By the time most owners go looking for answers, they’re already in trouble. At that point, the decision quickly turns to bankruptcy, settlement, or restructuring. When it comes time for payment relief, the decision to either settle, restructure or file for bankruptcy can be confusing for the unwary.
Settlement offers a chance to negotiate directly with creditors and pay less than the full amount owed. Restructuring involves renegotiating terms with creditors to make debt payments more manageable. And bankruptcy is not always the end of the road: Chapter 11 reorganization allows you to stay in business and restructure your debt with court involvement. Think of reorganization as the chance to stick a landing after the crash.
Chapter 11 Is Becoming Easier to Use
For years, though, that court route was hard for a small business to use. Traditional Chapter 11 was notorious for its high costs, and attorney fees, court proceedings and creditor negotiations can quickly consume a small business’s resources. For many businesses, like a family owned foundry or small consulting firm, this meant that Chapter 11 was out of the question. Today, the picture is different. Chapter 11 is becoming easier to use, especially for small to medium-sized businesses, thanks to a new provision in bankruptcy law called Subchapter V. In February 2020 the Small Business Reorganization Act (SBRA) took effect. The new law creates subchapter V of chapter 11 for small business debtors, greatly simplifying the process. Subchapter V makes the Chapter 11 process quicker, less costly, and simpler for small businesses.
The first difference owners notice is time. A traditional Chapter 11 case is complex and lengthy, and with all the procedural hurdles it can drag on for months or even years. For a small business, that kind of delay can be devastating. It’s a question of survival. Under Subchapter V, a business can propose and confirm a plan of reorganization in as little as 8 weeks.
The second difference is cost. Subchapter V is generally less expensive than a traditional Chapter 11 case, because it cuts down on procedural requirements and legal complexity. That matters, because cost clogs the works: the more bankruptcy costs you incur, the less cash flow you have available to invest in the future.
The biggest difference for most owners is what happens to their ownership. Traditional Chapter 11 has the absolute priority rule, which says that senior creditors are entitled to be paid in full before any subordinate creditors or equity holders keep any interest in the business. That rule often led to disputes and held up plans, and small business owners felt Chapter 11 was too “punitive” because the owners would get squeezed out of their company. In Subchapter V, by contrast, a plan can be confirmed without regard to the absolute priority rule. This is huge. This means that the business’s owners can keep their ownership interests while negotiating a plan with the creditors to restructure the business. A plan is more likely to be confirmed, and the debt can be brought down to a manageable level while the owners stay in control.
Subchapter V also introduced a new kind of trustee, whose job is to help get a consensual plan confirmed. The trustee is there to help you and your creditors negotiate your plan. In practice, the trustee often acts more like a mediator or conciliator, assisting with negotiation and consensus-building among stakeholders.
There are other differences as well. A Subchapter V case has no unsecured creditors committee and no requirement for a separate disclosure statement, and an individual debtor can restructure a home mortgage (other than a purchase money mortgage) that was used for business purposes. All of those different provisions mean that a small business can likely reorganize its debts much faster and with less expense in Subchapter V.
Settle with Creditors
This does not mean that bankruptcy is always the best option when debt gets too high. Many small business owners choose to settle directly with their creditors and avoid the expense of bankruptcy. If a business can settle with its creditors outside of bankruptcy, it can avoid a court-supervised process and keep more control over its future. But when a business cannot settle with its creditors outside of bankruptcy, Subchapter V offers a much more efficient and cost-effective option than a traditional Chapter 11 restructuring process.
Whether a small business should pursue bankruptcy under Subchapter V, settle with creditors, or try to restructure outside of court will depend on the facts. But the availability of Subchapter V has given small businesses new options when filing for bankruptcy. Bankruptcy laws change over time, and what we know today is not necessarily what we will know a year from now. Before you choose a path, you might want to consult with an attorney to determine what will make the most sense for your business.
