Macdonald | Fernandez LLP


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New Bankruptcy Provisions Offer Relief to Small Businesses

No one could have appreciated the timeliness of the enactment of Subchapter V of chapter 11 of the Bankruptcy Code, effective February 19, 2020 and known as the Small Business Reorganization Act of 2019 (SBRA), as modified by CARES (Coronavirus Aid, Relief, and Economic Security Act)  to increase the debt ceiling for eligibility to $7,500,000 (for one year only). For many businesses it will prove to be a lifeline to survival.

Chapter 13 has always been admired by small businesses and their lawyers because it offers individuals a way to restructure debt (1) without the necessity of obtaining creditor approval (i.e. no balloting or voting) and (2) by paying unsecured creditors no more than three years’ projected disposable income.  A limitation on the use of Chapter 13 is that it is limited to individuals with unsecured debt of not more than $394,725 (plus secured debt of not more than $1,184,200).

The new law allows the small business, whether individual, corporate or otherwise, to restructure debt of up to $7,500,000 (secured and unsecured taken together) by pledging to pay to creditors projected disposable income (defined as income received by the debtor that is not reasonably necessary for (a) support of the debtor and dependents, and (b) necessary business expenses) over a three-year period.

Two revolutionary features: the first is that creditor approval of the plan is not necessary, therefore eliminating the need for costly and time-consuming disclosure statement and solicitation of creditor votes—the hallmark of the traditional Chapter 11 case; secondly, The Absolute Priority Rule, which prohibits the company from retaining its business operations without paying creditors in full (unless creditors agree), is inapplicable in the Subchapter V case. The debtor can confirm its plan without the votes of creditors and without the support of an impaired class. (As with Chapter 11, creditors must receive an amount equal to liquidation value of debtor’s assets.)  Competing plans are not allowed; nor is there a disclosure statement requirement—limited disclosures are made in the plan

Significant provisions:

Opt-in election: there have been small business provisions in place in chapter 11 for several years. Those provisions continue, but do not contain the revolutionary features of SBRA, which requires an opt-in at the time of filing the chapter 11 petition; failure to elect Subchapter five treatment defaults the Small Business Chapter 11 case into one under the existing small business debtor rules. One therefore needs to distinguish whether a “small business case“ is the new Subchapter 5 created by SBRA or the former, Because both types of cases will run in tangent through the courts. A small business case under the former law is referred to as a “small business case,” whereas cases for which the new procedure is elected will be called “cases under Subchapter V of chapter 11.”

Considerations: Why would a business choose not to elect given the attractive features of subchapter V? There are two main reasons:  firstly, the business is not ready for a fast-track procedure and needs the much longer 300 day time period of the non-elective small business case to file its plan. Examples of such a situation are where the debtor is forced to file Chapter 11 either because of an imminent foreclosure or and unforeseen catastrophe like a sudden business reversal or a large judgment in a case it was not expecting to lose, and other situations where it needs bankruptcy relief but simply does not have an exit strategy.          

Subchapter V trustee: The second reason to avoid Subchapter V is that the business either does not care for, nor can it support, a trustee, albeit one with limited powers. The Subchapter V trustee is appointed in every Subchapter V case with the limited powers of advising regarding operations, assisting with disbursements, and assisting in negotiation of a consensual plan of reorganization. The Subchapter V Trustee does not have the broad powers of a Chapter 11 Trustee because he or she does not take possession of property of the estate and responsibility for the operations although, as in chapter 11, a traditional trustee may be appointed if the grounds exist under section 1104, such as fraud or gross mismanagement. The Subchapter V trustee is not the same as a chapter 13 trustee because he is not standing trustee and does not have the power to object to confirmation of the plan, etc.  The Office of the United States Trustee has created a pool of trustee candidates to be appointed on an ad hoc basis, depending on the type of business and needs of the case.

Time deadlines: The differences between the two cases are striking.  A small business debtor is allowed 300 days to file a plan and 45 days to confirm it; Subchapter V operates on a fast track, requiring the filing of a plan within 90 days. When considering the opt-in to Subchapter V the debtor and its lawyers must have their ducks lined up because it is not anticipated that Courts will be willing to grant an extension to a debtor who pleads it’s not prepared to file his plan. The debtor who does not file its plan on time risks conversion, dismissal or appointment of a trustee.

Best Interests of Creditors: As with Chapter 11, creditors must receive an amount equal to liquidation value of debtor’s assets.

Modification of trust deeds on residences now permitted: The SBRA changes the current prohibition against modifying the rights of holders of secured claims against the principal residence of the debtor. The debtor may now modify the rights of the holder of such a claim provided that the new value received was not used primarily to acquire the real property and the real property is used primarily in connection with the small business of the debtor.

Conclusion: the debtor can keep its business by paying its creditors the minimum necessary to comply with the projected disposable income requirement, subject to complying with the best interests of creditors test, without the necessity of obtaining creditor consent.  The benefits are significant, and it is to be expected that Subchapter V will be used extensively throughout the coming year and beyond.

- Iain A. Macdonald