What is Subchapter V bankruptcy, and how can it help restructure small business debt?

A new bankruptcy option is available for the small business community as of February 2020, when the Small Business Reorganization Act of 2019 (SBRA) was put into place. The SBRA creates a streamlined bankruptcy proceeding for small business debtors, as part of a subchapter to Chapter 11, aptly referred to as “Subchapter V.”

Subchapter V is a subchapter of Chapter 11, which shares many of the same rules and results for debtors but is theoretically faster and cheaper. If bankruptcy is the tool that creates a breathing space for businesses in trouble, Subchapter V is the version that aims to smooth the process for small-business owners, cutting out much of the expense and complexity of a full Chapter 11 case.

Subchapter V is tailored for owners who want to retain their equity and stay in business. It allows owners to wipe out debts and keep their businesses.

If the Subchapter V option wasn’t available, distressed businesses had mainly three options: Chapter 7, Chapter 11, and Chapter 13.

A Few Core Advantages

But every choice has tradeoffs, and Subchapter V is unusual because it was explicitly written with small business owners in mind. That’s one reason it’s so well suited to the smallest small businesses. It has a few core advantages:

• Unless you have a case where some strange rule applies, such as fraud, you can keep your equity and stay in business.
• Subchapter V debtors don’t have to pay some of the quarterly fees that Chapter 11 debtors usually do.
• The debtor is in the driver’s seat in a Subchapter V reorganization, filing the only reorganization plan.
• You don’t need creditors to vote in favor for the bankruptcy court to approve it. This is a notable departure from Chapter 11.
• Creditors can’t change a reorganization plan to get more money after a bankruptcy judge has approved it, so payments tend to be predictable and steady after a plan has been confirmed.

When a sole proprietor, partnership or corporation reorganizes, it writes a plan that spells out how much it will pay certain creditors and how much debt will be discharged. The debtor figures out how much is owed and who it’s owed to, collects their financial information and writes a proposal to get the business back to profitability. This is called a reorganization plan.

Rather than using bankruptcy as a door out, Subchapter V is a door back in.

It’s important to realize who gets to decide whether to file under Subchapter V. It’s the debtor, the owner, who has that choice. Not the lender, not a shareholder, not a partner in the business. You. It’s a fairly gentle system, built to move faster than Chapter 11.

What Actually Happens, Step by Step, in a Subchapter V Case

Here is how a case works its way through the bankruptcy court.

• Owners have to attach a statement of operations, a cash flow statement, and the company’s most recent tax return to their petition for bankruptcy. They must also provide a balance sheet.
• The court names a trustee who typically oversees the debtor and their estate, helping to make sure their reorganization plan works. In a Subchapter V case, the role of the trustee is usually limited, and the debtor usually retains control of most of their assets, except in specific situations.
• The court typically has a status conference within two months to check on the case.
• Two weeks before that conference, you need to file a written statement on what you’ve done and will do to get the creditors to agree to a plan.
• A reorganization plan itself has to be filed within 90 days of filing the bankruptcy petition.
• If your plan looks realistic, and the creditors can have a specific way to collect a shortfall if you default, the plan has a decent chance of being approved.
• When a plan is approved with the consent of the creditors, the owner is usually given a discharge at the same time. But when a plan isn’t consensual, the discharge usually comes at the end, when the debtor has made all of the payments.

The Most Common Questions Owners Ask About Subchapter V

Every bankruptcy is different, but small-business bankruptcy is complicated, and because Subchapter V is so new, it raises even more questions.

Below are the most common questions owners ask about Subchapter V, and the answers could help give you an idea if Subchapter V might work for you.

Subchapter V tends to be faster, less expensive and give owners more control than regular Chapter 11. For Subchapter V, think of this chapter as the best of Chapter 11 without the most expensive parts.

You generally qualify if your business is under a certain size, called “the debt limit” in bankruptcy circles. It’s a dollar figure representing how much combined secured and unsecured debt a business can have to qualify for Subchapter V. It’s $2,725,625. Businesses in single-asset real estate may be excluded.

The key difference is in what you do with your business after filing. In a Chapter 7 liquidation, businesses tend to sell off their nonexempt assets and go out of business; not so in Subchapter V, where businesses generally stay in business. It can change what would have been the forced end of a business into a manageable reorganization.

Sole proprietors and individuals can file Chapter 13, but partnerships and LLCs generally can’t. Both options let businesses restructure, and often let owners keep their assets. It’s important to get legal advice to make sure you understand what you’re doing and that you actually have a choice.

The most important person you didn’t know you’d meet is the trustee, who helps guide a debtor in developing a plan of reorganization. They aren’t in charge of seizing your assets, with the exception of a few cases. They also work to help bring a debtor’s creditors together and achieve a plan of reorganization that is reasonable and equitable. The debtor pays the trustee.

The “absolute priority” rule doesn’t apply in Subchapter V. In a regular Chapter 11, owners have to pay creditors in full or get them to approve their plan if they want to keep their equity. Under Subchapter V, the debtors can keep their equity if they can prove fair treatment, which could be an easier bar to get over.

The way Subchapter V counts debt toward the debt limit can be tricky to figure out. The key is that a debtor needs to count all business debt, both secured and unsecured, to determine whether they qualify.

Once you’ve filed all of the documents the law requires, the court then looks mainly at one of two things before approving your plan.

• The first factor is usually that the debtor is able to make every payment under the plan.
• The debtor will probably make all of the payments under their plan, and if they don’t, the creditors will get remedies to collect the money.

When the Subchapter V debtor has shown that the plan is fair, the bankruptcy court can approve it over the creditors’ objections, a cramdown. This creates a nonconsensual plan of reorganization, which is a little different. A cramdown extends the time before owners are absolved from their debts, and keeps the bankruptcy trustee on their case.

The typical duration of the plan is usually three to five years for consensual and nonconsensual reorganization plans.

In regular Chapter 11, the lawyer representing a debtor has to be truly independent and disinterested, but in Subchapter V they are allowed to have a certain level of financial interest in the debtor’s case. Under Chapter 11, the lawyer helping you through bankruptcy can’t be the one you owe money to for unpaid services. Subchapter V lets you hire an attorney you owe less than $10,000 to.

Lenders can’t change their terms on you after a bankruptcy plan is approved. You’ll know exactly how much you have to pay, exactly when, and exactly for how long. The only person who can change a Subchapter V plan after it’s confirmed is the debtor, not the creditors.

Subchapter V may not always be the best option, and depending on your situation, Chapter 11 may work better for you. Same for the other chapters: 7, 13, sometimes even 12. Chapter 12 is for family farmers and fishermen. Because the rules can be tricky, you should find a lawyer who is experienced and qualified to weigh your options and explain what is best for you, rather than hoping for the best.