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
