Almost every owner who calls us has a version of the same question. I owe money to five different creditors. Can I work out a lump sum settlement with each of them for less than what I owe and not go into bankruptcy? Lately the question comes with a second one attached, because somebody has told them about Subchapter V, and they want to know if settling with creditors means they never have to go near it. Sometimes, yes. But, maybe, sometimes, not. Like everything in bankruptcy, it depends. Let’s walk through why.
Subchapter V
Subchapter V is part of Chapter 11. Congress added it through the Small Business Reorganization Act of 2019, and it took effect on February 19, 2020. The trouble it was meant to fix is simple: most small debtors can’t afford the professionals that are necessary to file and navigate a traditional Chapter 11 case. Before 2020, many of them were pushed into Chapter 7 and simply shut down. Even if the company stood a real chance of survival, it was out of luck. The new law was meant to encourage small businesses to reorganize under Chapter 11 by reducing the cost and complexity of a case. Now a small business that needed to reorganize under Chapter 11 could actually afford to do it. In other words, it isn’t actually a different kind of bankruptcy; it’s just an easier, faster, and less expensive bankruptcy for small business debtors, built to keep the business operating for the benefit of its owners, employees, suppliers and customers.
Not every business can use it. At least half of the debts have to come from commercial or business activity, and a single asset real estate business does not qualify. There is also a ceiling on total debt. It started at $2.7 million, the CARES Act raised it to $7.5 million for a year, and that increase was extended to March 2022, so ask a bankruptcy attorney what the limit is when you are actually deciding. If your business doesn’t fit inside those lines, settlement is the obvious road. If you don’t qualify for Subchapter V but have real assets and a chance to pay at least a portion of what you owe, it might be worth a try. With one caveat: that might still be a good time to at least talk to a bankruptcy attorney first. If it does fit, the answer isn’t that simple. Even for qualifying debtors, Subchapter V is not a magic wand that will make all your debts disappear. It’s just a shorter path to reorganize and keep your business running for the long run.
So what does Subchapter V offer and what does it not offer? It’s faster and less costly than regular Chapter 11. There are no U.S. Trustee fees and no creditors committee. Only the debtor can file a plan, and no disclosure statement is required. Part of Subchapter V’s simplicity also involves streamlining the confirmation process for the debtor’s plan. Perhaps the most significant aspect of the changes to Subchapter V is that it does away with the traditional absolute priority rule (APR). Under Subchapter V, a company continues to operate its business “as a going concern.” The bankruptcy court appoints a Subchapter V trustee. That trustee does not run the company; think of them as a coach on the sidelines, or a built-in mediator between the parties. The cost of the trustee is not much in most cases, but the debtor is the one paying it.
The feature that matters most for anyone weighing bankruptcy against settlement is how plans get confirmed. In a Subchapter V, it is possible to have a plan that has been confirmed even though every single creditor voted against the plan. How is this possible? The plan has to be “fair and equitable,” and at the heart of that is the requirement that the plan pay creditors the greater of what they would get if the company liquidated or its projected disposable income for the following three to five years. Now we need to be clear. It is not that easy. It will still take a lot of work. The court will scrutinize every aspect of the plan to make sure it is fair and equitable. A running theme in these cases is how much the business owner is allowed to pay herself. How much will the owner draw as compensation for running the business? Is it fair? Reasonable? Creditors may object if the owner is paid above market, since that leaves less for them. A facility that permits plan confirmation over the objection of creditors is particularly useful where there are a large number of creditors who might disagree on the best approach to the plan. Whether there are five creditors or five hundred, the debtor does not need to obtain the approval of each of them.
Debt Settlement
Debt settlement works the other way around. Outside of bankruptcy, you could always pick up the phone and call a creditor and work out a deal to settle a debt for less than the full balance. Just because you want to settle the debt doesn’t mean the creditor wants to settle the debt. Remember, with settlement, we are bound by the level of cooperation of each creditor that we are negotiating with. We never know whether a creditor will accept a settlement at a certain level or not until we make that particular offer. With Subchapter V, you’re negotiating with everyone at once. Both can achieve a manageable outcome, but they solve different problems. Settlement can work—especially if you only have a few creditors and they’re all open to compromise. But if you have more than a handful of creditors, or if they’re split on how to handle the situation, settlement becomes harder, riskier, and sometimes impractical. Subchapter V, by contrast, gives you the power to restructure debts on behalf of all creditors, even the ones that don’t want to go along.
The Personal Guarantee
You borrowed money for your business. You signed the loan documents. You guaranteed the debt. You owe the debt. The business can’t pay. Someone recommends Subchapter V. You do your homework. You weigh your options. You discover Subchapter V might not save you. Debt settlement might. Here is why. I have the following conversation with my clients every day. “Mr. Owner, you signed a guarantee on this loan?” “Well, yeah. I don’t know that it gets discharged with this bankruptcy.” It doesn’t. A business bankruptcy does not remove the owner’s personal guarantee. Even after a confirmed plan, there is still the personal guarantee hanging over the owner’s head. The business can strip down its liabilities. When it comes time to pay the debts, creditors will be looking to the owner to make them whole. The most effective fix is for the owner to file their own Subchapter V, Chapter 7 or Chapter 13. If that isn’t an option, debt settlement is the best alternative.
It also helps to know that a Subchapter V filing does not always end in a confirmed plan. Once a case is filed, the business and its creditors often work things out and agree to dismiss it. The parties have reconciled their differences. It’s no longer necessary to confirm the plan. This is why Subchapter V can be a powerful tool. It’s not just about filing a plan. It’s about using the process to negotiate the best deal possible.
So where does that leave you? If you have five creditors, with no personal guarantees, and you can come to an agreement with each of them, then yes, maybe you can settle without filing for Subchapter V. But if you have five creditors who will not agree, a plan the court can confirm over their objections is something settlement cannot match. How many creditors are involved? Does everybody agree? Is there a personal guarantor? What will happen if I file and none of the creditors agree with me? Answer those honestly and you will usually know which road you are on.
