For the first time since the United States enacted the Bankruptcy Code, small businesses may utilize the benefits of Chapter 11, including eliminating debt and rejecting unprofitable contracts, without worrying about losing their business.

Normally, businesses of any size are ill-advised to enter Chapter 11 without a well-planned exit strategy, especially when the business aims to impose a reorganization plan despite the objections of certain classes of creditors.  This is due in large part to the absolute priority rule which prevents business owners from maintaining their equity interest if creditors are not paid in full. Subchapter V of Chapter 11 changes that.

Here’s why Subchapter V is a great tool for struggling businesses looking to survive the financial effects of COVID-19.

 

What Businesses Need to Know: A Snapshot of SBRA

The Small Business Reorganization Act (SBRA) was signed into law in August 2019 and took effect in February 2020. The SBRA, which is embodied in Subchapter V of Chapter 11 of the Bankruptcy Code, retains some components of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, including one-step confirmation, while adding new features intended to make Chapter 11 more accessible for small businesses. Highlights of Subchapter V include:

  • Qualification for Subchapter V – Originally, only a business debtor with non-contingent, secured and unsecured debt less than $2,725,625 could elect Subchapter V treatment.[1] This cap was temporarily increased for one year to $7,500,000 as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act passed on March 27, 2020. It should be noted, however, that entities which derive substantially all of their income from operating a single real property are ineligible for Subchapter V).
  • Streamline Procedures – In order to keep cases moving quickly, theoretically conserving administrative costs, a Subchapter V small business debtor must normally file its plan of reorganization within 90 days after entering bankruptcy.[2] However, 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.”[3] In the COVID-19 environment, courts are likely to grant extensions.
  • Plan Similar to Chapter 13 for Consumers – 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 to five years, during which time the debtor must devote its projected disposable income to paying creditors.[4] In a traditional Chapter 11 case, administrative expenses must be paid at plan confirmation; under Subchapter V, they may be paid over the life of the plan.[5] Debts are not discharged until the debtor completes all of its plan’s payments unless the plan proposes to pay creditors in full, in which case the debtor will receive a discharge upon plan confirmation.[6]
  • Perpetual Exclusivity – Only the small business debtor may propose a plan of reorganization under Subchapter V regardless of the expiration of exclusivity.[7]
  • Creditor Approval of Plan Not Needed – Confirmation of a small business debtor plan of reorganization under Subchapter V tracks the criteria of section 1129(a) of the Bankruptcy Code, with the critical exception that the debtor does not need to obtain the acceptance of an impaired class of creditors. Because creditor approval of the plan is not needed, there is no requirement for a separate disclosure statement.  Instead, the plan itself must include a brief history of the business operations of the debtor, a liquidation analysis, and projections with respect to the debtor’s ability to make payments under the proposed plan.[8]
  • No Absolute Priority Rule – Subchapter V eliminates the so-called “new value rule,” which normally requires equity holders to provide “new value” if they want to retain their equity interest in the business.[9] This means that equity holders can retain their interests in the business even if the plan does not pay unsecured/secured creditors in full.
  • No Creditor Committee – Creditors’ committees in small business cases are not allowed under Subchapter V “unless the court orders otherwise.”[10]
  • Subchapter 5 Trustee – Normally, a Chapter 11 trustee is appointed only for cause, such as fraud or gross mismanagement, and seizes control of the debtor’s operations. Under Subchapter V, a trustee is automatically appointed, but the debtor retains control of its assets and operations as the debtor in possession. Although Subchapter V trustees have authority to investigate the debtor’s financial affairs, their primary function is to facilitate a consensual plan among the debtor and its creditors, almost like a mediator would facilitate a settlement in litigation.[11]
  • Modification of Loans Allowed – Subchapter V also cushions small business owners from certain adverse personal consequences that might otherwise disincentivize a Chapter 11 filing. For example, if the debtor’s principal used his or her primary residence as security for a loan to fund the small business, the debtor’s plan may modify the loan.[12]

[1] See 11 U.S.C. § 101(51D)(A).

[2] See id. § 1189(b).

[3] See id.

[4] See id. § 1191(c).

[5] See id. § 1191(e).

[6] See id. § 1181(c).

[7] See id. § 1189(a).

[8] See id. § 1190(1).

[9] See id. § 1191(c).

[10] See id. § 1181(b).

[11] See id. § 1183(b)(7).

[12] See id. § 1190(3).

Brandon Tittle leads the firm’s Bankruptcy/Financial Restructuring Practice, with a focus on corporate reorganization, restructuring, acquisitions and litigation. He has a wealth of experience representing entities in their Chapter 7 and 11 cases and out-of-court restructurings and creditors’ committees. His practice also includes extensive general bankruptcy litigation.

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