How is Subchapter V different from Chapter 11, and how can creditors protect themselves?

A Chapter 11 bankruptcy that qualifies for Subchapter V is quicker and cheaper than an ordinary Chapter 11. Since it took effect on February 19, 2020, more than 3,000 debtors have filed Sub-V cases. Over a third were filed in California, Florida and Texas. Success rates are unclear. In Subchapter V, unsecured creditors do not have the automatic right they do in other Chapter 11 cases to get a creditors’ committee appointed to represent their interests, unless they take action themselves. They can petition the court for one, and the court can appoint one for cause. But unsecured creditors must bear the costs of seeking one. An additional benefit of a Subchapter V bankruptcy over a traditional Chapter 11 is that it is overseen by a Subchapter V trustee, who lacks traditional trustee powers. The trustee is present to work towards a consensual reorganization plan to which all the parties agree. Businesses often carry post-filing debt - debt they incur after they filed for bankruptcy. Sub-V cases allow many post-petition claims to be paid over three years rather than immediately or at the plan’s effective date, as occurs in ordinary Chapter 11 cases. Often these debts are for vendors and landlords. Think of a supplier that continues to provide goods and services for which payment is due after a debtor has entered bankruptcy. The supplier is likely going to be less willing to continue to make deliveries. The same goes for a landlord that is owed rent under a lease, which might not be willing to accept payments in installments over three years instead of right away. Chapter 11 can be unpredictable. Subchapter V, however, is quicker. Debtors have only six weeks to file their reports on their plan negotiations, and two months to have a status conference. The reorganization plan must be filed within three months. In Chapter 11, the court has often extended deadlines, allowing cases to drag. Courts have signaled that judges in Subchapter V cases are unlikely to be so generous. For creditors, the clock is ticking too. They must act quickly to assert their rights, lest they find themselves without a seat at the negotiation table. Some worry that businesses that aren’t really small could use Subchapter V to escape scrutiny. In Subchapter V, if a creditor does not actively petition the court, the company could potentially fast-track its reorganization. Critics are concerned, and Congress may need to impose more safeguards. Creditors should watch their debtors’ bankruptcy cases closely and consult counsel about the best way to protect their interests. Consulting with legal counsel who are experienced in the requirements and legalities of Sub-V bankruptcies before the filing may allow creditors to avoid some of the many potential pitfalls of a Subchapter V bankruptcy.

How Creditors Can Protect Themselves

How creditors can protect themselves

A faster, cheaper reorganization comes at the expense of some creditor protections. This may be justified for Main Street, but the fear is that non-Main Street debtors will strategically use it just to exploit the advantages. With a Subchapter V trustee lacking the powers of a traditional one and no committee to protect creditors’ interests unless the creditors act, creditors must be diligent.

Diligent creditors should be prepared to do some extra legwork to guard their interests. So you need to challenge the debtor’s eligibility to use Subchapter V, and gather as much information as possible. You need to challenge the numbers. Request full details for each type of debt that it lists. Evaluate whether unliquidated claims should be liquidated, or contingent claims treated as non-contingent. And be sure to talk to other creditors to see if they want a creditors’ committee.

Qualifying Debtors

Qualifying debtors must not have an affiliate that qualifies as an issuer under section 3 of the 1934 Securities Exchange Act. In a recent case in the Central District of California, a creditor objected because the debtor did not meet the criteria. The judge revoked the debtor’s Sub-V election. The court reasoned that the plain language of the statute applied, read “issuer” broadly enough to cover affiliated limited liability companies and corporations without publicly traded shares, and left any narrower reading to Congress. For creditors, this means that they should research their debtor and any affiliated entities. A debtor that uses Subchapter V should meet all the qualifications. You have to be assertive and proactive. The arguments might not be simple.

A Tension Baked in the Bankruptcy Code

As some courts have stressed, there is a tension baked in the bankruptcy code, balancing protecting creditors and relieving debtors. For creditors, the trick is knowing how to operate within this tension and defend their rights. Subchapter V has advantages for the debtor, but it also allows creditors the chance to protect their interests. You need to be a watchdog to make sure the debtor isn’t taking any shortcuts.