Opinion
8:24-bk-01255-RCT
07-19-2024
In re: MCKENZIE CONTRACTING, LLC, Debtor.
Chapter 11, Subchapter V
ORDER OVERRULING GCM PRIME LLC'S OBJECTION TO DEBTOR'S DESIGNATION AS A SUBCHAPTER V DEBTOR
Roberta A. Colton United States Bankruptcy Judge
This case was considered on June 14, 2024, at hearing on GCM Prime LLC's ("GCM") Objection Pursuant to Rule 1020(b) to Debtor's Designation as a Subchapter V Debtor. (Doc. 88). At the hearing, the Court directed the parties to file supplemental briefs, which they did. (Docs. 173, 175). As explained below, the Court overrules GCM's objection to Debtor's designation.
I. Objection to Debtor's Subchapter V Designation
On March 11, 2024, Debtor McKenzie Contracting, LLC filed a petition for bankruptcy relief under Chapter 11, Subchapter V. To avail itself to the protections afforded under Subchapter V, a debtor must have "aggregate noncontingent liquidated secured and unsecured debts as of the date of the filing of the petition . . . in an amount not more than $7,500,000."GCM filed the instant objection to Debtor's designation as a Subchapter V small business debtor, arguing that Debtor grossly understated its debt by omitting debt due to merchant cash advance ("MCA") claimants in order to get below the $7.5 million debt limit.
Doc. 1.
Docs. 88, 173. Initially, GCM's objection was based on other alleged debt in addition to the alleged MCA debt. However, at the hearing, GCM conceded that the inclusion or exclusion of the alleged MCA debt was dispositive.
For eligibility purposes, "[a] debt is considered contingent if it does not become an obligation until the occurrence of a future event, but is noncontingent when all of the events giving rise to liability have already vested prior to a debtor filing for bankruptcy protection."A debt is liquidated if the amount is readily and precisely determinable by reference to an agreement. A debt is considered unliquidated if the value depends on a future exercise of discretion, not restricted by specific criteria. A "disputed" debt is not excluded from the $7.5 million debt limit simply because it is disputed.
In re Letterese, 397 B.R. 507, 514 (Bankr. S.D. Fla. 2008) (citation omitted).
See In re Hall, 650 B.R. 595, 599 (Bankr. M.D. Fla. 2023) (citation omitted).
See In re Stone, 2017 WL 3722689, at *2 (Bankr. S.D. Fla. Aug. 28, 2017) (citation omitted).
See In re Heart Heating and Cooling, LLC, 2024 WL 1228370, at *19 (Bankr. D. Colo. Mar. 21, 2024) (citations omitted); see also U.S. v. Verdunn, 89 F.3d 799 (11th Cir. 1996).
The procedural requirements for determining noncontingent, liquidated debt for eligibility purposes are well-established. The Court may look to Debtor's schedules and to the creditors' proofs of claim. Absent objection, proofs of claim are prima facie valid. However, in evaluating eligibility, the Court does not purport to adjudicate the extent or validity of any specific claim, only how it is filed and/or scheduled.
See In re Zhang Medical, P.C., 655 B.R. 403, 409 (Bankr. S.D.N.Y. 2023).
See id. (citations omitted); Hall, 650 B.R. at 600 (citations omitted).
"The Bankruptcy Code and Bankruptcy Rules do not address who carries the burden of proof on a debtor's Subchapter V eligibility when an objection is filed." However, "a significant majority of courts conclude that the debtor bears the burden of proof for Subchapter V eligibility by a preponderance of the evidence." This Court adopts the majority position.
In re Carter, 2023 WL 9103614, at *2 (Bankr. N.D.Ga. Dec. 13, 2023) (citation omitted).
Id. (citations omitted).
As Debtor explained at the hearing, Debtor has total filed claims of $8,074,372.57, of which $1,631,540.97 arise from four claims based on MCA transactions that Debtor contends are contingent and unliquidated (and thus would be excluded from the $7.5 million debt limit). According to Debtor, its noncontingent, liquidated debt (based on filed proofs of claim) totals $6,442,831.60-well under the $7.5 million threshold. Thus, the Court must review the proofs of claim filed by the four MCA claimants to determine whether they have filed claims for noncontingent, liquidated debt that must be counted towards the $7.5 million debt limit.
The four MCA claimants are: (1) Capybara Capital, LLC - $249,354.00, (2) GCM - $709,240.27, (3) Vox Funding, LLC - $322,227.20, and (4) Fox Capital Group, Inc. - $350,719.50.
Additionally, there is a potential fifth MCA claimant, Square Lending, LLC, that has not filed a proof of claim, but which Debtor included on its schedules as having an unliquidated claim of $43,508.27. (Doc. 58, p. 21-22).
II. MCA Agreements
MCA agreements provide an alternative to traditional financing; in exchange for an immediate advance of cash from the "buyer," the "seller" sells its future accounts receivable.The buyer purports to purchase a specified percentage of the seller's underlying customer accounts receivable in exchange for an up-front purchase price that is less than the future amount to be collected by the buyer. "Buyers" carefully draft their MCA agreements to avoid the transactions being recharacterized as usurious loans. Thus, an issue that often arises is whether an MCA agreement is a true sale of accounts receivables or a disguised loan. For eligibility purposes, a proof of claim filed as a true sale would not generally be included in the Subchapter V debt limit calculation.
Kathleen L. DiSanto & Luis E. Rivera II, Know When to Hold 'Em, Know When to Fold 'Em: The Differences between a Loan and Merchant Cash Advance, ABI Journal, p. 78 (Jan. 2023).
The deciding factor in the "sale" versus "loan" dispute is generally the transfer of risk- if the "buyer" is absolutely entitled to repayment under all circumstances, then the risk remains with the "seller" and the transaction is considered a loan. Obviously, the economic substance of the transaction controls this determination.
See, e.g., In re GMI Group, Inc., 606 B.R. 467, 484 (Bankr. N.D.Ga. 2019); LG Funding, LLC v. United Senior Properties of Olathe, LLC, 2020 WL 1161121 (N.Y.A.D. 2 Dept, Mar. 11, 2020); Fleetwood Services, LLC v. Ram Capital Funding, LLC, 2022 WL 1997207, at *9 (S.D.N.Y. June 6, 2022) (citation omitted).
See Lateral Recovery LLC v. Queen Funding, LLC, 2022 WL 2829913, at *6 (S.D.N.Y. July 20, 2022); Fleetwood Services, 2022 WL 1997207, at * 10 (citations omitted); GMI Group, 606 B.R. at 485.
"Usually, courts weigh three factors when determining whether repayment is absolute or contingent: (1) whether there is a reconciliation provision in the agreement; (2) whether the agreement has a finite term; and (3) whether there is any recourse should the [seller] declare bankruptcy." "The three factors provide only a guide to analysis. They do not dictate the conclusion, and a court need not find the presence of all three factors in concluding that a transaction is a loan."
LG Funding, 2020 WL 1161121, at *2 (citations omitted).
Fleetwood Services, 2022 WL 1997207, at *9 (citations omitted).
The first factor-whether there is a reconciliation provision in the agreement-is important, because:
A reconciliation provision allows for adjustments of the daily withdrawal amounts based upon the seller's actual collection of future receivables: "The reconciliation provisions allow the [seller] to seek an adjustment of the amounts being taken out of its account based on its cash flow (or lack thereof). If a [seller] is doing poorly, the [seller] will pay less, and will receive a refund of anything taken by the [buyer] exceeding the specified percentage (which often can also be adjusted downward). If the [seller] is doing well, it will pay more than the daily amount to reach the specified percentage."
GMI Group, 606 B.R. at 484 (quoting K9 Bytes, Inc. v. Arch Capital Funding, LLC, 2017 WL 2219916, at *5 (NY. Sup. Ct. May 04, 2017)).
When a true reconciliation provision exists, and reconciliation actually occurs, this factor would support a finding of a true purchase of receivables rather than a disguised loan.However, when the buyer has the ability to nullify any obligation to reconcile (for example, by describing it as a courtesy that the buyer has the discretion to extend), such would support a finding that the transaction is a disguised loan.
See Lateral Recovery, 2022 WL 2829913, at *5.
See id.
The second factor-whether the agreement has a finite term-is important because "[a] fixed term is typical of a loan, while an indefinite term of receiving a fixed percentage of actual receipts may suggest that the [buyer] has assumed the risk associated with the receivables not being collectable." The third factor-whether there is any recourse should the [seller] declare bankruptcy-is important because "[i]f the [seller's] bankruptcy triggers a default, this factor would weigh in favor of finding the agreement to be a loan because it would suggest that the [buyer] has not assumed the risk of loss of not collecting on the receivables but instead is relying on the creditworthiness of the [seller] to be repaid."
Id. at *6 (citation omitted).
Id. (citation omitted).
With this framework in mind, the Court considers the MCA agreements attached to the proofs of claim filed in this case. The Court notes at the outset that MCA claimants Capybara Capital, LLC, Vox Funding, LLC, and Fox Capital Group, Inc. have not: (i) objected to Debtor's Subchapter V designation, (ii) briefed the issue of whether their MCA agreements are true sales or loans, or (iii) participated in this contested matter in any way. Furthermore, GCM has not specifically addressed the terms of any of these other MCA agreements; GCM only argues that its MCA agreement is a debt that must be counted towards the $7.5 million debt limit.
A. GCM
GCM filed a proof of claim for $709,240.27 and attached its MCA agreement with Debtor. The claim is filed as a wholly unsecured claim, and GCM describes it as a "Commercial Asset Sale." An annual interest rate of 16% is claimed. The claim also includes a $176,344.70 charge for attorneys' fees that is arbitrarily calculated at 33% of the amount due. Without pointing to any specific notice or event of default, GCM argues that Debtor defaulted under its MCA agreement prior to filing for bankruptcy. Therefore, GCM argues that the full amount owed to it is due and no longer contingent and unliquidated (and as such, must be counted toward the $7.5 million debt limit).
POC 36-1.
POC 36-1, p. 2 of 3.
POC 36-1, p. 2 of 3.
POC 36-1, part 3, p. 1.
GCM appears to now argue that its MCA agreement evidences a "loan" of money that Debtor "borrow[ed]." (Doc. 173, p. 3). GCM makes this assertion despite crafting its MCA agreement to state the following:
The transaction described by this Agreement is a commercial asset sale in which [GCM] is purchasing a portion of [Debtor's] future revenue stream for a discounted upfront price. [Debtor] hereby acknowledges and affirms that no payment made pursuant to the terms of the asset sale described herein is intended, in whole or in part, to constitute compensation for the use or forbearance of money. This Agreement has no predeterminable term, with the actual term hereof depending on numerous factors completely outside the control of [GCM]. If [Debtor's] business declines, or if [Debtor's] business fails while operating in the ordinary course prior to [GCM] collecting the Total Amount Sold, and [Debtor] shall not have materially violated, or deliberately frustrated performance of, the terms of this Agreement, and [Debtor] shall not have otherwise deceived [GCM], [Debtor] shall not have defaulted hereunder, and [GCM] shall have no recourse. [Debtor's] filing for bankruptcy protection shall not be a default hereunder (unless such filing constitutes prima facie evidence that [Debtor] shall have made materially false representations to [GCM] to induce [GCM] to enter this Agreement). [GCM] understands the risks that [Debtor's] business may slow down or fail in the ordinary course (including, but not limited to, as may result from third-party risk, such as [Debtor's] account debtors failing to perform their obligations to [Debtor]). . . . The Parties hereby stipulate as follows: (i) [Debtor] is not borrowing money and there is no debt being created hereby; (ii) there is no interest rate being charged; (iii) there is no amortization schedule; (iv) there is no fixed payment schedule; (v) there is no predeterminable term hereof (nor any time period in which [GCM] shall have any right to collect the Total Amount Sold); (vi) [GCM] shall have no absolute right to receive any guaranteed dollar amount hereunder; and (vii) no information supplied to [Debtor] in conjunction with any law or regulation in any jurisdiction (including information supplied to [Debtor] in the form of an expected annual percentage rate or any other rate) shall be interpreted in any way to imply the existence of an interest rate or that this transaction is anything but a true sale.(POC 36-1, part 2, p. 3 of 39," 1.2).
Despite arguing that all of the MCA claims are noncontingent and liquidated, GCM fails to point to a specific default claimed by any of the other MCA claimants. Thus, even if the Court were to assume GCM's claim is noncontingent and liquidated, without the inclusion of the other MCA claimants' claims, Debtor's total noncontingent, liquidated debt totals only 7,152,071.87-well below the $7.5 million debt limit. As explained below, the Court finds that Debtor has met its burden of proving, for the purposes of Subchapter V eligibility, that the other three MCA claimants have filed proofs of claim as sales (rather than loans) that should not be counted toward the $7.5 million debt limit.
At most, GCM argues that this Court may look to the filed proofs of claim, none of which have been objected to, [and] consider the nature of the debt. On their face, the proofs of claim are not contingent or unliquidated because all of the events giving rise to liability for those claims occurred pre-petition; and the amounts due are readily calculable." (Doc. 173, p. 7). This vague allegation is not sufficient for this Court to conclude that Debtor defaulted, pre-petition, on any of the other MCA claimants' MCA agreements.
Debtor's noncontingent, liquidated debt (based on filed proofs of claim, not including the claims of any of the MCA claimants) totals $6,442,831.60. After adding GCM's claim of $709,240.27, the total claims (excluding the other MCA claimants' claims) equal $7,152,071.87.
B. Capybara Capital LLC
Capybara Capital LLC ("Capybara") filed a proof of claim for $249,354.00 and attached its MCA agreement with Debtor. The proof of claim is based on its "Sale of Future Receipts Agreement," and the claim states that the annual interest rate is "0.00%". A review of the terms of Capybara's MCA agreement supports Debtor's contention that this proof of claim has been filed as a true sale.
POC 5-1.
First, the MCA agreement contains a reconciliation provision that provides that either party may request a reconciliation at any time, and that within three calendar days after Capybara verifies the reconciliation information, Capybara will adjust Debtor's payment amount on a going-forward basis. Second, the MCA agreement provides that it does not have a fixed time for repayment. Third, the MCA agreement does not state that filing for bankruptcy would trigger a default of the agreement.
Finally, the MCA agreement specifically states that it is not a loan and that Capybara assumes the risk of non-payment:
[Debtor] is selling a portion of a future revenue stream to [Capybara] at a discount, not borrowing money from [Capybara]. There is no interest rate or payment schedule and no time period during which the Purchased Amount must be collected by [Capybara]. . . . [Capybara] assumes the risk that Future Receipts may be remitted more slowly than [Capybara] may have anticipated or projected because [Debtor's] business has slowed down, and the risk that the full Purchased Amount may never be remitted because [Debtor's] business went bankrupt or [Debtor] otherwise ceased operations in the ordinary course of business. [Capybara] is buying the Purchased Amount knowing the risks that [Debtor's] business may slow down or fail, and [Capybara] assumes these risks based on [Debtor's] representations, warranties and covenants in this Agreement that are designed to give [Capybara] a reasonable and fair opportunity to receive the benefit of its bargain. By this Agreement, [Debtor] transfers to [Capybara] full and complete ownership of the Purchased Amount of Future Receipts and [Debtor] retains no legal or equitable interest therein.
POC 5-1, part 2, p. 4 of 15, ¶ 5.
Under the Capybara MCA agreement, Capybara assumes the risk of non-payment, and Capybara is not absolutely entitled to repayment under all circumstances. Therefore, for purposes of determining eligibility for Subchapter V, the Capybara proof of claim is filed as a contingent, unliquidated debt that should not be counted towards the $7.5 million debt limit.
C. Vox Funding, LLC
Vox Funding, LLC ("Vox") filed a proof of claim for $322,227.20 and attached its MCA agreement with Debtor entitled, "Future Receipts Sale Agreement." The claim states an annual interest rate of "0.00%". A review of the terms of the MCA agreement supports Debtor's contention that Vox's proof of claim has been filed as a true sale.
POC 46-1.
First, the MCA agreement contains a reconciliation provision that provides that either party may request a reconciliation at any time, and that after verification of receipts by Vox, Vox will adjust the payment amount on a going-forward basis to more closely reflect Debtor's actual future receipts multiplied by the specified percentage. Second, the MCA agreement provides that it does not have a fixed time for repayment. Third, the MCA agreement does not state that filing for bankruptcy would trigger a default of the agreement.
Finally, the MCA agreement states that the transaction is not a loan and that Vox assumes the risk of non-payment:
[Vox] does not charge any interest, finance charges, points, late fees or similar fees (except as permitted by applicable law in connection with civil judgments). [Vox] is purchasing the Future Receipts at a discount. Because the transaction evidenced by this Agreement is not a loan, there are no specific scheduled payments and no repayment term. If [Debtor's] business slows down and [Debtor's] Future Receipts decrease or if [Debtor] closes its business or ceases to process Payment Cards and [Debtor] has not violated any of the representations, warranties and covenants provided in Section 16 below, there shall be no default of this Agreement. [Vox] assumes the risk that [Debtor's] business may fail or be adversely affected by conditions outside the control of [Debtor] provided [Debtor] has not breached a representation, warranty or covenant set forth in Section 16 below.
POC 46-1, part 2, p. 5 of 11, ¶ 13.
Under the Vox MCA agreement filed with its proof of claim, Vox assumes the risk of non-payment, and Vox is not absolutely entitled to repayment under all circumstances. Therefore, for purposes of determining eligibility for Subchapter V, the Vox proof of claim is filed as a contingent, unliquidated debt that should not be counted towards the $7.5 million debt limit.
D. Fox Capital Group, Inc.
Fox Capital Group, Inc. ("Fox") filed a proof of claim for $350,719.50 and attached its MCA agreement with Debtor. The stated basis of the claim is "Accounts/Purchased Receipts," and the annual interest rate is stated as "0.00%". A review of the terms of Fox's MCA agreement (entitled, "Future Receivables Sale and Purchase Agreement") supports Debtor's contention that the Fox proof of claim is filed as a true sale.
POC 47-1.
POC 47-1, p. 2 of 3.
First, the MCA agreement contains a reconciliation provision that provides that either party may request a reconciliation at any time. Second, the MCA agreement provides that it does not have a fixed time for repayment. Third, the MCA agreement does not state that filing for bankruptcy would trigger a default of the agreement.
Finally, the MCA agreement states that Fox assumes the risk of non-payment:
[Fox] agrees to purchase the Receipts knowing the risks that [Debtor's] business may slow down, go bankrupt or fail, and [Fox] assumes this risk based exclusively upon the information provided to it by [Debtor] and [Debtor's] business operations prior to the date of this Agreement, and upon [Debtor's] representations, warranties and covenants contained in this Agreement that are designed to give [Fox] a reasonable and fair opportunity to receive the benefit of its bargain. This sale of Receipts is made without express or implied warranty to [Fox] of collectability of the Receipts and without recourse against [Debtor], any Owner or any Guarantor if Receipts are not generated in the regular course of [Debtor's] business operations or cannot be collected, except as specifically set forth in this Agreement. Thus, the period of time over which it will take [Fox] to collect the Purchased Amount is not fixed, is unknown to both
parties as of the Effective Date and will depend on how well or poorly [Debtor's] business performs following the Effective Date. As an extreme example, in the event [Debtor's] business ceases to exist after [Fox's] purchase of the Receipts and prior to the delivery of the Purchased Amount as a result of a cessation of revenues for reasons outside [Debtor's] control, [Fox] may never collect all or a substantial portion of the Purchased Amount.
POC 47-1, part 2, p. 4-5 of 13, ¶ 1.9.2.
Under the Fox MCA agreement filed with its proof of claim, Fox assumes the risk of non-payment, and Fox is not absolutely entitled to repayment under all circumstances. Therefore, for purposes of determining eligibility for Subchapter V, the Fox proof of claim is filed as a contingent, unliquidated debt that should not be counted towards the $7.5 million debt limit.
III. Conclusion
After reviewing the four proofs of claim filed by the MCA claimants, the Court finds that it is not necessary to determine if GCM's proof of claim is a noncontingent, liquidated debt because the other three MCA claimants have filed proofs of claim that, on their face, are contingent, unliquidated debts that should not be counted towards the $7.5 million debt limit. As a result, Debtor has met its burden of proving that its noncontingent, liquidated debt falls below the $7.5 million debt limit, and, as such, Debtor is eligible for Subchapter V treatment. Accordingly, the Court OVERRULES GCM's Objection Pursuant to Rule 1020(b) to Debtor's Designation as a Subchapter V Debtor (Doc. 88).
It is SO ORDERED.
Attorney Fred Kantrow is directed to serve a copy of this order on interested parties who do not receive service by CM/ECF and file a proof of service within three days of its entry.