Small businesses are the backbone of the US economy. As things start returning to normal, and as our economy continues to improve coming out of the pandemic, we are all hopeful that small business comes roaring back to profitability and fiscal health. However, a recent survey found that as many as 59% of small businesses are likely to scale down, close, or sell in the coming year, and many have less than a month’s cash on hand (see Business Today). It is not surprising that some businesses will have a difficult time dealing with debt accrued during pandemic lockdowns.
Chapter 11 of the US Bankruptcy Code is tailor-made for situations where a business weathers a difficult financial situation and is ready to become profitable or return to profitability but needs to restructure or reorganize its obligations to be successful. However, Chapter 11 is expensive and often complicated. Chapter 11 cases take a long time, and only about 25% of cases filed ever successfully reorganize and emerge from bankruptcy. Small business specifically usually lacks the resources to make Chapter 11 a worthwhile endeavor.
Recognizing this, Congress passed the Small Business Reorganization Act of 2019 (SBRA). The SBRA amended Chapter 11 of the Bankruptcy Code by adding Subchapter V specifically to allow small business reorganization under the bankruptcy code.
What is a Small Business Debtor?
In the original SBRA, which became effective in February 2020, a business was eligible to file under Subchapter V if its aggregate debts were less than about $2.7 million. However, recognizing that the pandemic was likely to cause more businesses to become distressed, Congress passed the CARES Act, which temporarily increased the small business debt limit to $7 million. This temporary increase has since been extended through March 27, 2022, by the Covid-19 Bankruptcy Extension Relief Act, which was signed into law on March 27, 2021.
Individuals may also qualify to file under Subchapter V if they are engaged in commercial activity and their debts primarily arise from business or commercial activities. Thus, someone who operates as a sole proprietor or who has guaranteed the debts of a business endeavor may be able to file under Subchapter V.
The increased debt limit means that, for a short period of time, more businesses qualify to file under Subchapter V. From now through the end of March 2022 (unless extended again), individuals and businesses with $7 million or less in debt can file to reorganize under Subchapter V of Chapter 11 of the Bankruptcy Code.
What are the advantages of a Small Business Reorganization?
There are several advantages to debtors that qualify to file Chapter 11 as a small business. In general, the process is less expensive and more streamlined. It also allows the debtor to retain more control over the process.
There are several specific changes that benefit small business:
- Shorter time. The debtor must file the Chapter 11 plan within 90 days of filing the bankruptcy petition. Things that often take a long time, such as the drafting and approval of a disclosure statement and the appointment of a committee of unsecured creditors, does not happen in Subchapter V. And the standard applied by the court for approval of the plan is easier to meet than in a typical Chapter 11.
- The Debtor controls the plan. Under Subchapter V, only the debtor can file the plan of reorganization and ask for the bankruptcy court’s approval. Similarly, only the debtor can seek to have the court modify the plan once it is approved. These provisions make it much easier for the debtor to remain in control of the business.
- Absolute Priority Rule does not apply. Under a normal Chapter 11, all creditors must be paid in full before equity holders are permitted to receive anything. This is often a significant barrier to small businesses that have few shareholders and who want to retain their equity ownership. Under Subchapter V, a plan can be confirmed over the objection of unsecured creditors and allow small business owners to maintain control over their companies.
- Modification of loans secured by the debtor’s principal residence. Debtors often finance their business using the equity in their homes. In Subchapter V, debtors may modify loans secured by their primary residence that was used for this purpose.
Is Subchapter V Right for Your Business?
This is only a very short summary of Subchapter V. There are, of course, additional considerations and drawbacks that must be considered. If you think a Subchapter V bankruptcy may be right for you, we at Revolution Law Group would be happy to discuss it with you in detail.
The information included here is for informational purposes only, is not exhaustive of all considerations when creating documents, is not intended to be legal advice, and should not be relied upon for that purpose. We strongly recommend you consult with an attorney and do not attempt to create your own documents.