Right Place at the Right Time

The Enactment of New Subchapter V, and How It May be the Bankruptcy Lifeline Small Businesses Need to Survive COVID-19

By: Jason S. Ross, Esq., LL.M. (in Taxation)

DISCLAIMER: While this post is intended to provide valuable and useful information, it should in no way be construed or interpreted as legal advice.  Should you have any specific questions or otherwise be interested in obtaining assistance with your pending legal matters, please contact the law offices of Bauer Gutierrez & Borbon, PLLC, as our attorneys and staff are ready and able to assist.

Looking back to August 2019, when the Small Business Reorganization Act (“SBRA”) was signed into law and slated to go into effect in February 2020, one would think that Congress had a crystal ball and knew what fate held on the horizon.  As time would shortly reveal, in March of 2020 the U.S. economy would come to a screeching halt as direct result of the national and local responses to the global Coronavirus (COVID-19) pandemic.  From Governors issuing stay-at-home orders to the closing of non-essential businesses, many small businesses found themselves being forced to “close up shop” and cease all activities—in some instances, for two (2) or more months.  The financial consequences of these preventative actions have impacted small businesses especially hard. Under the SBRA—commonly known as Subchapter V, referring to new Subchapter V of Chapter 11 of the U.S. Bankruptcy Code (11 U.S.C. § 1181, et. seq)—small businesses struggling to survive our current economic state may find a much-needed lifeline. 

A Brief History of the Small Business Reorganization Act (“SBRA”)

The SBRA was arguably long overdue in the grand scheme of bankruptcy legislation.  Prior to its enactment, many financially distressed small businesses consulted with bankruptcy lawyers only to be informed that they were ironically “too poor” to reorganize under “traditional” Chapter 11 bankruptcy.  Congress’s first attempt to address this issue came in 2005 when they enacted the Bankruptcy Abuse Prevention And Consumer Protection Act (BAPCPA), which promised to streamline the Chapter 11 process for small businesses. However, as the BAPCPA played out, this “reform” actually gave creditors more power in the Chapter 11 process and imposed increased reporting requirements and other procedural burdens that many felt outweighed the actual filing benefits for small businesses.  Being largely ineffective in addressing the gaping needs of small businesses, Congress, in 2019, went back to the drawing board and enacted the SBRA, creating Subchapter V of Chapter 11 of the U.S. Bankruptcy Code, entitled “Small Business Debtor Reorganization.” While Subchapter V retains some of the components of the BAPCPA, such as one-step confirmation, the Subchapter adds new and additional features intended to make Chapter 11 more accessible and practicable for small businesses. 

Some Highlights of Subchapter V

Subchapter V Increased Debt Limits Provided by the CARES Act

As drafted and initially intended, Subchapter V was only available for a business debtor with non-contingent, secured and unsecured debts less than $2,725,625.  Additionally, debtor entities that derive substantially all of their income from operating a single-asset real estate operation are ineligible for Subchapter V.  While most “mom & pop” businesses fall within these debt parameters, many small businesses that could benefit from the SBRA exceed this modest “debt threshold.”  In an effort to benefit as many small businesses as possible, even before the current pandemic, the National Bankruptcy Conference and others in the industry advocated for raising the debt cap. Albeit, while no long term debt cap increase was implemented prior to this recent crisis, Congress, as part of its response to the COVID-19 pandemic, under the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), increased the cap to $7,500,000 for the next year, in hopes that the higher cap will benefit not only small business owners, but also their creditors, suppliers, customers, employees, and the overall economy. While Congress may decide in the future to extend this increased debt threshold, as it stands currently, this increased cap will lapse and fall back to the statutory debt cap of $2,725,625 on March 27, 2021.

Subchapter V Allows for Easier Plan Confirmation

While in “regular” Chapter 11 proceedings, creditors vote on a reorganization plan for the debtor; under Subchapter V, a debtor can confirm a plan even without acceptance by creditors.  To do so, the plan must not discriminate amongst the creditors and must be “fair and equitable.”  Further, Creditors are still protected to some extent, as they must still receive as much under the reorganization plan as they would if the debtor were forced to liquidate under Chapter 7. 

Additionally, Subchapter V also includes an option for the debtor to contribute all “projected disposable income” in making payments in accordance with a confirmed plan. Much like a Chapter 13 case for individuals with regular monthly income, Subchapter V allows a debtor to spread repayment of its debt over three (3) to five (5) years, during which time the debtor must devote its projected disposable income to paying creditors. “Projected disposable income” is defined as all income which is received by the debtor and which is not reasonably necessary for the maintenance or support of the debtor (or a dependent of the debtor) and/or those expenditures necessary for the continuation and preservation of business operations.  In many instances, this model of allowing the debtor to address its creditors through a confirmed plan benefits both debtors (by allowing them to spread payments out over time) and creditors (by  providing a formal mechanism for meaningful recovery from debtors who may not have much money on hand, but have a realistic expectation of income moving forward).

To confirm the plan, the court must find that either: i) the debtor will be able to make all payments under the plan, or ii) there is a reasonable likelihood that the debtor will be able to make all payments under the plan and the plan contains appropriate remedies to protect creditors if payments are not made as proposed. Debts are not discharged until the debtor completes all of its plan payments.

Expediated Timeline and Streamlined Procedures Under Subchapter V

The process under Subchapter V moves at light speed when compared to traditional Chapter 11 standards.  As with all bankruptcy proceedings, the process starts with the filing of the initial bankruptcy petition.  Under Subchapter V, along with the bankruptcy petition, the debtor is also required to file certain other financial documentation (i.e., a balance sheet, statement of operations, cash flow statements, and federal tax returns).

Following the initial bankruptcy filing, the Court will hold a status conference within 60 days.  At least 14 days before said conference takes place, the debtor must report, in writing, to the Court detailing the efforts it has made, and it will make, in order to reach a consensual plan with the debtor’s creditors.  

In an effort to keep cases moving quickly, theoretically conserving administrative costs, a Subchapter V debtor must normally file its plan of reorganization within 90 days after entering bankruptcy. However, it should be noted that the Bankruptcy Court may extend this deadline “if the need for the extension is attributable to circumstances for which the debtor should not justly be held accountable.” Under the current “COVID-19 environment,” it would seem rather probable that courts are likely to grant extensions liberally, further benefiting debtors. 

Furthermore, under Subchapter V, only the debtor may file a plan of reorganization. This differs from “regular” Chapter 11 where, if the debtor fails to file a plan of reorganization within a certain period, creditors or other parties in interest may file a plan of reorganization on the debtor’s behalf.            

Also, as another time-saving measure, under Subchapter V a debtor does not need to file a disclosure statement. A “disclosure statement,” under traditional Chapter 11, is a required filing designed to provide creditors with sufficient information to analyze and vote for or against the debtor’s proposed reorganization plan.  While this may seem like a trivial request to the ordinary individual, in practice, disclosure statements can often lead to protracted disputes and delays as the parties argue over the adequacy of the disclosures.  As an alternative to a disclosure statement, under Subchapter V, the debtor’s proposed plan of reorganization must include a brief history of the business operations, a liquidation analysis, and projections demonstrating the ability of the debtor to make the proposed plan payments.

Trustee Functions under Subchapter V

Typically, in Chapter 11 proceedings, a trustee is appointed only for cause, such as fraud or gross mismanagement, and would then seize control of the debtor’s operations. Under Subchapter V, a trustee is automatically appointed, but does not take possession of a debtor’s assets and lacks the ability to sell those assets—thus allowing the debtor to retain control of its assets and operations. 

Under Subchapter V, the trustee serves more like a mediator and handler—facilitating the development of a consensual plan among the debtor and its creditors, appearing at major hearings, and ensuring that the debtor makes timely payments under the plan.  While the Subchapter V trustees do have authority to investigate the debtor’s financial affairs, that is not their primary function. Rather they are appointed in an effort to assist and aid the debtor through the Subchapter V process.             

Much like the involvement of trustees in Chapter 13 proceedings, the involvement of the Subchapter V trustee is supposed to be that of an impartial third-party that may increase the likelihood of fair and equitable resolutions among the debtor and its creditors, and may be particularly useful for a small business whose creditors are unwilling to make reasonable concessions in light of the impending financial crisis. As is typical, the debtor must pay the Subchapter V trustee, but such payments are incorporated and paid over the course of the overall confirmed plan of reorganization.

Subchapter V May Be More Cost Effective

Subchapter V also makes further changes to Chapter 11, making a Subchapter V proceeding less costly as compared to traditional Chapter 11 proceedings. 

Under Subchapter V, the requirement for a separate document that discloses the background of the case and alternatives to the plan is eliminated, unless the judge decides otherwise.  This additional filing would usually add at least a month to the process and provides additional opportunities for creditors to object to the proposed plan. 

Further, under Subchapter V, creditors’ committees—a staple in traditional Chapter 11 cases—are eliminated unless they are found to be needed for cause.  Under a traditional Chapter 11 case, there is the automatic creation of creditors’ committees, with attorneys’ and other professional fees paid by the debtor. 

Finally, as previously mentioned, Subchapter V allows for easier plan confirmation.  Under Subchapter V, the debtor’s reorganization plan does not have to be nearly as detailed as in a typical Chapter 11 proceeding and further can be confirmed over the objection of creditors. Also, while in traditional Chapter 11 cases administrative expenses had to be paid at time of the plan or reorganization’s confirmation; under Subchapter V, these administrative expenses may be paid over the life of the plan, thus providing increased financial flexibility to the debtor.

Additional Debtor Protections Added Under Subchapter V

Subchapter V also cushions and helps insulate small business owners from certain adverse personal consequences that might otherwise disincentivize a Chapter 11 filing. One prime example of such protections are, if the debtor’s principal (i.e., the small business owner) used his or her primary residence as security for a loan to fund the small business, the debtor’s plan may modify said loan.  Additionally, Subchapter V eliminates the so-called “new value rule,” which normally would require equity holders to provide “new value” if they wanted to retain their equity interest in the business.  Now under Subchapter V, small business owners can keep their equity in the small business, so long as they distribute their projected disposable income to creditors in accordance with their confirmed plan of reorganization.

Summation

The COVID-19 pandemic has caused effects which are unprecedented in living memory.  Just a few months ago, small businesses that were otherwise on fundamentally sound footing and financially stable have now been forced to explore the fully panoply of options available to them in effort to address their newfound financial strife, including Subchapter V.  Normally, businesses of any size are ill-advised to enter Chapter 11 without a well-planned exit strategy but provided the circumstances and the enactment of this new Subchapter, this crisis may undoubtedly be the exception. Subchapter V may allow small businesses to responsibly pause their obligations for long enough to negotiate with lenders, landlords, and other creditors (who are being inundated with similar requests) and hopefully, resume normal operations once the immediate peril of the pandemic subsides. While we hope that debtors, lenders, landlords, suppliers, and federal, state, and local authorities will work together to keep small businesses from failing, if you feel you may need to file bankruptcy to save your small business, it may be prudent for you to consider taking advantage of the newly-available benefits of Subchapter V of Chapter 11 of the Bankruptcy Code. 

As always, we here at the law offices of Bauer Gutierrez & Borbon, PLLC pride ourselves in offering dynamic, creative, efficient, and cost-efficient services and solutions to individuals and businesses of any size. Particularly for small businesses and small business owners, we hope you find this information useful and informative. Should you have any questions or desire to schedule a free consultation to discuss your legal matters with one of our skilled attorneys, please contact our offices as we are more than happy to assist you with any and all of your legal needs.