In re McKenzie Contracting, LLC

1

In re: MCKENZIE CONTRACTING, LLC, Debtor.

No. 8:24-bk-01255-RCT

United States Bankruptcy Court, M.D. Florida, Tampa Division

July 19, 2024

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.^[1] 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."^[2]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.^[3]

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."^[4]A debt is liquidated if the amount is readily and precisely determinable by reference to an agreement.^[5] A debt is considered unliquidated if the value depends on a future exercise of discretion, not restricted by specific criteria.^[6] A "disputed" debt is not excluded from the $7.5 million debt limit simply because it is disputed.^[7]

The procedural requirements for determining noncontingent, liquidated debt for eligibility purposes are well-established.^[8] The Court may look to Debtor's schedules and to the creditors' proofs of claim.^[9] Absent objection, proofs of claim are prima facie valid.^[10] 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.

"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."^[11] 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."^[12] This Court adopts the majority position.

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^[13] (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.^[14] 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.

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.^[15]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.

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.^[16] Obviously, the economic substance of the transaction controls this determination.^[17]

"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."^[18] "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."^[19]

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."^[20]

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.^[21]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.^[22]

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."^[23] 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."^[24]

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.^[25] The claim is filed as a wholly unsecured claim, and GCM describes it as a "Commercial Asset Sale."^[26] An annual interest rate of 16% is claimed.^[27] The claim also includes a $176,344.70 charge for attorneys' fees that is arbitrarily calculated at 33% of the amount due.^[28] 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).^[29] 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.^[30] 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^[31]-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.

B. Capybara Capital LLC

Capybara Capital LLC ("Capybara") filed a proof of claim for $249,354.00 and attached its MCA agreement with Debtor.^[32] 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.

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,...