Opinion of Interest – In re Serendipity Labs, Inc.

The U.S. Bankruptcy Court for the Northern District of Georgia ruled in In re Serendipity Labs, Inc., 620 B.R. 679 (Bankr. N.D. Ga. 2020) that a debtor was ineligible to proceed under the newly enacted Subchapter V of Chapter 11, designed specifically for small businesses, because it was an affiliate of an “issuer” (as defined in section 3 of the Securities Exchange Act of 1934), even though that issuer owned only 6.51% of the shares authorized to vote on the debtor’s bankruptcy filing.  Subchapter V went into effect in February 2020 and offers an expedited reorganization process for small-business debtors who meet the eligibility requirements under Section 1182(B) of the Bankruptcy Code.  However, Section 1182(B)(iii) precludes Chapter 11 debtors from proceeding under Subchapter V if they are an “affiliate” of an issuer (generally a company that has issued classes of securities required to be SEC-registered or that are publicly-traded or that otherwise are public reporting companies).  An “affiliate” is defined in Section 101(2)(A) of the Bankruptcy Code as an “entity that directly or indirectly owns, controls, or holds with power to vote, 20 percent or more of the outstanding voter securities of the debtor”; thus, if the issuer here had such holdings, the debtor was ineligible.  The debtor argued that because the issuer, while owning 27.36% of the debtor’s voting securities, held less than 20% of the shares actually entitled to vote on the debtor’s bankruptcy filing, it did not qualify as an “affiliate” of the debtor.  The court rejected the debtor’s argument, concluding that an entity that owns more than 20% of the voting securities of a debtor is an affiliate regardless of whether it has the power to vote such securities (or not) on any particular matter.