How do Subchapter V trustees get paid in small business bankruptcy cases?

The Small Business Reorganization Act was signed into law on August 23, 2019, and took effect on February 19, 2020. Aimed at making reorganization simpler and more manageable for small companies, it put a new Subchapter V in chapter 11. Subchapter V was Congress’ attempt to give small businesses their own small-scale reorganization procedure. It couldn’t have been more timely. A few weeks later COVID-19 arrived to wreak havoc on companies everywhere.

To be eligible as a small business under section 1182(1), the company must have total debts of less than $2,725,625. The CARES Act temporarily raised this amount to $7,500,000 for cases filed on or after March 27, 2020. To qualify for Subchapter V, the debt can include both secured and unsecured debts, but not debts owed to “affiliates” or “insiders”.

Two extensions of the $7.5 million cap ended on June 21, 2024, reverting it to $3,024,725, the original adjusted for inflation.

Subchapter V was built to reduce the costs of reorganization for small debtors. Subject to court discretion, Subchapter V cases do not have a creditors’ committee. There is no disclosure statement to prepare and no U.S. Trustee fee for the case. Plan provisions related to equity ownership may be more accommodating for entrepreneurs, too. The law also generally requires the debtor to propose a plan within 90 days. These streamlined features are set up to encourage small businesses to find the option that works best.

For small businesses, Subchapter V brought chapter 11’s option for keeping your company going to many for whom it was otherwise out of reach. It isn’t surprising that filings by small companies have shot up almost 150 percent since then.

A Dedicated Trustee

Every Subchapter V case has a dedicated trustee whose role is to work with the debtor to move the case forward as efficiently as possible. In a Subchapter V, the trustee’s main job is to review claims, appear at hearings, investigate finances, file a final report and distribute property according to the plan. If the court takes away the debtor’s ability to run the business, the trustee replaces the owner, stepping into the shoes of the debtor. But the new law also calls on trustees to act as facilitators to make the reorganization happen, and these duties are decidedly not part of the traditional trustee’s role. Section 1183(b)(7) requires that the trustee “facilitate the development of a consensual plan of reorganization.”

They don’t hold executive positions, but you can’t ignore the trustee in these cases. They are involved in almost every aspect of the case. One of their most valuable jobs is bringing the parties together. Since there is no creditors’ committee, parties end up looking to the trustee to settle differences and make the reorganization happen. And a study of confirmed reorganization plans from 2020-2023 found that the success rate for subchapter V plans (about 52 percent) was more than double that for other small business chapter 11s (around 22 percent). Why the stark difference? Mediation is likely a key driver of the increase in successful reorganizations among small companies.

The trustee’s work starts the moment the bankruptcy court assigns the case to them. They set up the meeting of creditors and interview the debtor. And the § 1188 status conference comes up early. It’s understandable that a trustee would want to act fast when bankruptcy strikes. Aside from that, many of their other responsibilities, like reviewing claims and analyzing finances, depend on how contested the case is.

How the Trustee Gets Paid

Under a Subchapter V, courts will expect trustees to be involved in cases. They won’t expect them to sit in the back of the room. They lean on the trustee to resolve disputes and figure out whether a plan is likely to work. Since cases require serious trustee work, how the trustee gets paid is a real question. Yet with just a generic nod to administrative expenses, the new law doesn’t explain how trustees should bill for the work.

Trustees get paid through the estate. Their fees are considered an administrative expense. Trustees often only collect their fees if the reorganization comes through. The trustee’s claim as an administrative expense is valuable only if there is money in the case. If the estate has money, the trustee can expect to be paid. If not, the trustee should consider the options for getting compensation secured.

Many debtors go into a Subchapter V intending to keep the business going but wind up converting the case to liquidation, or have their case dismissed instead. That’s almost half of the cases. Trustees work fast in hopes they will later be paid. In practice, it means that trustees often work hard for no pay. Trustees are in a difficult spot. They must often devote substantial time and effort to the case with the understanding that they may be paid little or nothing. Delayed pay may reduce their willingness to devote significant time and energy.

Courts want to do justice, but bankruptcy trustees are not free labor. For now, judges have no choice but to pick up the pen and address the trustee’s role case by case. A trustee can ask to have the debtor pay them a retainer at the beginning of the case. Another way to deal with the problem is for the court to put a hold on any dismissal of the case until the trustee fees are paid. It raises concern about equity with other estate creditors that might not be paid at all.

The Trustee Compensation Issue

The U.S. Bankruptcy Court in the Southern District of New York came up with a new plan to address the trustee compensation issue. Since December 2023, subchapter V cases come with a form case management order outlining the deadlines for the parties to hold conferences and for the debtor to file a plan. It also requires debtors to set aside $1,000 a month in the case for administrative expenses, including trustee fees. The monthly set-aside means that cash available to pay trustee expenses builds up over the life of the case instead of waiting for a big payment at the end. Those expenses include trustee fees and costs that depend on how actively involved the trustee is. But the very mention of “set-aside” triggers worries about whether debtors have the cash flow to make it happen.

In an Oregon case, the trustee in In re Roe proposed a $7,500 retainer. The court held the retainer wasn’t in the ordinary course, so it needed 363(b) court approval. Instead, the court OK’d a trust account split in which all administrative claimants share pro rata.

The court’s reasoning here is that the Code says claims of the same priority get treated equally. The subchapter V trustee’s role is to make reorganization happen, and the Code vests the trustee with whatever powers are needed to perform that role.

Texas went one step further. The Northern District put together a set of procedures detailing the pay schedule for subchapter V trustees. Debtors pay $1000/mo interim fees to secure the trustee’s fees at confirmation or dismissal. Under Clerk’s Notice 22-01, the court may alter the amount after notice and a hearing, with final approval under § 330. The payment must be in any budget filed by debtor to authorize the use of cash collateral.

The bankruptcy court in the Eastern District of Virginia suggests a role for the U.S. Trustee. In re Hao involved the debtor running up legal fees and trustee costs, with no real prospect for payment. The court saw this as continuing loss and converted the case, as the U.S. Trustee asked, to a Chapter 7. Sharing that watchdog job with the U.S. Trustee may ease tensions when a debtor in a Subchapter V is running up administrative fees without a clear path to pay them.

New Jersey’s bankruptcy court is looking ahead with an early warning about administrative expenses and trustee fees. They’ve revised their Subchapter V status report form, and now ask the debtor what they can expect on the subject when the parties come to the § 1188(a) conference. This heads off any surprises and gives the parties a chance to think it through. The form has sent up a flag for debtors and their counsel to address the issue early, building in a good habit to prevent problems later.

Subchapter V has brought significant changes to the table for small businesses who might not otherwise be able to afford the bankruptcy process. Subchapter V makes the trustee’s role a central one. Judges deal with the thorny question of trustee fees on a case-by-case basis, but it would be worthwhile to put more thought into a long-term strategy. A clear way to organize the pay system is key to maintaining the integrity of the trustee’s role, and to the effectiveness of the Subchapter V process as a whole. Don’t assume you can ignore the trustee’s role, or jump to conclusions that the rules for your case will be the same as in other districts. If you are looking into a Subchapter V, expect to be asked for how you plan to pay the trustee. No matter how the court runs your case, the trustee’s fees are a matter to build into the budget early. Time will tell how trustees, debtors and courts will work this issue out.

As set out in House Judiciary Committee Report 116-171, 116th Cong., 1st Sess., at 1, the goal of Subchapter V was to simplify reorganization for small businesses.

The U.S. Trustee Program (USTP) districts - which are every state except Alabama and North Carolina - recorded 1,118 subchapter V filings in 2020, and 2,647 subchapter V filings in 2024 through Sept. 30. The effect of the return to the lower debt limit remains to be seen.

11 U.S.C. § 1183(b)(7) calls on subchapter V trustees to “facilitate the development of a consensual plan of reorganization.”

Section 1183(b)(1) through (7) lists out the trustee’s duties.

Confirmation rates from USTP data.

Trustees and other administrative claimants can be paid over the life of a reorganization plan in subchapter V under a cramdown plan, pursuant to § 1191(b). Consensual plans are provided under 11 U.S.C. § 1191(a). In ordinary chapter 11 cases, administrative claims are paid on the effective date unless the claimant agrees to other terms.

The conversion/dismissal figure is from USTP data.

The $1,000 amount is just a starting point. Whether it is enough would depend on the facts of the case.

The case in Oregon is In re Roe, No. 23-32077-THP11, 2024 WL 206678 (Bankr. D. Or. Jan. 18, 2024).

The case in Texas is In re Lager, No. 22-30072-MVL11, 2024 WL 3928157, at n.9 (Bankr. N.D. Tex. Aug. 23, 2024).

In re Hao, 644 B.R. 339 (Bankr. E.D. Va. 2022).

§ 1188(a) is the 60-day status conference. The debtor must file the status report at least 14 days before the conference.

Another possible way to involve debtors in thinking about trustee fees early is in cash collateral motions. It could be an effective way to deal with the issue early on and head off problems later. It only works, though, where motions to use cash collateral get filed.