The Small Business Reorganization Act: Why the New Subchapter V May Make More Sense for Some Businesses Than a Traditional Chapter 11
By John Archer & Scott Norcross
As many businesses navigate their fourth week of a complete shutdown, the $2 trillion CARES Act should ease some of the financial pain caused by the coronavirus. For companies that have significant debt, the pandemic may still serve as the tipping point. Small businesses could face the very difficult decision to file bankruptcy. But what chapter of the Bankruptcy Code should be used? A traditional Chapter 11 filing can be a complex and expensive endeavor which is unlikely to result in a confirmed plan for reorganization. Many have argued that Chapter 11 was designed for large publicly traded companies and not small businesses. Due to burdensome disclosure requirements, high administrative costs and long delays, numerous small businesses have opted for unsupervised wind-downs, receiverships and other types of dissolution efforts.
In light of the foregoing, Chapter 11 may not be a viable tool for all companies because it will be an expensive, long and complex process to reorganize and emerge from bankruptcy. However, there is a more streamlined approach to small business reorganizations. In the fall of 2019, Congress passed the Small Business Reorganization Act (SBRA), commonly referred to as Subchapter V, which became effective in February of 2020.
To qualify for this election, a company must have secured and unsecured debts under $2,725,626. Recently, the CARES Act increased the debt limit from $2,725,625 to $7.5 million – including both secured and unsecured claims. Businesses with debts of $7.5 million or less will now qualify to file cases under Subchapter V. This increased limit will only be effective for a one year period and will return to $2,725,625 after the one-year period.
Some of the differences between the SBRA and a traditional Chapter 11 are as follows:
The goal of Subchapter V is to provide an effective reorganization option for small business at a lower cost and on a faster schedule. As such, within 60 days of the filing, the bankruptcy court is expected to hold a status conference in an effort to find an expeditious and economic resolution. Minimally, 14 days prior to the conference, the debtor is required to file a report detailing its efforts to attain a consensual plan of reorganization. The debtor further must file a plan 90 days after the order for relief. All of these deadlines are aimed at expediting the process.
Appointment of Trustee
The trustee will facilitate a plan of reorganization and could further monitor payments to creditors. The Small Business Trustee has a role similar to the chapter 13 trustee in a consumer bankruptcy case. He or she will act as an intermediary for plan payments and have the authority to investigate the financial affairs of the debtor and object to the allowance of proofs of claim. The Small Business Trustee’s role concludes upon substantial consummation of the confirmed plan.
Only the Debtor Submits a Plan
As mentioned above, the debtor must submit a plan of reorganization within 90 days and is the only party allowed to submit a plan. This is a significant change because the small business debtors enjoy the same perpetual plan exclusivity as do family farmers and fishermen under chapter 12 and consumer debtors under chapter 13. The small business debtor does not need to solicit plan acceptances with a separate disclosure statement, which saves time and expense. In this case, the plan itself will include a brief history of the business operations of the debtor, a liquidation analysis and projections for plan payments.
No Creditors’ Committee and Payment of Professionals
Subchapter V does not provide for a committee of unsecured creditors without a court order. In addition to eliminating creditors’ committees, Subchapter V provides that professionals are not disqualified from being employed by the estate under section 327 of the Bankruptcy Code if they hold a claim against the debtor of less than $10,000 that arose prior to the commencement of the case.
Delayed Payment of Administrative Expenses Claims
The SBRA removes the requirement that the debtor pay priority claims on the effective date of the plan. This includes the payment for goods and services provided during bankruptcy, which allows a company to stretch payment over the course of the plan that could be as long as five years.
Under the SBRA, the discharge will be dependent on terms of the plan and not consent of the creditors. The court must grant the debtor a discharge after completion of all payments due within the first three years of the plan, or such longer period as the court may fix (not to exceed five years). The discharge relieves the debtor of personal liability for all debts provided under the plan except any debt: (1) on which the last payment is due after the first three years of the plan, or such other time as fixed by the court (not to exceed five years); or (2) that is otherwise non-dischargeable. All exceptions to discharge in Section 523(a) of the Bankruptcy Code apply to the small business debtor. This is a departure from a typical corporate Chapter 11 which has limited exceptions to discharge.
Elimination of the Absolute Priority Rule
In a traditional Chapter 11, unsecured creditors must be paid in full if the debtor wishes to retain equity in the company. Subchapter V removes this requirement, and only requires that the plan not discriminate and that it be fair and equitable, so long as the debtor’s projected disposable income is contributed to the plan.
Subchapter V offers the ability for individuals to modify their mortgage under certain circumstances. An individual can modify the mortgage on his or her principal residence, provided that the mortgage loan was not used to acquire the real property but was used primarily in connection with the debtor’s business. Modifications of this nature are not possible in chapter 13 or traditional Chapter 11 matters.
Will Subchapter V prove to be a viable reorganization option for small businesses? Only time will tell. However, if the current health crisis continues indefinitely, many businesses may be considering this Bankruptcy Code election as an option.
If you have any questions or would like to discuss further, please reach out to John Archer at email@example.com or 216.736.7224 or Scott Norcross at firstname.lastname@example.org or 216.736.7264.