Chapter 11 has a version built for companies like yours. Subchapter V of the Small Business Reorganization Act is designed to be a simpler, cheaper and quicker way for small businesses to reorganize their affairs. It limits what creditors can do to block the reorganization of closely-held businesses. It works for a business with total debts of $7.5 million or less, a ceiling the CARES Act raised from about $2.7 million as a time-limited increase that could be extended, so check the current figure. Contingent debts (like a guarantee that hasn’t yet been called) and unliquidated debts (like a pending lawsuit) don’t count toward the total. Businesses that are mainly single-asset real estate are excluded. At Delancey Street we negotiate business debt rather than file bankruptcy cases, but the owners we talk to deserve to know what Chapter 11 can do for them. Here are eight things.
Timing comes first. Some days the numbers are good, and other days they aren’t. But on many days there’s a constant, predictable drain of cash and inventory; a negative cash flow. This is the burn rate. The longer the burn rate lasts, the less likely the company is to last. When the burn rate has lasted so long that the shop has no cash in the bank, that’s a death spiral. By then it may be too late. Don’t wait for the death spiral. File a bankruptcy petition while there’s still money in the system.
Your Business Can Keep Going While It Reorganizes
First, it stops collection. Once the case is filed, the automatic stay means everyone who has a claim against the debtor has to stop trying to collect that claim. The automatic stay is meant to prevent the chaos of a pre-petition run on the cash register, and to give the debtor some breathing room to regroup. In plain terms, all your creditors are frozen out. Your lenders can’t repossess your inventory or equipment. Your landlord can’t evict you. Garnishments and lawsuits stop too, and a creditor who ignores the stay can be sanctioned by the bankruptcy court.
Second, it keeps you in charge. Your business can keep going while it reorganizes its debts. Under Subchapter V the debtor keeps control of the company as debtor in possession and restructures its finances. That means you and your management team continue to make day-to-day decisions on what to do with inventory and equipment. There’s a trustee in every case, but that doesn’t mean someone is running the show. Instead they act as a kind of adviser and educator, working closely with you and your lawyer, while making sure things don’t get too contentious with the creditors so that the process can move forward toward a plan you and they can accept. They get paid 5% of what is doled out to creditors, which means they have an interest in seeing your reorganization succeed.
Third, it lets you shed leases. You can dump unprofitable store and warehouse leases. Leases are what the law calls ”executory contracts” - where you and the landlord each still owe the other time-bound duties. If you’re running a bunch of locations and one or more aren’t making money, you can get rid of them, even while you’re running the business. The motion to reject can be in your day one paperwork, and landlords are pretty powerless to object. And the rejection is retroactive to the filing date. The landlord’s claim for damages gets capped at the greater of one year or 15% (but no more than three years) of the remaining lease time, plus whatever back rent they’re owed. They’ll get that through your plan, over three to five years. Outside bankruptcy, a broken lease tends to turn into a large court judgment and a garnished bank account. If, on the other hand, a lease or sales contract is beneficial to the business, it can be retained as part of the reorganization. To keep it, though, you must cure defaults within a reasonable time and take the whole contract, burdens and all.
Fourth, it stretches out the debt and can shrink it. A Subchapter V plan is a three to five year payment schedule. You commit all your projected disposable income to it, and the creditors often get a ‘haircut’ rather than paid in full. You can also spread out your administration expenses over the plan instead of having to pay them in cash right away.
Fifth, it takes away the creditors’ veto. The hard part about a regular Chapter 11 is that it takes creditor votes to confirm the plan, so the confirmation process can get awfully complicated and expensive. Subchapter V is different: the judge can confirm a plan without getting any creditor votes as long as it passes the best interests test (creditors get at least what they would in a Chapter 7), doesn’t unfairly discriminate, and is fair and equitable - which usually means handing over the debtor’s “disposable income” for three to five years. Disposable income is what’s left after covering business expenses (and the owner’s salary) that are reasonably necessary to run the business.
Sixth, it lets you keep your company. The ”new value rule” — which in practice forced owners who wanted to keep their company to go out and raise cash to buy their equity back from creditors in addition to paying them off over time — is gone in Subchapter V. Without the new value rule, the endless debates over whether you need to put up new value, and whether that value needs to be auctioned, are also gone.
Seventh, it costs less. No party other than the debtor may propose a plan in Subchapter V, so you don’t risk the expense and uncertainty of a competing plan offered by one of your creditors. Also, you will be required to file the plan within 90 days of filing, so that the process moves along more quickly. Usually, no creditors’ committee will be appointed, so you don’t have to pay the committee’s lawyers and other professionals, who can come to view your business and its owners as an adversary. And you don’t have quarterly fees to the U.S. Trustee, as other Chapter 11 debtors do. Finally, you won’t have to deal with a disclosure statement, which can be costly and burdensome for a small business.
Eighth, it clears the decks. Once the plan’s confirmed, the “property of the estate” normally reverts to the business and the creditors have to live with the treatment they’re given. Then you can get back to what you do best: not wrestling with banks and suppliers but focusing on running and growing your business. And when all the plan payments are made, the debtor gets a discharge of debts that arose before confirmation, a release of liability for those debts beyond what the plan provides.
Secured Lenders Are Handled Differently
Two more details matter. Secured lenders are handled differently. If you owe your lender more than your equipment is worth, your debt is considered split: part secured, part unsecured. A $15,000 loan on a $10,000 truck is $10,000 secured, $5,000 unsecured. Lenders are still entitled to have their collateral protected from a drop in value. On your first day in bankruptcy you also get some routine orders that keep the business functioning. Bankruptcy counsel normally works with the affected creditors ahead of time to nail these down before you file. One order lets you use cash collateral (the lender consents or the judge orders it) when the lender has a lien on your cash flow or equipment. Another order can let you pay the pre-filing portion of your people’s payroll and benefits, even though normally you’re not supposed to pay any of your pre-filing unsecured debts after you file.
Business Debt Settlement Company
Delancey Street isn’t a law firm, we’re a business debt settlement company. Where it can work, we can negotiate with merchant cash advance funders and lenders to accept less than the full balance owed. If your business needs bankruptcy protection, we’ll refer you to an independent bankruptcy attorney. The initial consultation is free and confidential. If there’s a better, cheaper way to solve your problem, we tell you that on the first call.
