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Increased Debt Limits Once Again under the Small Business Reorganization Act

By:      The Bankruptcy & Creditors’ Rights Group at Trenam Law

Nicole Carnero, Summer Associate at Trenam Law

When the Small Business Reorganization Act of 2019 (“SBRA”) was signed into law on February 19, 2020, it represented a significant milestone for small businesses in desperate need of bankruptcy relief. Through the SBRA, Congress created Subchapter V, a unique Chapter 11 bankruptcy process that exclusively applies to small businesses. It was meant to address the concern that small businesses were disadvantaged because traditional Chapter 11 bankruptcy is primarily geared towards large businesses. In many instances it can be far too expensive, cumbersome, and difficult to navigate for small business owners. Subchapter V allows small business debtors the same benefits of traditional Chapter 11 through a simplified process that was created with them in mind.

The SBRA was proposed and passed through Congress before small businesses were affected by the COVID-19 pandemic. Barely a month after the SBRA came into effect, the Coronavirus Aid, Relief, and Economic Security Act was passed to provide access to economic relief for the general public. This modified the eligibility requirements for Subchapter V by temporarily increasing the debt limit threshold from $2,725,625 to $7,500,000 through March 27, 2021.[1]  As a result, approximately 1,643 Subchapter V bankruptcies were filed within its first year, accounting for 23% of total chapter 11 filings.[2]  In contrast, traditional Chapter 11 bankruptcies only increased by 14.5% despite the pandemic related restrictions that occurred in 2021.[3]

In December 2020, the Consolidated Appropriations Act of 2021 further extended the $7,500,000 debt threshold for Subchapter V cases filed through March, 2022.[4]  Because over 3,250 cases had been filed since the enactment of the SBRA, Congress recognized a need to further extend the Subchapter V debt threshold to make bankruptcy more accessible to small businesses.[5]

Once again, on June 21, 2022, President Biden signed into law the Bankruptcy Threshold Adjustment and Technical Corporations Act, which again raised the debt threshold to $7,500,000 and made the increase retroactive to Subchapter V cases filed within March 27, 2022 and June 21, 2022.[6] Congress will consider making this change permanent in 2024.[7] This article provides a brief overview of some of the key differences between Subchapter V and a typical Chapter 11, and highlights some of the key facets of a Subchapter V case that are important for creditors to keep in mind to protect their interests.

  1. ELIGIBILITY REQUIREMENTS

 Pursuant to Section 1182 of the Bankruptcy Code, a Subchapter V debtor must be “a person engaged in commercial or business activities that has aggregate noncontingent liquidated secured and unsecured debts [as of the date of the petition] on an amount not more than $7,500,000.”[8]  To break this definition down further:

 1) The debtor or its affiliate must be a person engaged in commercial or business activities. This includes an individual, partnership, or corporation that is engaged in the business at the time the bankruptcy is filed.[9]

2) A small business debtor’s aggregate secured and unsecured debts must be:
(a) noncontingent – a debt that is not dependent on the occurrence of a future event for the liability to arise;

(b) liquidated – a debt that has a fixed determined amount; and

(c) cannot exceed $7,500,000.

3) At least 50% of the total debt must arise from the commercial or business activities of the small business debtor.[10]

Creditors should consult with counsel to determine whether the debtor made a proper election of Subchapter V.[11]

  1. KEY FACETS OF SUBCHAPTER V

 Creditors should understand the ways in which Subchapter V differs from traditional

Chapter 11 and tailor their approaches and strategies accordingly.

 1) Appointment of a Subchapter V Trustee: A traditional Chapter 11 trustee is only appointed “for cause.”  In contrast, a Subchapter V standing trustee is automatically appointed.[12]  The trustee’s role is meant as a facilitator of a consensual plan process.[13] A Subchapter V trustee can help broker agreements between stakeholders and help ensure the debtor’s compliance with the confirmed plan.[14] Because the trustee works to facilitate matters for all stakeholders in a Subchapter V case, creditors should communicate with the trustee as soon as possible to express their concerns.[15]

2) Accelerated Timelines: The court holds a status conference within 60 days after the debtor files for bankruptcy.[16] A debtor must file a notice with the court explaining its progress in confirming the repayment plan within 14 days before this conference.[17] Further, a debtor must file a plan within 90 days – rather than the traditional 180 days – and can only obtain an extension in limited circumstances.[18] An accelerated timetable for the debtor can be a leverage point for creditors in negotiations.

3) Elimination of the Absolute Priority Rule: The Absolute Priority Rule[19] prohibits business owners from retaining their equity interest in a debtor company unless all the creditor classes are paid in full.[20]  In traditional Chapter 11 bankruptcies, equity holders can overcome this rule by giving “new value” to the business.[21] Subchapter V eliminates the Rule entirety for small businesses. This may disadvantage creditors because small business debtors can retain their equity interest without paying creditors in full if their projected disposable income is dedicated to the plan. Creditors counsel should conduct due diligence as to whether the debtor is truly dedicating its entire disposable income over the course of the plan.[22]

             4) Reduced Creditor Oversight: In a traditional Chapter 11, the U.S. Trustee must determine whether a creditors committee should be appointed.[23] The committee provides oversight throughout the bankruptcy case, and it may hire professionals to ensure the creditors’ interests are being protected.[24] In contrast, a committee can only be appointed in a Subchapter V upon a showing of “cause.”[25] “Cause” exists if having a committee will significantly improve creditor recoveries and help expedite the case.[26]

5) No Creditor Voting: Unlike in a traditional Chapter 11, a repayment plan can be confirmed without creditor votes in a Subchapter V.[27]  Creditors should consult with counsel to determine whether the plan is “fair and equitable with respect to each class of claims and interests” and does not “discriminate unfairly.”[28] These analyses are more important in Subchapter V.

6) Creditors Cannot File Competing Plans:  Creditors can file competing reorganization plans in traditional Chapter 11 when the debtor fails to do so within a set amount of time.[29] In contrast, only the debtor can file a plan in a Subchapter V.[30] This change, coupled with the shortened deadline to file a plan, further accelerates Subchapter V cases.[31] Creditors should get involved early and speak with the Subchapter V trustee to ensure their interests are reflected in the debtor’s repayment plan.

7) No Disclosure Statement Requirement: Unlike in a traditional Chapter 11, a debtor is not required to file a disclosure statement in a Subchapter V.[32] This limits the amount of information that debtors must provide to creditors. However, debtors are still required to provide creditors with some information, such as a brief history of their financial operations and their projected ability to make plan payments.[33] It is then incumbent on creditors to do their own review of the information.

8) Modified Rights of Secured Claim Holders: The SBRA enacted a unique provision for Subchapter V debtors who leverage their personal assets.[34] Section 1190(3) of the Bankruptcy Codes allows debtors to modify claims secured by a security interest in their principle residence.[35] This is only permitted when the debtor uses their residence as collateral to grant a security interest to a secured party and receives new value in exchange.[36] The new value must then be used primarily in connection with the debtor’s business.[37]

9) Deferred Payment of Administrative Expense Claims: In a traditional Chapter 11 case, the debtor must pay administrative expense claims in the ordinary course of business, or in full on a plan’s effective date.[38] In contrast, a small business debtor in a Subchapter V may extend these payments throughout the life of the plan.[39] For this reason, creditors must carefully monitor post-petition payments.

Conclusion

 The increased debt threshold for Subchapter V cases are here for another two years (and maybe longer), making Subchapter V alluring for struggling small businesses. Creditors must pay close attention and react quickly to a Subchapter V bankruptcy filing.

[1] Teadra Pugh, Analysis: Four Statistical Snapshots of Subchapter V’s 1st Year, Bloomberg Law, (Feb 22, 2021), https://news.bloomberglaw.com/bloomberg-law-analysis/analysis-four-statistical-snapshots-of-subchapter-vs-1st-year.

[2] Id.

[3] Id.

[4] Jennifer McLemore, Subchapter V of Chapter 11: New Rules and New Players to Help with Small Business Reorganization, (Oct 29, 2021), https://www.jdsupra.com/legalnews/subchapter-v-of-chapter-11-new-rules-4470399/.

[5] Colleen Restel, Senate’s Bankruptcy Threshold Adjustment and Technical Corrections Act Retains $7.5 Million Eligibility for Subchapter V Small Business Debtors, Lowenstein Sandler (May 2, 2022), https://www.jdsupra.com/legalnews/senate-s-bankruptcy-threshold-9537958/.

[6] Ryan Baggs, What the Subchapter V Debt Limit Raise Means for Small Biz, Law 360, https://www.law360.com/articles/1507050/what-the-subchapter-v-debt-limit-raise-means-for-small-biz.

[7] The Bankruptcy Threshold Adjustment and Technical Corrections Act Increases the Debt Threshold for Small Businesses under the SBRA and Wage Earners in Chapter 13, Practical Law Legal Update w-036-0186

[8] 11 U.S.C § 1182(a).

[9] Small Business Bankruptcy Under The SBRA: Overview, Practical Law Practice Note Overview w-023-8889

[10] Id.

[11] Jennifer Raviele, Subchapter V Changed the Chapter 11 Bankruptcy Landscape – How Should a Creditor Protect Itself?, JD Supra, (May 6, 2022), https://www.jdsupra.com/legalnews/subchapter-v-changed-the-chapter-11-1845098/#:~:text=May%206%2C%202022-,Subchapter%20V%20Changed%20The%20Chapter%2011%20Bankruptcy%20Landscape,Should%20A%20Creditor%20Protect%20Itself%3F&text=Subchapter%20V%20was%20intended%20to,mid%2Dsize%20and%20large%20companies.

[12] Practical Law, supra.

[13] Id.

[14] McLemore, supra.

[15] Ravielle, supra.

[16] 11 U.S.C § 1188(a).

[17] William L. Norton III, The Pros and Cons of the Small Business Reorganization Act of 2019, Bradley, (June 27, 2022), https://www.bradley.com/insights/publications/2020/08/the-pros-and-cons-of-the-small-business-reorganization-act-of-2019.

[18] Norton, supra.

[19] 11 U.S.C. § 1129(b)(2)(B).

[20] Jason Ayres, (Not-So) Small Business Reorganization Act: CARES Act Expands SBRA Eligibility, Foster Garvey, (June 27, 2022), https://www.foster.com/newsroom-alerts-small-business-reorganization-act-cares-act-expands-sbra-eligibility#:~:text=To%20make%20chapter%2011%20more,to%20qualify%20for%20SBRA%20relief.

[21] Id.

[22] Ravielle, supra.

[23] Jill C. Walters, Subchapter V. vs. ‘Ordinary’ Chapter 11 Practice Changes for Small Business Debtors, Bloomberg Law, chrome-extension://efaidnbmnnnibpcajpcglclefindmkaj/https://www.womblebonddickinson.com/sites/default/files/2021-09/SubchapterV_vs_Ordinary_Chapter11_Practice_Changes_Small_Business_Debtors.pdf.

[24] Id.

[25] Ravielle, supra.

[26] Id.

[27] Id.

[28] 11 U.S.C § 1191(b).

[29] 11 U.S.C § 1121(c).

[30] Walters, supra.

[31] George Cauthen, The Small Business Reorganization Act: An Unintended Lifeline For Small Businesses Considering Restructuring Due to COVID-19, Nelson Mullins, (Aug 24, 2020), https://www.nelsonmullins.com/idea_exchange/insights/the-small-business-reorganization-act-an-unintended-lifeline-for-small-businesses-considering-restructuring-due-to-covid-19#:~:text=In%20a%20traditional%20Chapter%2011,plans%20must%20be%20filed%20quicker.

[32] Walters, supra.

[33] 11 U.S.C § 1190(a)(1).

[34] Walters, supra.

[35] 11 U.S.C § 1190(3).

[36] Id.

[37] Id.

[38] Sam Della Fera Jr., ‘Small Business’ Bankruptcies: What You Need to Know about Subchapter V of Chapter 11, (Jan 27, 2022), https://www.law.com/njlawjournal/2022/01/27/small-business-bankruptcies-what-you-need-to-know-about-subchapter-v-of-chapter-11/.

[39] Id.

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