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Subchapter V Bankruptcy
Subchapter V (some call it “V,” others call it “Five”) is a new subchapter of Chapter 11 of the Bankruptcy Code that is specifically designed to help small businesses reorganize in a more streamlined and efficient process that your typical Chapter 11. The “old” Chapter 11 was really drafted with large corporations in mind. Sure, there’s been a small business debtor designation for years, but other than allowing debtors to combine and the Disclosure Statement and Chapter 11 Plan into one hearing and notice, prior to Subchapter V (created through the Small Business Reorganization Act of 2019), being a small business debtor meant following more stringent reporting requirements and more draconian and inconvenient deadlines.
Subchapter V modifies or even eliminates certain Chapter 11 rules and procedures that make it far easier for small businesses to confirm plans or reorganization and, most importantly, allow owners to retain control of their company.
If your small business is having significant financial troubles, you will need the help of an experienced Subchapter V bankruptcy attorney to help you through this complex process.
Should My Business File Chapter 11?
Answering this question requires the management to actually know what caused the financial strain in the first place. One thing that is vital to any successful Chapter 11 Plan of Reorganization is cash flow. Without cash flow, no business can survive, even in bankruptcy.
Here are the things that a Chapter 11 Plan can do for your business:
1. Immediately stop any creditor collection efforts, including any pending litigation against your company, which can either be continued in the bankruptcy court, or resumed at a later date in its original venue.
2. Prevent utility companies from pulling the plug (pun intended).
3. Stop any real property and equipment foreclosure actions.
4. Allow the business to pay back its outstanding debts (including tax debts) over a period of years. Unsecured creditors are often paid pennies on the dollar pursuant to the provisions of a confirmed plan.
Here are the things that a Chapter 11 Plan cannot do for your business:
1. Create a marketable product or service.
2. Increase revenue.
3. Give management the skills and drive necessary to operate a successful business and operate it through the extensive Chapter 11 process.
Who Qualifies to file Subchapter V?
SubChapter V is a designation you must actively choose if you or your business qualifies to be a small business debtor under the newly created code section. The CARE Act temporarily allows companies and individuals with up to $7,500,000.00 in secured and unsecured non-contingent (one where all events giving rise to the liability for the debt occurred prior to the debtor’s filing) and liquidated (meaning the amount owed is known) debts to choose to proceed under Subchapter V. The prior debt limit was only $2,725,625, and after the expiration of the CARES Act this year, it may fall back down to the old level.
Secondly, you must be engaged in “commercial or business activities”, except if that activity is owning single asset real estate. In short, if you are an individual, you probably need to be, at the very least, a 1099 contractor rather than an individual that works a W2 job for a large company. Creditors will try to argue that you are not engaged in “commercial or business activities” if you work for someone else.
Important Features of Subchapter V
No Disclosure Statement Requirement
A chapter 11 disclosure statement is a document that traditionally must be filed alongside a Chapter 11 debtor’s plan to give creditors adequate information regarding the plan for them to case a vote. However, in Subchapter V, this requirement is eliminated in order to speed along the process of confirming a plan of reorganization and to cut down on legal fees. The Chapter 11 Plan must include some of the information that is typically present in the disclosure statement; however, most debtor’s counsel put that information in plans anyways, so it’s still far less work.
No Absolute Priority Rule (Owners Retain Equity More Easily)
This is arguably the most bombastic and beneficial inclusion in the new Subchapter V. Traditionally, if all creditors classes did not vote for a Chapter 11 Debtor’s Plan, the Debtor would have to request the Court to “cramdown” the plan and confirm it over the dissident creditors. The issue cramdown plans is that under the traditional rules of Chapter 11, if a class of unsecured creditors voted against the plan (or failed to vote at all), the existing owners could not retain their ownership interest in the company without contributing significant new value (read: more money!) into the company. Many times, if unsecured creditors were not on board under traditional Chapter 11 rules, your Chapter 11 plan’s hopes and dreams were dashed by the absolute priority rule.
Under the new Subchapter V, even if not a single class of creditors vote for your plan, as long as you contribute all your businesses disposable income for up to 5 years to your creditors, the Court will confirm your plan. Disposable income includes income that is reasonably necessary to be expended “for the payment of expenditures necessary for the continuation, preservation, or operation of the business of the debtor.” 11 U.S.C. § 1191(d)(2). Rest assured that what constitutes disposable income will be hotly contested in any cases not consensually (where all creditor classes vote in favor of the plan) confirmed. You will need the counsel of an experienced Chapter 11 attorney who regularly deals with small business cases to carry you through the minefield that is the new Subchapter V.
Paying Administrative Expenses Through the Plan
In traditional Chapter 11 cases, Debtors had to pay all their administrative expenses by the Effective Date of the Plan. The Effective Date is the date in which your plan becomes effective (complicated, I know). This is usually 30 days after the plan is confirmed. The problem with this for many small business debtors is that Chapter 11 attorneys fees, even for small business debtors, can be quite high, depending on the complexity of the case. Debtors often have to pay accountants and other professionals as well during the case. If the Debtor incurs certain debts after filing the bankruptcy, they can be categorized as administrative expense claims (post-petition trade vendor debt is one example). The new Subchapter V trustee (we’ll get to this shortly) also charges fees in place of the U.S. Trustee quarterly fees. Those fees may also be able to be paid over the life of the plan. If your monthly plan payments are $2,500 for five years, the first payments will go directly to your administrative claimants. This makes is far easier for debtors to confirm Chapter 11 plans without a treasure trove of cash in the bank and also allows debtor’s counsel to get paid through the plan.
No U.S. Trustee Fees
Under traditional Chapter 11, debtors must pay fees to the U.S. Trustee program every calendar quarter. These fees range from $325/quarter to 1% of all gross revenue over $1,000,000 for the quarter. For small business with high revenues and low profit margins (roofing contractors, restaurants, and trucking companies come to mind) these fees can kill a case. What’s replaced are the hourly rates of the individual assigned to be the Subchapter V trustee to your case. While the code is new, the fees should not be exorbitant, and fortunately, debtors can now pay those fees over the life of the plan.
SubChapter V Trustee
A new role has been created among the players in Subchapter V. This person is called the Subchapter V trustee, and that person’s job is to stay abreast of the occurrences in the case and facilitate a consensual plan of reorganization with the debtor’s creditors. The Subchapter V trustee also makes recommendations regarding the debtor’s plan to the court, evaluates the debtor’s assets, and assesses the debtor’s prospects for success. This person is a neutral party in the case. They want you to succeed, but they will call you out for not playing by the rules.
No Creditors’ Committees
In order to ensure the Subchapter V bankruptcies remain affordable, there are no creditors’ committees allowed to be appointed unless ordered by the bankruptcy court for good cause shown. This would be extremely rare in a Subchapter V case. In fact, I have never seen a creditor request the appointment of a committee in a small business case, and the judges would be very hesitant to grant such a request unless the company has hundreds of very small creditors that could otherwise not have a voice. Even then, it would be an uphill battle for the requesting creditor.