How is Subchapter V bankruptcy different from Chapter 11 for a small business?

Chapter 11 is mostly used by businesses to restructure their finances. It is open to individuals, too, and sometimes the only option when debts exceed the Chapter 13 limits. But high costs and hurdles mean that small businesses and individuals fare the worst of all. The result is a system that may not be fair to smaller debtors.

Small Business Reorganization Act (SBRA)

Congress finally recognized that small businesses and individuals aren’t well-served by Chapter 11. It created a new way through the chapter, called subchapter V, as part of the Small Business Reorganization Act (SBRA). Congress enacted it in 2019 and it went into effect on February 19, 2020. The goal was to help small businesses and individuals confirm a consensual plan quickly, with the help of a subchapter V trustee. The Act is an effort to even the field for smaller debtors. The aim is to give the debtor more negotiating power while keeping control of the business, cut procedural burdens and costs, and provide more oversight while moving the case along faster. Subchapter V originally applied to debtors whose debts are below $2,725,625. Congress raised this threshold to $7,500,000 under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) in 2020. No such ceiling applies to traditional Chapter 11 reorganization cases.

A traditional Chapter 11 or Subchapter V case doesn’t use an operating trustee. Instead, the debtor company runs the business in both. To help get a consensual plan confirmed (approved by the court) quickly, an SBRA trustee is appointed right from the start of the case. This trustee doesn’t take over the company. Instead, the SBRA trustee watches over its viability, helps debtors and creditors reach a consensual plan, and makes sure financial reports are complete and accurate. The trustee’s role can include acting as the disbursing agent for plan payments. Unsecured creditors may form a committee in Chapter 11, with its lawyer fees and costs paid by the debtor as an administrative expense. In a Subchapter V, there is no creditors’ committee. This difference reduces costs to the debtor. In a regular Chapter 11, the plan must be accepted by at least one impaired class of creditors. An impaired class doesn’t take part in many individual cases. But in a subchapter V case, no creditor need approve of the plan. A nonconsensual plan must still meet certain statutory requirements. Time is of the essence. It is one of the hallmarks of Subchapter V. The subchapter V debtor must file a plan within 90 days of filing. The debtor usually has no deadline to propose the plan in a traditional Chapter 11, although there is a 300-day deadline for a small business case. In Chapter 11 you have to prepare a disclosure statement and get court approval before you can solicit plan votes. A disclosure statement gives background about the debtor’s history, its finances, the proposed plan, how it would be funded, and its projections. It’s a very large expense. Subchapter V does away with a disclosure statement, saving the debtor the substantial cost of drafting and producing it. In a traditional Chapter 11 case, the debtor has a 120-day exclusive right to propose a plan of reorganization. This period can be extended for cause. After that, any party in interest, like a creditor or the creditors’ committee, can file a plan. In a subchapter V case, however, only the debtor can propose a plan. This makes the debtor’s position much stronger when negotiating with creditors. It means the debtor doesn’t have to worry about a different plan that could leave it worse off. Chapter 11 has an absolute priority rule. The absolute priority rule means that each class of creditors has to be paid in full before those below it get anything. The rule is usually raised only if a creditor objects to a plan. But that’s not a comfort if you’re an individual trying to keep a house with equity. It can force you to give up a house in which you have equity if you can’t pay the unsecured creditors in full. The absolute priority rule doesn’t apply in a subchapter V case. Chapter 11 debtors owe a quarterly U.S. Trustee fee figured on every disbursement in the quarter. It is $250 for disbursements from $0 to $62,624, and a sliding percentage fee for greater amounts. In a sale, the sale proceeds can be counted as disbursements, generating a sizable fee. Take a hypothetical case, filed under Chapter 11, where the debtor proposed to sell property to pay off a $500,000 mortgage. If the U.S. Trustee took a 0.4% fee on the $500,000, that’s a $2,000 fee. But there is no U.S. Trustee fee in a subchapter V. Adding up these unique provisions, you can see the benefits for a small business. The provisions do away with some significant obstacles to success. There is no quarterly U.S. Trustee fee and no disclosure statement to draft, print, and mail.

Home Loan

In bankruptcy law a loan secured by deed of trust on a primary residence cannot be modified. But the SBRA changed that. Now a subchapter V debtor may modify a home loan, but only if the proceeds went to help start or fund the business. Say you took out a home equity loan to start or fund the business. Under Subchapter V that loan could be modified.