How does Subchapter V bankruptcy work for small businesses and their creditors?

Congress added the Small Business Reorganization Act of 2019 (SBRA) to the Bankruptcy Code. You can find it in Subchapter V of Chapter 11. It went into effect on February 19, 2020. It provides a faster and cheaper option for small businesses to reorganize under chapter 11 than the traditional chapter 11. While it gives the debtor business more bang for the buck, it does not leave creditors in the lurch. They have tools to protect themselves too.

Debtor Advantage

One of the biggest advantages of subchapter V is its speed, compared to a regular chapter 11. You have only 90 days from the petition to deliver the plan. There are very few circumstances where you can get an extension. In regular chapter 11, the case often gets bogged down at the plan stage. Months and months go by and the lawyer fees add up. The point of Subchapter V is a fast, efficient and low-cost plan for the small business.

Another debtor advantage under the SBRA is that you are the only one who can file a reorganization plan. No creditors can file competing plans as they can under regular chapter 11. There is also no disclosure statement required. Possibly the debtor’s most important tool in SBRA is that the absolute priority rule does not apply. That means the owners can keep their equity without adding new value even if creditors are not paid in full. Often there is no creditors’ committee, whose professionals’ bills have to be paid by the debtor in a regular chapter 11 case. And a committee can get in the way of the reorganization.

The Trustee Is Appointed

In every Subchapter V case, a trustee is appointed. The office of the United States Trustee chooses one from a panel of lawyers, CPAs and others, often selecting based on the particular case. The trustee may review cash control practices, professional retentions, budgets and operating reports. In essence, it keeps the small business honest while letting the small business keep running.

The principal job of the trustee under the SBRA is to assist you in fashioning a plan that you all can agree to and that the court can confirm. The trustee is neutral and will work directly with vendors and secured lenders to see if they can get agreement, which can be hard with creditors dealing only through their lawyers in a regular chapter 11. Direct communication is vital; it makes the case fast, and keeps down the costs. SBRA gives the trustee the added duty of making sure the debtor prepares the required liquidation analysis and disposable income calculations. This makes the trustee key to keeping the case efficient and cheaper.

Creditors Can Take Steps to Safeguard Their Interests

But creditors are not left out in the cold either. For example, because of the SBRA’s 90-day timeline, creditors have to act fast, filing timely claims that reflect the proper amount and priority of their claims. Let’s take a look at some of the specific issues creditors face and how they can deal with them.

The first thing the creditor wants to do is question whether you can use the SBRA. It may seem nit-picky, but can be a good way to attack the case. Once the petition is filed, any creditor can challenge whether you are eligible for the SBRA. Eligibility means that, before the petition, you were conducting a business, with debts of no more than $7,500,000, at least half of which were related to business. The debts must be counted as of the petition date.

The court mostly places the burden of proving eligibility on the debtor. Because of this, a creditor who objects to the SBRA can press the debtor to establish eligibility and that it meets the requirement. It is likely not eligible, for example, if it is an individual and the debts are from a dissolved business. Some debtors that were barely in business when they filed their petitions were found to be eligible.

Among the other restrictions on eligibility is that Subchapter V debtors cannot be affiliates of securities issuers. The courts have read this broadly, applying it to both public and private issuers. But when the debtor is also part of a group of companies, look closely at its corporate family. The debtor may look small, but it might really be part of something bigger. Checking the corporate structure could be a real tool for creditors. The leverage for the creditor is raising the eligibility issue in a timely fashion.

Under the SBRA the debtor usually can stay in control, keep the business running. Since the debtor stays in charge under the SBRA and is the sole plan proponent, the creditors’ votes and objections are their main control. A committee is usually not appointed in Subchapter V, but any creditor can vote or object to the plan. It can object to the plan if it is not fair and equitable or discriminates against the objecting creditor. It should not passively accept what is done to it and wait for later. With no committee the creditor needs to speak up for itself. It needs to read the plan, vote on it and object if it needs to object.

For individuals, the Bankruptcy Code says that certain debts, like fraud and other kinds of improper conduct, will survive a discharge order and have to be paid. But what if the debtor is a corporation, since the limit is in section 523(a), which governs individuals? Does section 1192, saying the debtor under a Subchapter V plan does not get a discharge for section 523(a) debts apply to corporations? If the SBRA debtor receives a discharge under a non-consensual plan, creditors may be able to contest discharge of those debts even when the debtor is a corporation; that could give creditors leverage to negotiate better treatment under the plan. Not all courts have agreed on this; however, it may be one additional source of leverage for a creditor owed money because of fraud.

For the debtor, the benefits of the SBRA come from speed and cost. For the creditor, the focus is on how the case is moving, and the part it can play to get what it deserves. The creditors should be an active participant in the process.