How can my small business prepare for and qualify for Subchapter V bankruptcy?

Chapter 11 is the corporate reorganization chapter. Historically, small businesses have avoided it because it’s so time-consuming and expensive. Aiming to make restructuring practical for small businesses, Subchapter V offers the benefits of Chapter 11 but with fewer of the drawbacks. The goal is keeping small businesses operating as going concerns.

Whenever a business or owner files bankruptcy, the stress can push everyone toward acting on impulse. If you have any say in the process, resist that. Developing a well-informed strategy ahead of time matters. The U.S. Bankruptcy Court issued best-practice guidance for Subchapter V filers. Below are highlights of the court’s guidance.

Small Business Debtor

Does the business qualify to file under Subchapter V? Before starting a Subchapter V filing, says the court, determine if the company meets the threshold qualifications of section 1182. “Small business debtor” is the official name for a company that qualifies to file under Subchapter V. Section 1182 of the bankruptcy code sets out the qualifications in detail. Section 101(51)(D) provides a related definition. That sounds simple enough. The court notes that reading those definitions is a start, but only one part of making the eligibility determination.

A company generally has to meet three requirements to qualify as a small business debtor. Meeting them only gets you in the door. Whether you will qualify as a small business debtor for all practical purposes is an additional determination.

First, you must be engaged in business or commercial activity when you file. Courts have interpreted this as requiring active operations. You may be winding down a company for the very reason that you are filing bankruptcy, but the bankruptcy court will want to see signs of an ongoing enterprise. If you can, says the court’s guidance, make the filing before operations end entirely or consider starting up some other business activity.

Second, noncontingent, liquidated, secured and unsecured debts cannot exceed $7.5 million when totaled. If a creditor disputes a debt, the debt may be treated as contingent, so if disputed claims or debts would put the company over the $7.5 million cap, be ready to document the dispute.

Third, to establish eligibility to file under Subchapter V, the company needs to be able to show that at least 50 percent of its debts arose from commercial or business activity. If personal debts predominate, the debtor can’t qualify as a small business debtor.

Filing under Subchapter V when your company does not qualify is a needless expense and waste of time. Most small businesses with debts below $7.5 million can use this bankruptcy form, but don’t assume that means your company can use it. To avoid needless delays, talk with an experienced bankruptcy lawyer before filing.

The Debtor Needs to Submit a Plan of Reorganization

A Subchapter V bankruptcy starts when the debtor company files its petition with the U.S. Bankruptcy Court. Within 90 days after filing, the debtor needs to submit a plan of reorganization. The court advises not to rely on a possible extension. Start on the reorganization plan right away. The court’s guidance says it’s a best practice to start preparing the plan before filing. Debtor’s counsel should also be working on the Plan of Reorganization in advance.

Section 1129(a)(11) sets the basic standard, feasibility, for evaluating reorganization plans.

Feasibility under section 1129(a)(11) of the Code refers to the court’s determination that the company reorganization plan will likely work as structured. The court has to be convinced that the plan is not likely to lead to further reorganization or liquidation of the company or a successor, unless the plan itself contemplates that.

Identifying whether a Subchapter V reorganization plan is feasible takes thorough financial analysis and knowledge of the requirements of Chapter 11 plans. The reorganization plan should demonstrate feasibility and provide the court with the basis for the filer’s feasibility conclusion. Assess all of it with an experienced bankruptcy attorney before filing.

Other Routes to Addressing Business Debt

Subchapter V isn’t for every small business. If a feasible reorganization plan does not seem possible, consider other routes to addressing business debt, including informal workouts with creditors, or perhaps an equity infusion. Other options include Chapter 7 liquidation, or an assignment for the benefit of creditors.