Owners who are behind on merchant cash advances, loans or lines of credit often ask us at Delancey Street whether they should just file Chapter 11. You will see hundreds of articles that answer that question, usually with that stale “It depends” response. A valid question deserves a more useful answer, and for a small business that answer starts with Subchapter V. The Small Business Reorganization Act of 2019 (the “SBRA”), which took effect on February 19, 2020, created a new option, called Subchapter V of chapter 11, for reorganization under the Bankruptcy Code. It was meant to help owners for whom the large costs that a traditional Chapter 11 case often involves made a plan hard to confirm. Subchapter V is generally seen as more efficient and less expensive than the traditional chapter 11 process, and imposes fewer burdens on smaller debtors. Here are nine things it means for you as an owner.
Eligibility for Subchapter V
First, you have to qualify, and you have to choose it. The chapter 11 reforms are not open to all companies. Subchapter V was written for businesses with no more than $2,725,625 in debt. But the CARES Act raised the debt ceiling from $2,725,625 to $7,500,000 in both secured and unsecured (non-contingent and liquidated) claims for one year (or longer if extended by Congress). At least half of that debt has to come from the business’s commercial activities, although the business cannot be principally engaged in owning “single asset” real estate. And you must also ”elect” Subchapter V for it to apply.
Second, how you count your debt matters. Only non-contingent, liquidated debt can be counted. A guarantee of someone else’s debt that is not in default, or a tort claim like a slip-and-fall, is left out of the total. Also, debtors can potentially artificially label certain debts as contingent and unliquidated in order to make themselves eligible for the new law. Pro tip: don’t. Keep in mind, though, that creditors and the U.S. Trustee can contest your eligibility for Subchapter V, and parties generally have thirty days after the creditors’ meeting (or after an amended designation) to object. Even before Subchapter V, at least one court voided a small business election because the debts ran over the ceiling.
Owners Will Keep the Company and Run It
Third, you can keep your company. This is the part owners are really going to enjoy. In a traditional chapter 11, to confirm a plan over a class of unsecured creditors’ objections, owners have to either pay the class in full or put new money into the business to purchase new equity in the reorganized debtor. Because equity holders in most small businesses tend to be the only managers that can run the company, this rule often requires creditors to consent to the reorganization. That hands creditors a lot of leverage. Subchapter V changes the math. Assuming they want to continue in the business, owners will keep the company and run it, even if all creditors vote against the plan. So long as the owner pays the unsecured creditors whatever disposable income he or she has (meaning what’s left over from business operations after the necessary expenses of operating the business are paid) for three years, or up to five if the court extends it, an owner will retain his or her ownership interest. This is a stark departure from old chapter 11.
Fourth, the clock is short, but the plan is yours. Subchapter V gives you 90 days after filing to file a plan, unless there is delay for which you should not be held responsible. Creditors may not file a competing chapter 11 plan of reorganization. You own it.
Fifth, it costs less. When you file a Small Business Reorganization Act (Subchapter V) case, it is less expensive than a regular Chapter 11 for several reasons. There’s no requirement to have a disclosure statement unless the court orders one for cause. It costs money to generate and pay for that document. Your plan still has to include a brief history of the business, a liquidation analysis and projections showing you can make the payments. Unlike in a regular chapter 11 case, you may be able to avoid the cost of a committee and its professionals, if no creditor committee is appointed by the bankruptcy court. And a Subchapter V debtor is not required to pay a quarterly U.S. Trustee fee.
Sixth, some bills can wait. In a regular chapter 11, administrative expenses are payable on the effective date of the plan or in the ordinary course of business. In a Subchapter V reorganization, those expenses can be paid over the life of the plan. The flip side is that suppliers may take a dimmer view of continuing to provide goods or services to small businesses if they risk ending up with deferred administrative expense claims.
Seventh, a trustee will be watching. The trustee’s role is not to take over your company. The rules are simple — owners continue to operate the business, but a Subchapter V trustee will monitor things. In most situations, the trustee’s main job will be to report back to the bankruptcy court about your financial situation, evaluate the assets, and recommend whether the debtor’s proposed plan should be approved. If your chapter 11 plan is approved but not agreed to by creditors, the trustee will distribute any payments under the plan.
Creditor Protections
Eighth, creditors still have teeth. A plan of reorganization must provide creditors a minimum of as much as they would receive in a liquidation. Other key protections include the right of secured creditors to force the debtor to keep them fully secured (thus, they will receive any post-confirmation appreciation on the value of the collateral) and the right to receive “adequate protection” from the shrinking value of collateral that the debtor seeks to keep. They can also ask the court for relief from the automatic stay to go after that collateral. All of this to say, in a Subchapter V case, non-debtor parties still have significant leverage over the small business debtor when it comes to reorganizing.
Ninth, some old obligations come along with you. If you want to keep a contract or lease going, you have to cure any pre-bankruptcy default and, where required, provide assurances that you will keep up with payments going forward. The Code also still allows a supplier who shipped goods in the 20 days before bankruptcy to treat that debt as an administrative expense. When the law took effect there was no case law yet on how these creditor protections would play out under Subchapter V.
So where does that leave you? This changed landscape may mean some owners can hold on to their businesses without creditors taking over. It’s great to know the fundamentals of a Bankruptcy proceeding, and how Subchapter V fits in. But it can be hard to figure out what is right when your business is about to go under. Delancey Street is a business debt settlement company, not a law firm. Our senior advisors negotiate with funders and lenders for less than the full balance owed; we don’t sell you another loan. If a case can’t be won, or a cheaper option exists, we say so on the first call, and when Subchapter V is the better path we refer you to a vetted independent bankruptcy attorney. Either way, now that we have an idea of what the law is and what your options are, you can have an informed discussion about bankruptcy.
