If your company borrowed from a bank, an equipment lender or a merchant cash advance funder, the lender very likely filed a UCC-1 financing statement. A UCC-1 is a notice to the world that a lender has a security interest in specific assets. When the business falls behind and the owner starts looking at Subchapter V, the first worry is usually whether that lien survives. It does. Please do not let anyone tell you that filing a bankruptcy case erases a valid lien. What Subchapter V changes is how much leverage the lender has once a plan is on the table, and to see why, it helps to start with the leverage it has now.
A senior lender with liens on substantially all of a distressed company’s assets controls the game before and after bankruptcy. The lender’s agreements give it a lot of control over the company, and it holds the trump card in a post-default situation. When the company defaults, the lender may agree to forbear from exercising its rights to seize the collateral. Forbearance is not free: the owner may have to accept drastic concessions, including a veto over any company spending and a say over which creditors are paid and how much and when, whom the company can hire, what assets are sold and to whom, whether to file a Chapter 11 bankruptcy, and more. The company’s options are further constrained by the fact that all its assets are already pledged to the lender and the company may not be able to borrow elsewhere.
Plenty of owners expect a filing to end all that. “I filed for bankruptcy!” they say. Then they go right back to doing what the lender always made them do, because the bank often still controls the company indirectly. Sometimes the company will need to dip into cash that’s the bank’s collateral, which is called “cash collateral.” The company then has to file a motion (called a “cash collateral motion”) asking the court for permission to use it. And the prepetition lender often hands out the DIP loan (debtor-in-possession financing) and also will use the DIP terms as a stick, to make the company hit certain cash-flow goals or get a plan approved by a date certain. Whether the owner is able to cut a deal with the bank about the cash collateral also matters for the timing of the case.
Subchapter V was added by the Small Business Reorganization Act of 2019. Subchapter V is mostly friendly to owners at the expense of unsecured creditors. For example, in a Subchapter V reorganization plan, the owners can retain 100 percent of their equity interest in the debtor, even if unsecured creditors do not receive full payment. The absolute priority rule does not apply. Unsecured creditors who are subject to a cramdown receive the debtor’s projected disposable income over three to five years. Secured lenders have different treatment. The cramdown rules for secured creditors are exactly the same as in a regular Chapter 11 reorganization. The secured creditor’s lien is not stripped.
Secured lenders also get to hold on to another helpful ace in the hole under Subchapter V: the Section 1111(b) election. It gives them a stick and in some cases the power to kill a reorganization plan. Why? Because the owner still has to propose a feasible plan, one that the business can actually afford, and if the lender exercises the Section 1111(b) election, the payment demanded can be so large the business can’t pay it and the plan is doomed. The lender’s position is devalued much less than that of the unsecured creditors.
And don’t forget that the election is limited. Some courts have asked whether the value of the collateral was so low that it was “inconsequential.” One court decided that when the collateral was worth 15 percent of the claim, that wasn’t inconsequential. Another court said 15.6 percent wasn’t inconsequential. A third refused to come up with a formula and said 8.2 percent was inconsequential. Other courts have local rules saying the lender has to make the election by a certain deadline — say 14 days after the plan is filed, unless the court decides on another deadline. Finally, a plan can’t use the election as a back door to overpay the lender. In Topp’s Mechanical, for example, the court refused to confirm a plan that would have paid the lender over $500,000 more in interest than its claim under the plan, money that would otherwise go to the unsecured creditors. That, the court said, would be unfairly discriminatory.
Subchapter V’s Cramdown
Where Subchapter V really does change the picture is for the undersecured lender - someone whose loan is bigger than the value of the collateral. Because the loan is undersecured, the lender’s claim to the shortfall is an unsecured deficiency claim. In a normal Chapter 11, an undersecured lender with a large deficiency claim often ends up controlling the vote of the unsecured class. (At least one impaired class must vote to accept the plan.) So the lender could block confirmation. Under Subchapter V’s cramdown, that requirement goes away. The deficiency claim is no longer a veto point. An undersecured lender has much less clout to block confirmation.
When an owner confirms a plan over the objections of creditors under Subchapter V, he or she must prove the business either can, or is reasonably likely to, make the payments required under the plan, and that the plan provides an appropriate remedy for creditors if the plan payments fail. The law doesn’t say much about what an appropriate remedy is, other than letting the debtor sell its nonexempt assets for cash. For a secured lender the answer is simple: the plan allows the lender to retain its lien. Which means the UCC lien stays on the assets through the life of the plan. For the record, the owner gets no discharge until all payments under the plan are completed.
So, to answer the question in the title: Your secured creditor’s lien survives a Subchapter V case. The lender will likely try to push a solution that is attractive to them but depends on whether they’re undersecured or oversecured on the collateral. Subchapter V is typically fast and inexpensive relative to a straight Chapter 11, but its main advantages are against unsecured debt. There are other paths: a friendly Article 9 foreclosure (the lender sells your collateral via a public or private sale with your cooperation) or an out-of-court workout (a negotiation with one or a few creditors, which works best when the creditor count is low). Know who is holding a lien on which assets before you pick your path.
