidence on remand is substantially different; (4) other changed circumstances exist; or (5) a manifest injustice would otherwise result. Id. at 155 (citations omitted).
NetJets argues that the bankruptcy court abused its discretion by
applying law of the case to its earlier ruling that RS Air was eligible for
subchapter V, when new evidence presented at the final confirmation hearing
defeated RS Air's eligibility. NetJets argues that the bankruptcy court failed to
consider new evidence that: (1) RS Air had not reported any income since at
least 2004; (2) Perlman's alleged tax benefit flowing from his ownership of RS
Air was not a benefit and but rather a loss because the cost of producing the
benefit exceeded the amount of the tax benefit itself; (3) the financial model
supporting RS Air's income calculations treated expenses as "income," did not
comply with GAAP, and was inconsistent with the definition of "disposable
income" under the Code; and (4) RS Air's disposable income would be
*23
negative using a strict definition of "disposable income." NetJets contends that
the bankruptcy court's decision was particularly egregious because the
subchapter V designation was an interlocutory ruling.
See Amarel v. Connell
,
The problem facing NetJets is that all of the alleged new evidence it argues that the bankruptcy court should have considered relates to the fact that RS Air had no net profit. As we stated above, a profit motive or net profit is not required for subchapter V eligibility. In addition, much of this evidence was not "new." In overruling NetJets' initial objection, the bankruptcy court found that RS Air was created to receive a depreciation tax benefit marketed by NetJets rather than to generate a net profit. At a prior confirmation hearing, Perlman testified that RS Air would likely have no projected disposable income within the next five years, if ever. We also find it somewhat disingenuous for NetJets to complain about this purported new evidence that was consistent with its long-standing argument that RS Air was not a business with income, and consistent with RS Air's position that jet share ownership's primary business value is a tax benefit, not income.
Accordingly, any failure by the bankruptcy court in not considering the exceptions to law of the case was harmless error.
CONCLUSION For the reasons stated above, we AFFIRM both the Subchapter V Order and the Confirmation Order.
Notes
[1] Unless specified otherwise, all chapter and section references are to the Bankruptcy Code, 11 U.S.C. §§ 101-1532.
[2] As relevant here, § 1182(1)(A) provides that the term "debtor" "means a person engaged in commercial or business activities . . . that has aggregate noncontingent liquidated secured and unsecured debts as of the date of the filing of the petition or the date of the order for relief in an amount not more than $7,500,000 (excluding debts owed to 1 or more affiliates or insiders) not less than 50 percent of which arose from the commercial or business activities of the debtor." NetJets does not challenge RS Air's eligibility based on
[3] The interlocutory Subchapter V Order merged into the final Confirmation Order.
See United States v. Real Prop. Located at 475 Martin Lane
,
[4] The SBRA became effective on February 19, 2020. See 11 U.S.C. §§ 1181, et seq. Small Business Reorganization Act of 2019 (HR 3311), Pub. L. No. 116-54, 133 Stat. 1079 (Aug. 23, 2019). The statute as originally enacted defined the debtor under § 101(51D), in the same way as a small business debtor who does not elect to proceed under subchapter V. As part of the Coronavirus, Aid, Relief, and Economic Security Act (HR 748), Pub. L. No. 116-136, 134 Stat. 281, 116th Cong. 2d Sess. (Mar. 27, 2020), the definition was changed to temporarily increase the debt limit to $7,500,000 for debtors who elected subchapter V and included a sunset of one year. The one-year sunset for this temporary amendment was extended to March 27, 2022, by the COVID-19 Bankruptcy Relief Extension Act of 2021, Pub. L. No. 117-5 (Mar. 27, 2021). In this case, § 1182(1)(A) applies for the definition of a subchapter V debtor.
[5] An LLC is a "person."
Gilliam v. Speier (In re KRSM Props., LLC)
,
[6] We note the case of
Ho v. Dowell (In re Ho)
,