In 2019, Congress passed the Small Business Reorganization Act which created a new subchapter of the Chapter 11 bankruptcy code called Subchapter V specifically for small businesses.[1] Lawmakers aimed to provide “a better path for small businesses to successfully restructure, reduce liquidations, save jobs and increase recoveries to creditors” by creating Subchapter V.[2]
In February of 2020, Subchapter V became effective just before a national health crisis that catalyzed significant economic distress[3] especially for small businesses.[4] Since then, many Chapter 11 cases have petitioned the courts to change from Chapter 11 to Subchapter V because of the significant benefits associated with the new area of the code.[5] Below highlights a few differences between Subchapter V and the former small business requirements under Chapter 11 of the code, the impact of Subchapter V thus far, and discuss the implications of Subchapter V moving forward.
Reduced Paperwork and Costs
Subchapter V helped to relieve the previous mass of paperwork required for small businesses filings under Chapter 11.[6] Unlike other filers, small business filers had to include additional solicitation and disclosure filings for restructuring confirmation of a bankruptcy plan.[7] Now, small businesses need only provide certain disclosures in the bankruptcy plan instead of adding extra disclosure statements, which reduce administrative costs.[8] While required in a Chapter 11 proceeding, a Subchapter V filing does not require the formation of an official committee of unsecured creditors and appointment of the U.S. Trustee.[9] This significantly reduces administration costs.[10] Further, Subchapter V expedites the completion of the bankruptcy procedure, known as confirmation, because it requires smaller timeframes for filing a plan (90 days compared to 180 days in Chapter 11).[11]
Use of a Trustee
Unlike in non-small business restructurings, Subchapter V requires an appointment of a trustee in every case.[12] A trustee assists the debtor in proposing, executing, and confirming the plan as well as distributing the proceeds of the estate to entitled creditors and shareholders.[13] A North Carolina Bankruptcy Court recently held that Trustees appointed to a bankruptcy estate must show that their services are necessary in order to be compensated when the debtor is already represented by counsel.[14] Similar to Chapter 13 proceedings in which a trustee is assigned to individual payment plan cases, Congress added an appointment of a trustee to help small businesses navigate the technical challenges associated with reorganizing.[15] Moving forward, we will continue to see more trustee-related issues play out in court.
The Absolute Priority Rule Remains
The code does not require the Absolute Priority rule, or the requirement of a shareholder vote, found in section 1129(b)(2)(b)(ii).[16] The absolute priority rule requires that a dissenting class of unsecured creditors must be paid in full before the estate pays any class with less or “junior” priority such as shareholders.[17] The rule allows for a court to confirm a plan over the objection of unsecured creditors so long as all the debtor’s current projected disposable income funds the bankruptcy plan.[18] Congress eliminated the absolute priority rule to allow owners of small businesses to continue to manage their business and to encourage successful small business reorganization.[19] This is increases the likelihood of a successful small business reorganization. This is because fewer stakeholders have input in the factors allowing the company to emerge from bankruptcy.[20]
A shareholder vote requirement would incentivize all parties to negotiate and to collaborate for a consensual plan.[21] Because there is no requirement for a shareholder vote, creditors are no longer incentivized to work together, which could encourage further fighting among creditors, committees, and debtors.[22] This problem increases litigation and adversary proceedings, increasing costs that could be used to otherwise pay creditors.[23]
Best Interest Test Remains in Subchapter V
Creditor protections from Chapter 11 remain in Subchapter V.[24] Notably, the debtor must ensure that creditors would receive at least as much money in the restructuring compared to the debtor’s liquidation, known as the “Best Interest Test.”[25] The theory is that creditors may be deprived of their contractual rights[26] so long as they get the same or more compared to if the debtor liquidates. An issue relating to confirmation often turns on the valuation of the estate.[27]
The Global Pandemic’s Effect on Subchapter V
In 2014, small businesses contributed 43.5% to the United States GDP.[28] Amidst the pandemic, more than 70% of businesses in general identified the global health crisis as having a large or moderate effect on business.[29] A small business debtor under the bankruptcy code is a person: (1) engaged in commercial business activity; (2) with no more than $2 million in debt; and (3) who’s debts came from commercial or business activities.[30] As part of the CARES act, Congress temporarily lifted the debt ceiling of small business debtors to $7,500,000.[31] As a result, more debtors could find relief under Subchapter V.
Some have opined that raising the debt ceiling made it possible for large companies, not typically thought of as small businesses, to qualify for Subchapter V.[32] This is because in order to qualify, companies need non-contingent and unliquidated claims totaling less than $7.5 million, and some mid-sized companies can now more easily squeeze into this qualification.[33] Also, raising the debt ceiling could encourage more people to file for restructuring compared to others who would have liquidated otherwise, because they could not afford filing under Chapter 11.
This may encourage those who really should not have filed in the first place to file, only to send them back to court to refile again under Subchapter V or Chapter 7. Refiling can negatively affect the business owners, their livelihood, and especially the creditors whose debt was already converted, or restructured in some other way. On the other hand, for a Subchapter V bankruptcy plan to be confirmed it still must satisfy 1129(a)(11), in which the reorganization plan must be feasible.[34] Generally, the standard for feasibility is on a case-by-case basis and serves as a tool to ensure the bankruptcy is not a pipe dream.[35]
Use of Subchapter V Currently
There has been a slow but steady increase in filings for Subchapter V since it became effective in February of 2020.[36] In 2020, there were more bankruptcies compared to the previous seven years.[37] Only 2012 had more bankruptcies within the last eight years, with around 7,700 Chapter 11 bankruptcies.[38] As of October, around 1,000 small businesses took advantage of Subchapter V proceeding across the country.[39] According to AACER, there were around 7,000 Chapter 11 filings in 2020.[40]
Conclusion
So far, Subchapter V has been utilized and provided much-needed relief to small businesses facing financial insolvency issues especially amidst the global pandemic.[41] While the increase in the debt ceiling allows more debtors to find relief under Subchapter V, it opens up the possibility for other mid-sized businesses to tweak valuations in order to qualify for Subchapter V. However, because only around 15% of Chapter 11 filings have been Subchapter V,[42] it remains to be seen if there is a high risk of businesses taking advantage of the new debt ceiling.
[1] See 11 U.S.C § 1181-1195.
[2] Senate Passes Small Business Reorganization Act, HAVEN ACT and Family Farmer Reorganization Act, Am. Bankr. Inst. (Aug. 1, 2019), https://www.abi.org/newsroom/press-releases/senate-passes-small-business-reorganization-act-haven-act-and-family-farmer.
[3] See id.
[4] See U.S. Trustee Program Ready to Implement the Small Business Reorganization Act of 2019, Dep’t of Just. (Feb. 19, 2020), https://www.justice.gov/opa/pr/us-trustee-program-ready-implement-small-business-reorganization-act-2019.
[5] Hailey A. Varner and Lauren Beslow, Small Businesses May Be Able to Retroactively Amend Bankruptcy Petition Under the Small Business Reorganization Act, Lexology (Aug. 25, 2020), https://www.lexology.com/library/detail.aspx?g=3a268158-ed98-4061-afe2-7d5b79f95986.
[6] See Symposium, The Pros and Cons of the Small Business Reorganization Act of 2019, 36 Emory Bank. Dev. J. 383, 383 (2020).
[7] A confirmation bounds stakeholders to the bankruptcy plan. See Elizabeth Warren et al., The Law of Debtors and Creditors: Text, Cases, and Problems, 634 (7th ed. 1986).
[8] 5 Collier Bankruptcy Practice Guide ¶ 92.14A (2020).
[9] Id.
[10] Id.
[11] 11 U.S.C. § 1189.
[12] 11 U.S.C. §§ 1190-1191, 1123.
[13] Id.
[14] See Lisa Uhlman, Subchapter V Trustees Must Show ‘Special Need’ for Fees in DOP Cases: Judge, Westlaw Bankruptcy Daily Briefing (June 15, 2020).
[15] See The Pros and Cons of the Small Business Reorganization Act of 2019, supra note 6.
[16] See The Pros and Cons of the Small Business Reorganization Act of 2019, supra note 6, at 385.
[17] 11 U.S.C. § 1129(b)(2)(b)(ii).
[18] Id.
[19] See The Pros and Cons of the Small Business Reorganization Act of 2019, supra note 6, at 385.
[20] See The Pros and Cons of the Small Business Reorganization Act of 2019, supra note 6, at 385.
[21] See Warren, supra note 7, at 599.
[22] See Warren, supra note 7, at 599.
[23] See Warren, supra note 7, at 599.
[24] See 11 U.S.C § 1181-1195.
[25] See 11 U.S.C. § 1129(a)(7). See also Warren, supra note 7, at 665.
[26] For instance, the bankruptcy code allows for breaking of contracts such as the ability to assume or reject a lease. 11 U.S.C. § 365.
[27] See Warren, supra note 7, at 665.
[28] See Warren, supra note 7, at 665.
[29] Small Business Pulse Survey: Tracking Changes During the Coronavirus Pandemic, U.S. Census Bureau, (Jan. 14, 2021).
[30] 11 U.S.C. § 101(51)(D)(A).
[31] 15 U.S.C. 116 § 9051.
[32] Andrew M. Troop & Andrew V. Alfano, CARES Act Expands Eligibility Under the Small Business Reorganization Act: What Distressed Small Businesses and Their Creditors Should Know, Pillsbury (Apr. 17, 2020), https://www.pillsburylaw.com/en/news-and-insights/cares-act-expands-eligibility-under-small-business-reorganization-act.html#:~:text=In%20response%20to%20the%20COVID,non%2Dcontingent%20and%20liquidated%20debt.
[33] Id.
[34] See 11 U.S.C. § 1129(a)(11).
[35] Id.; see also Warren, supra note 7, at 625.
[36] Slow Start to Chapter 11 Subchapter V Bankruptcy Filings, Epiq (Oct. 7, 2020), https://www.epiqglobal.com/en-us/about/news/restructuring-bankruptcy/slow-start-to-chapter-11-subchapter-v-bankruptcy.
[37] Id.
[38] Id.
[39] AACER Commercial Chapter 11 Bankruptcies by Month, 2011-2020, Epiq, https://www.aacer.com/bankruptcy-statistics-and-trends.
[40] Id.
[41] See Slow Start to Chapter 11 Subchapter V Bankruptcy Filings, supra note 36.
[42] See Slow Start to Chapter 11 Subchapter V Bankruptcy Filings, supra note 36.
