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Subchapter V: How This New Bankruptcy Option Protects Small Businesses

By Clark R. Hammond and Gary Lee

For some struggling small businesses, a new bankruptcy option offers a cheaper, easier and less cumbersome path to restoring financial health than a traditional reorganization plan under Chapter 11 of the U.S. Bankruptcy Code.

The timing is fortuitous. As an economy battered by the COVID-19 pandemic sputters its way further into 2021, facing business bankruptcy may increasingly be a necessary reality. This would be uncomfortable in normal times but seems outright brutal now.

Bankruptcy is often an arduous, contentious process that can take years and years to complete. Further, the complexities, and potentially explosive costs, of business reorganization plans governed by Chapter 11 threaten to squash a smaller debtor company out of existence rather than lead it back into daylight.

The difficulties of debtor life under Chapter 11 were on the minds of U.S. lawmakers before the pandemic took hold. The Small Business Reorganization Act of 2019 (SBRA) was signed into law in August 2019.

It took effect on February 19, 2020, just weeks before the World Health Organization declared the pandemic.

The law amended Chapter 11 to include a new Subchapter V, which governs a distinct bankruptcy framework for qualifying a “small business debtor.”

Which businesses qualify as a “small business debtor” eligible to choose this bankruptcy route under Subchapter V?  

“Debtor” under Subchapter V is defined specifically as a “small business debtor.” Well, then what does that mean?

The SBRA amended the existing definition of “small business debtor” in section 11 USC 101(51D)(A) to expand the debt threshold for eligibility. Now, that ceiling for eligibility, which includes both secured and unsecured debt, rests temporarily at $7.5 million. If and when COVID-19-related economic relief lapses, though, that maximum will reset to $2.725 million as set by the SBRA. That’s still up from the original $2 million prior to enactment.

The updated definition of “small business debtor” does exclude owners of “single-asset real estate,” making these property owners ineligible for Subchapter V. Section 101(51D)(B) also excludes “a group of affiliate debtors” with aggregate debt greater than the $2.725 million maximum.

What advantages does a Subchapter V bankruptcy proceeding provide vs. regular Chapter 11? 

Subchapter V is an option for these small business debtors, not a mandate. Yet the benefits are appealing enough that if your business find itself in the situation, choosing Subchapter V just makes infinite sense.

  1.  Only debtors can file a Subchapter V reorganization plan. A common fear that a barely-breathing small business might possess is that one of its creditors will beat it to federal bankruptcy court and file an “involuntary” Chapter 11 petition. Under Subchapter V, only the debtor can initiate the petition, giving it a dose of additional control under pressure. The debtor then has 90 days to file its reorganization plan to the court.
  2. Subchapter V debtors do not need to submit a full financial disclosure statement. One of the most grueling, intensive and expensive parts of a Chapter 11 reorganization is requirement of a disclosure statement that lays all of its financial wounds bare in painstaking detail. In contrast, Subchapter V dictates that only a “plan” that includes a “brief history” of business operations, a “liquidation analysis” and projections as to payment terms and amounts under the plan. The plan also needs to submit control of future earnings and income to the bankruptcy trustee. Here, the debtor saves time, money and stress.
  3. Subchapter V debtors do not need to pay quarterly fees to the U.S. Trustee’s office. Under most bankruptcies, The U.S. Trustee’s appointee is entitled to a quarterly fee for their work in advising the debtor and overseeing the reorganization plan. As a handbook published by the U.S. Department of Justice released soon after the passage of the SBRA makes clear, that is not the case under a Subchapter V proceeding. This is another expense the small business debtor avoids under the plan. Unlike a traditional Chapter 11, however, the Court will appoint a Subchapter V Bankruptcy Trustee, who will be entitled to a fee.
  4. Subchapter V promotes an accelerated timeframe for confirming and completing a reorganization plan. The new subsection requires the bankruptcy court to hold a status conference within 60 days after the petition is filed by the small business debtor and an order for relief is granted (See 11 USC 1188). The policy consideration is not ambiguous, as this statute tacks on the language, … “to further the expeditious and economical resolution of a case under this subchapter.” The confirmation of the Subchapter V also does not require the affirmative vote of any creditors, removing another Chapter 11 obstacle. Additionally, the subsection dictates that the reorganization plan be scheduled over a span of three years or, if that proves too ambitious, across five years.
  5. There is no requirement to form a creditors’ committee for oversight of unsecured debt. When we said a Chapter 11 saga can be arduous, we meant it. That process is subject to the mandatory consideration or use of a committee of the debtor’s unsecured creditors, which can weigh down the efficiency with which the debtor winds through and satisfy the details of the confirmed plan. Subchapter 5 does away with this mandate, through the appointed trustee retains the right to file a motion to form a committee if deemed necessary.
  6. Only the small business debtor can request a modification of the reorganization plan. This change affords extra protection to the debtor by putting the power to modify any plan that has been confirmed but has not yet been consummated solely in its hands. Unlike under Chapter 11, a trustee can not apply for modification. That matters because the debtor no longer has to worry about facing larger regular payments as their business conditions improve.
  7. Subchapter V debtors are not subject to the “absolute priority” rule and can retain equity in their companies. This may prove to be the greatest benefit the SBRA offers. Under Chapter 11, a debtor’s senior creditors are said to have “absolute priority” in recovering debts. They get the first dive in the pool, so to speak. As a result, debtors often find that that this burden is so great that they cannot maintain control of the company and have to cede their equity. Not so under Subchapter V. The new law explicitly disclaims the rule so long as the court finds that the plan is “fair and equitable” and doesn’t unfairly discriminate against any of the creditors. This provision clears the way for another, which requires that the debtor must pay amounts equal to its “disposable income” in a given time period. These two adjustments help prevent a loss of control or a total collapse.

The COVID-19 debt ceiling of $7.5 million has been extended through March 27 2022, and will sunset back to the specified $2.725 million absent an extension. Even so, Subchapter V looks to have lasting impact in any case. It is an avenue to endure business hardship with greater success.

No representation is made that the quality of the legal services to be performed is greater than the quality of legal services to be performed by other lawyers.

Need an attorney to help you best plan a bankruptcy? Contact Wallace Jordan today.