The Small Business Reorganization Act and Subchapter V Bankruptcy

Posted on by Neil E. McCullagh, Christopher A. Hurley in Creditors' Rights, Bankruptcy and Insolvency

The Small Business Reorganization Act of 2019 (the “SBRA”) became effective on February 19, 2020, and is aimed at giving small business debtors a simpler and less costly avenue to successful reorganization. The SBRA created “Subchapter V” of the Bankruptcy Code to distinguish small business bankruptcies from typical larger Chapter 11 cases. It is available to “small business debtors,” originally defined as individuals or business entities whose total noncontingent, liquidated debts are no more than $2,725,625 and at least 50% comprised of debts that arose from business activity. The CARES Act temporarily increased the debt limit to $7.5 million until March 2021.

Persons or entities whose primary business activity is owning “single asset real estate,” which means, with some exceptions, real estate on which the prospective debtor is not conducting any substantial business, are not eligible for relief under the SBRA.

Subchapter V has already proven popular with small businesses looking to reorganize, including those affected by COVID-19. According to the American Bankruptcy Institute, over 900 Subchapter V cases have been filed across the country since the SBRA became effective in February. As courts encounter more Subchapter V cases, they will undoubtedly continue to provide additional guidance on the application of this new bankruptcy law.

There are a number of distinguishing factors between a typical Chapter 11 case and the new Subchapter V. Of course, rules regarding the automatic stay still apply. But creditors may notice several ways in which their participation in the case has changed. This article is intended to provide an overview of what creditors should expect when faced with a debtor filing bankruptcy under Subchapter V.

Quicker Timeline to Plan Confirmation

The SBRA created new streamlined deadlines for moving the case forward. The debtor must hold a status conference within 60 days of filing their bankruptcy petition and must work quickly to propose a reorganization plan. The deadline for filing a Subchapter V plan is only 90 days—a substantial reduction from the 300 days provided to small business debtors in regular Chapter 11 cases. Unlike a regular Chapter 11 case, only a debtor may propose a plan of reorganization.

The SBRA also eliminated the requirement that a debtor file a disclosure statement, which should aid in faster plan confirmation. In a typical Chapter 11 case, the debtor must file a disclosure statement setting forth the debtor’s operating history, assets, and liabilities, with projections regarding the debtor’s ability to pay under the terms of a proposed plan. Voting on a plan does not happen until after a hearing and court approval of the disclosure statement. By allowing a debtor to include this information as part of its plan, Subchapter V further shortens the time to confirmation.

Trustee Oversight

New in Subchapter V is the appointment of a trustee, who plays a role similar to a Chapter 13 trustee. The debtor typically retains control of its business, but the trustee supervises the case and may disburse plan payments. In Subchapter V, the trustee is also tasked with facilitating a plan of reorganization that is more likely to be accepted by creditors.

Mortgage Modification

Typically, in a Chapter 11 (or Chapter 13) case a debtor’s plan may not modify the rights of creditors who hold claims secured only by an interest in the debtor’s principal residence. This anti-modification rule generally prevents debtors from “stripping down” the loan or, in other words, voiding the creditor’s lien to the extent the debt is unsecured. Under Subchapter V, however, an individual debtor may modify a mortgage so long as the loan was not primarily a purchase-money mortgage and instead was used primarily in connection with the debtor’s small business.

Consensual vs. Non-Consensual Plan Confirmation and Administration

The SBRA overhauls a few aspects of plan confirmation. First, the court may confirm a plan regardless of whether any creditors vote in favor of confirmation. By contrast, the court cannot confirm a plan in a normal Chapter 11 case unless at least one impaired class of creditors votes to accept it (an impaired creditor is one who is asked to accept less than what it is owed). In other words, Subchapter V provides that a plan can be confirmed with or without the consent of impaired creditors.

As laid out in the chart below, there are several reasons why obtaining consent of impaired creditors may be beneficial to debtors. A non-consensual, or “cramdown,” plan may nonetheless be confirmed as long as the plan does not discriminate unfairly against the non-consenting impaired classes and is fair and equitable to those creditors.

Consensual

Cramdown

Time of Discharge

Upon confirmation of the plan

After the debtor completes all payments due within the first three (or up to five) years of the plan

Payment of Administrative claims

Paid upon confirmation of the plan

May be paid over the life of the plan through regular plan payments (over three to five years)

Amount of trustee oversight

Trustee is terminated upon confirmation, leaving the debtor to make plan payments

Trustee acts as a disbursing agent for plan payments

Post-confirmation plan modification

No modification permitted except in limited circumstances

Debtor may modify the plan any time within the life of the plan, subject to court confirmation.

Creditors should be aware of these differences in plan administration when negotiating plan terms with debtors. As noted, Subchapter V provides a few incentives for debtors to obtain creditor consent to a proposed plan, such as an earlier discharge and less involvement (and therefore fewer expenses) by the trustee. Savvy creditors may be able to use these incentives to their advantage in negotiating more favorable plan terms.

Default or Dismissal

Creditors should also understand the consequences of a debtor’s default under the terms of the plan or dismissal of the case, which vary depending on whether the debtor’s plan is consensual or non-consensual.

1. Consensual Plans

When a debtor defaults on its obligations under a consensual plan, the default provisions negotiated in that plan typically control. This takes into account the fact that creditors have the opportunity to negotiate better plan terms in exchange for their affirmative vote.

As noted in the chart above, once the court confirms a debtor’s Subchapter V plan, the debtor receives its discharge. This may be the case even if the obligations remain unfulfilled under the terms of the plan. Nonetheless, the case may be subject to dismissal. In a typical Chapter 11 case, courts have held that dismissal does not affect the debtor’s discharge or the fact that the debtor is bound to the terms of its plan of reorganization. It is expected that the dismissal of a Subchapter V case after confirmation of a consensual plan will have the same result. Accordingly, it is vital that creditors negotiate strong default terms and repayment obligations to protect themselves if the debtor is unable to make payments or meet other plan requirements.

2. Cramdown Plans

With regard to a cramdown plan, the Bankruptcy Code provides that the debtor must provide “appropriate remedies” in case of default. This means that the court will not confirm a plan in the first place unless it provides enough protection to creditors. It remains to be seen what courts will consider to be appropriate remedies, but the Bankruptcy Code states that this may include liquidation of the debtor’s nonexempt assets.

Because a debtor does not receive a discharge until the completion of a cramdown plan, dismissal of the case in this situation likely reinstates the pre-bankruptcy relationships between debtors and creditors.

About the Authors

Neil E. McCullagh is an attorney who works with banks on a wide variety of issues, including lending, insolvency, workouts, creditors' rights, bankruptcy, and collections.

Christopher A. Hurley is an associate in the Creditors’ Rights section of the firm, focusing on creditors’ rights, commercial litigation, and bankruptcy.

Spotts Fain publications are provided as an educational service and are not meant to be and should not be construed as legal advice. Readers with particular needs on specific issues should retain the services of competent counsel.