When you can’t make payments on your obligations, you might try negotiating a settlement with your creditors. Subchapter V in bankruptcy court is an alternative that a business can choose rather than pursuing debt settlement outside of court. They work very differently. You need to choose a path based on what makes the most sense for your business’s financial health.
Until February 19, 2020, most small businesses in reorganization could not file a traditional Chapter 11 bankruptcy because it was too expensive and they had to shut down and be liquidated in a Chapter 7 case. Chapter 13 is only for individuals and there are debt limits. To assist small businesses, Congress enacted the Small Business Reorganization Act of 2019, which added Subchapter V to Chapter 11 to streamline Chapter 11 reorganization for small business debtors and to use a faster, cheaper process so the business can continue. It helps the debtor, and also the employees, suppliers, customers and taxing authorities.
Not everyone can use it. Essentially, for a Subchapter V case, at least 50% of the debts should stem from commercial or business activities. The business itself does not need to be continuing, at least according to early case law such as In re Wright (Bankr. D.S.C. 2020) even when the business owner guaranteed the debts personally. The business cannot be a single asset real estate business. Also, the business debts need to fall under the new limit. At enactment the limit was $2.7 million; the limit was increased to $7.5 million on March 27, 2020, under the CARES Act, and applied for one year (it was recently extended for an additional year, and is set to expire in March 2022). Those figures date from the law’s early years, so check the current limit before you count on it.
Far Simpler than a Traditional Chapter 11
If you qualify, the case is far simpler than a traditional Chapter 11. There are no U.S. Trustee fees, and removing the requirement that a creditors’ committee be appointed cuts down on expenses. Hiring counsel is simpler with Subchapter V. Under Subchapter V, only the debtor gets to file a plan, so there is no risk of creditors filing a competing plan and so, at least in that respect, costs are reduced. There is no disclosure statement under Subchapter V so that is also a savings. Creditor voting is no longer necessary either. A mortgage on your home can be modified if it was business related, and the plan is easier to change after confirmation. Most important, the absolute priority rule no longer bars confirmation. That rule is complicated, but this is a big deal.
A new feature of the U.S. bankruptcy system is the appointment of a trustee to supervise the debtor in every Subchapter V case. The trustee does not take control of the debtor’s business as it would in a traditional Chapter 11. Instead, the trustee will try to help you work out an agreement with creditors (the built-in mediator), and oversee your case. What happens next depends on the plan. For example, in a case with a consensual plan, the trustee’s duties end upon the substantial consummation of the plan, typically when payments to creditors begin. In a nonconsensual plan, the trustee makes those payments until the plan is completed. You pay the trustee, so don’t lean on them more than you need to, though the fees are usually modest.
That nonconsensual plan is where Subchapter V gets its real power. In a traditional Chapter 11, at least one impaired class of creditors has to accept the plan. Even if all the creditors vote against the plan, you can get it confirmed, provided it is “fair and equitable” to them. Usually, that means they get the greater of either: (a) what they would receive if the business’s assets were liquidated, or (b) all of your “disposable income” for a period of three to five years. For a business, “disposable income” is any money left over after the business pays expenses necessary to keep it operating such as payroll, rent, marketing and supplies. There is often a dispute over what expenses are truly necessary. The creditor’s main complaint is that the owner can’t pay himself a high salary because it would leave less money for creditors.
Debt settlement offers nothing like that. For one thing, you can only settle your debts through debt settlement if the creditors agree. A creditor who refuses simply refuses, while a Subchapter V plan can be confirmed over that creditor’s objection. For a business that qualifies and can still make money, that leverage is hard to beat.
But there is a catch that can send an owner back to settlement: the personal guarantee. A business files bankruptcy. The creditors trim the business’s debts. The creditors turn to the owner’s personal guarantee to pick up the difference. The business bankruptcy does not remove the guarantee. The best thing to do is for the business owner to file his own bankruptcy case. That could be a Subchapter V, a Chapter 7 or a Chapter 13, depending on the situation. If that’s not an option, debt settlement is the best alternative.
So the two are not always rivals: settlement can handle the guaranteed debt a Subchapter V case leaves behind. Subchapter V itself is a powerful tool, and small businesses owned by regular people have come through it with lower overhead and leaner operations where before they would almost certainly have failed. The real question is whether it is right for your small business, or if some other tool in your business arsenal is better. Getting that answer right may be the difference between your business still being around in a few years and going out of business. You don’t know until you compare the options.
