Many of the owners we talk to at Delancey Street are behind on merchant cash advances and loans whose payments keep squeezing their cash flow, and they want to know whether bankruptcy is the answer. For a small business, a traditional Chapter 11 case can be costly, lengthy, and complicated. So, if a business is behind on its loans and wants to continue operating while reorganizing its debt, Subchapter 5 could be the answer. Here are eight things business owners should know about Subchapter 5.
Built for Small Businesses
First, it was built for small businesses. Before it existed, a small company that wanted to reorganize had to go through the same complex process as a large company. Congress enacted Subchapter V (also called Subchapter 5) in 2019, and it took effect on February 19, 2020, shortly before the COVID-19 pandemic. Simply put, Subchapter V was intended to make Chapter 11 proceedings simpler, less costly, and faster for small businesses.
Second, not every business qualifies. Subchapter V is limited to small business debtors. To qualify, a business needs total noncontingent, liquidated secured and unsecured debts of not more than $3,024,725. At least 50% of the debt must be incurred by the business activities of the debtor. During the pandemic Congress temporarily increased the limit to $7.5 million; the limit returned to the pre-pandemic amount, adjusted for inflation, on June 21, 2024. Even so, Subchapter V is still a valuable asset for owners trying to keep their small businesses.
Third, the clock moves fast. Once the petition is filed, the business has 90 days to propose a plan. That’s a major undertaking. The deadline exists to encourage fast movement on reorganization and to give creditors some protection so they aren’t left in the dark for too long. But it can be daunting if the way to reorganize isn’t obvious. Perhaps the biggest advantage for owners, beyond speed, is that they get to remain in control of their business. The debtor is the only one who can propose the plan, which protects the owner’s interest in keeping it. If the debtor does not file a confirmable plan within the deadline, the case can be dismissed or converted to Chapter 7, which means liquidation.
Fourth, there is a trustee but no creditors’ committee. In a regular Chapter 11 case, there is a creditors’ committee. In Subchapter V there is no creditors’ committee. No creditors’ committee means lower costs. A trustee is appointed in every Subchapter V case. A trustee oversees a debtor’s progress, monitors the debtor’s financial condition, and assists the debtor and its creditors in the negotiation of a plan. The trustee is an overseer, not someone who runs the debtor’s business or liquidates the debtor.
Fifth, under Subchapter V, the creditors don’t vote on the plan. The plan only must be “fair and equitable.” In Subchapter V, a plan does not have to be accompanied by a disclosure statement, and there’s no approval of a disclosure statement. Congress noted that creditors often don’t take an active part in smaller cases when their claims aren’t big enough to justify the time, money and effort, so it largely removed creditor approval from the process. The logic: if creditors won’t vote, there’s no reason to require a creditor vote.
Sixth, you can keep your business without paying creditors in full. In a normal Chapter 11 reorganization, the absolute priority rule is in effect. That means that if the company’s creditors are not paid in full under the reorganization plan, then the owners can’t keep an interest in the company. Subchapter V gets rid of the absolute priority rule, and it also eliminates the requirement that the owners contribute money to the company to avoid losing their equity interests. In other words, the owners can keep the company even if the creditors are not fully paid. That rule change has major ramifications for owners who want to preserve their companies. But beware. That doesn’t mean it’s easy to achieve and it doesn’t mean that the bankruptcy judge is just going to let you off the hook.
Seventh, “fair and equitable” has a specific meaning. You can’t keep all your income. Your Subchapter V plan has to be fair and equitable. That means you’d better be paying your disposable income to your creditors - for the first three to five years of the plan (the court sets the period). The only way you can avoid paying your disposable income to your creditors is by ensuring that the value of the property you distribute under the plan is not less than your projected disposable income. And under the Code, disposable income is defined, in part, as income that is not necessary for the continuation, preservation or operation of the business.
Eighth, your creditors can still fight the plan. Just because they can’t vote doesn’t mean they can’t have a voice. It’s not their vote that matters in Subchapter V. It’s their support or opposition, specifically whether they object to your plan. In a Subchapter V case, it is up to the creditor to object to the plan on time. Therefore, a creditor must review a plan for fair treatment of its claim and file a timely objection to an unfair plan. In that respect, it resembles Chapter 13, which individuals generally use. For creditors, a Subchapter V reorganization plan may mean they will not be paid 100%. Many believe creditors can be disadvantaged by the process.
Before you file, carefully weigh the advantages and disadvantages of Subchapter V. Delancey Street is not a law firm, so we refer owners to a vetted independent bankruptcy attorney for bankruptcy when it is the right call, and the attorney-client relationship is between the owner and that attorney. Our first consultation is free and confidential. If there is a more affordable solution - something other than bankruptcy - we will say so immediately. That may mean our senior advisors negotiating with merchant cash advance funders and lenders for less than the full balance owed, not selling you another loan. Whatever you decide, we aim to make sure you know all of your options.
