When a business is buried in debt, the owner has two broad paths: close it down, or try to get a bankruptcy court to let them keep running their business under a Chapter 11 plan, and pay off their debts over time. On the surface this is a big decision. Owners may have built up significant customer bases, reputations and/or employees that they will lose if they choose to close shop.
Classic Chapter 11 Reorganization
For most small companies, though, the second path has been hard to reach. A “classic” Chapter 11 reorganization can be expensive. You’re on the hook for your attorneys’ fees, as well as those of the creditors’ committee. The U.S. Trustee charges quarterly fees ranging from $250 to $250,000, depending on how much money you’re moving. One article estimated that the bill can run 1% to 5% of the company’s total assets.
Money is not the only problem. If you’re filing a traditional Chapter 11, the debtor has to come up with a reorganization plan within 120 days after filing and get it confirmed within 180 days. The court can extend those dates, but if the time runs out, creditors get the right to propose their own plan. Typically, the debtor also has to get the creditors to agree to the plan. With so many parties to satisfy, the process can be very long and complex, and cases can last months or even years. In Chapter 11 the owner no longer gets to run things as they please. You must get approval for anything outside the “ordinary course of business,” like selling assets, paying prior claims, borrowing more money or appointing new officers to restructure the business. Those filings and hearings mean additional attorney fees, and the company has to pay those bills.
Worst of all for an owner is the “absolute priority rule.” It means that lower-rank creditors can’t get paid at all until higher-rank creditors are paid in full. In practice, that usually means that if the creditors aren’t paid in full, the owners of the company will lose their ownership interest. There’s a way around that but you have to inject some “new value” - usually a substantial amount of cash.
Assignment for the Benefit of Creditors
If you close the business, you can either go straight to Chapter 7 liquidation, or opt for an “assignment for the benefit of creditors” (ABC) in state court (in Florida, the rules are in Chapter 727 of the Florida Statutes). In an ABC the owner signs an irrevocable assignment of assets to an assignee (usually an attorney or accountant who does this), files detailed schedules of creditors and assets, hands over the assets, and testifies under oath about the finances. When the ABC starts, an assignee gathers all the assets and converts them to cash and pays creditors a fair share. Each creditor is paid in a strict order of preference dictated by the statute (like Chapter 7). The assignee may continue the business for up to 45 days, or longer only if the court determines it’s in the best interests of the estate. The purpose of an ABC is to dissolve the business, and thus there can be no going forward or any potential restructuring.
Subchapter V of the Bankruptcy Code
So for years a small business had two options, and neither was appealing: close the doors for good, or gamble on an expensive Chapter 11. The picture changed in 2020. Subchapter V of the bankruptcy code is a streamlined form of Chapter 11 specifically for small businesses. Enacted by the Small Business Reorganization Act and in effect as of February 19, 2020, it allows a small business to submit a plan to repay creditors over three to five years while continuing to operate, rather than liquidating. Initially limited to businesses with debt of up to $2,725,625, the limit was raised to $7.5 million during the COVID-19 pandemic, and that increase was made permanent by a law passed in June 2022.
Under Subchapter V there’s no requirement to have a committee of creditors, which means the business won’t have to pay the committee’s lawyers and advisers, and it also avoids quarterly U.S. Trustee fees. In a regular Chapter 11 case administrative expenses like bankruptcy lawyers’ fees must be paid in full when the plan goes into effect, but in Subchapter V those fees can be spread out over the plan. Most important for an owner, Subchapter V may let owners stay in the business without putting in any fresh capital even if creditors don’t get paid in full, and even if no class of creditors votes to approve the plan. That’s because there’s no “absolute priority rule” with Subchapter V, but all of the business’s projected disposable income for the 3- to 5-year plan has to go to the creditors, and secured creditors will get the benefit of their collateral. Of course, creditors still must get at least as much as they would have gotten in liquidation.
Under subchapter V, only the business can file a plan, and it must do so within 90 days after filing - though the court may grant an extension for good reason. Because the plan can be confirmed even over creditor objections, the reorganization is expected to be quick. A trustee will be appointed and you will turn over any future income of the business as required to carry out the plan, which gives your creditors peace of mind.
Time can matter when you want to switch from a normal Chapter 11 to a Subchapter V. Some courts have let small business debtors switch their earlier petition when the case was still young, but a Florida bankruptcy judge turned down a debtor who tried to change to Subchapter V more than a year after filing because several deadlines had passed and the judge had already issued rulings. The takeaway: it is best to make the election early.
So, Chapter 11 or closing the business? The decision whether to file for Subchapter V or close shop depends on the owners’ evaluation of the facts. The question is whether there is a reasonable chance of getting on top of the debt, using the opportunities offered by Chapter 11 Subchapter V, or closing the doors for good and liquidating the assets. If there’s a chance to keep the business and redeem the investment, Subchapter V deserves a hard look, ideally with a bankruptcy attorney, before you shut anything down.
