As a result of the COVID-19 pandemic, Congress amended the Bankruptcy Code and passed the “Coronavirus Aid, Relief, and Economic Security Act” also known as the “CARES Act”, which was signed into law by the President on March 27, 2020. Specific amendments were made to Subchapter V of Chapter 11 of the Bankruptcy Code to change and expand the availability of small business bankruptcy relief. Subchapter V is a relatively new section of the Bankruptcy Code that became effective earlier this year prior to the COVID-19 outbreak to make it easier for small businesses to successfully reorganize under Chapter 11 of the Bankruptcy Code. Under the regular provisions of Chapter 11 there are significant challenges and obstacles for small business debtors to successfully reorganize in Chapter 11.
The new Subchapter V was enacted on August 23, 2019 as part of the Small Business Reorganization Act (“SBRA”), which became effective on February 19, 2020. Under SBRA the debt limit or cap for debtor eligibility for Subchapter V small business debtors was $2,725,625. Under the CARES Act this has been increased to $7,500,000. However, the CARES Act contains a sunset provision, and will expire one year after March 27, 2020. So after March 27, 2021 the SBRA eligibility limits will go back down to $2,725,625.
Both individuals and business entities (such as corporations or LLCs) are eligible to file as small business debtors under SBRA (as modified by the CARES Act). However, at least half of the debtor’s total debt must come from business activity. So for an individual debtor who has a mix of business and consumer debt (i.e., non-business related debt for personal, family and household reasons), as last 50% of the total debt must be business related.
In addition, a single asset real (“SAR”) estate debtor is not an eligible small business debtor under SBRA. A SAR debtor is a debtor in the business of owning a single real estate asset, such as a building.
There are significant differences between a Subchapter V small business bankruptcy and bankruptcy under the regular provisions of Chapter 11:
- Elimination of Creditor Voting. Under the regular provisions of Chapter 11, “impaired creditors” (meaning creditors who are not getting paid in full or whose rights are otherwise affected under a plan) are entitled to vote on a plan. The voting process in a normal chapter 11 case is complicated, time consuming, and expensive (mailings are required to be sent by mail to all creditors containing a plan, disclosure statement and ballots). This is not mandatory in Subchapter V cases. It is possible to confirm a case without any creditor voting as long as the requirements for confirmation are met.
- Simplified Plan Confirmation Process. Under the regular provisions of Chapter 11, to confirm a plan (i.e., obtain approval of a plan of reorganization) creditors get to vote on a plan, and unless the plan leaves all creditors’ claims unimpaired (i.e., 100% plan without impairment of rights), the plan must be approved by a least one impaired accepting class. This is not required in a Subchapter V case. In addition, it is possible for a debtor to obtain acceptance of a Chapter 11 plan without any creditor voting as long as the plan does not discriminate unfairly and is “fair and equitable” (discussed below) and creditors do not receive less money than they would if the debtor had filed for Chapter 7 liquidation. Creditors also have no right to file competing plans at any time.
- Elimination of the Absolute Priority Rule (§ 1129(b)). The absolute priority rule, which also embodies the “fair and equitable” standards in normal Chapter 11 cases, provides that the existing equity holders (shareholders of a corporation or members of a LLC) cannot maintain their ownership interest in the debtor in Chapter 11 unless all other non-consenting impaired creditors which come ahead of equity are paid in full. In a normal non-SBRA case the only way the owners are able to get around this is to put new value into the business (which means they essentially have to come up with new money to buy it back from creditors). Subchapter V borrows conceptually from Chapter 13 (wage earner repayment plan) and provides that the plan must provide for payment to creditors of all of the “projected disposable income” of the debtor to be received for a minimum period of 3 years, or longer period not exceeding 5 years as the Bankruptcy Court may fix. “Disposable income” in the context of a non-individual debtor means income not necessary to be spent for the “continuation, preservation, operation of the business” (i.e., net income after operating expenses and salaries).
- Elimination of Creditors’ Committee. Unlike in a normal Chapter 11 case in which an official committee is routinely appointed, and the fees and expenses of any professionals retained by that committee, such as lawyers and accountants are paid by the debtor, in a Subchapter V case there usually will be no creditors’ committee, unless the Bankruptcy Court orders the appointment of one for cause.
- Elimination of United States Trustee’s Fees. In a normal Chapter 11 case the debtor is required to make quarterly payments to the Office of the United States Trustee based on a percentage of disbursements made during the quarter. This is eliminated in Subchapter V cases.
- Flexibility to Modify Chapter 11 Plan. Under Subchapter V the debtor has considerable ability to modify a confirmed plan to a much greater extent than in a normal Chapter 11 case. A confirmed plan can be modified at any time within 3 years, or such longer time as fixed by the Bankruptcy Court.
Please contact Stephen Starr at Starr & Starr, PLLC at sstarr@starrandstarr.com or 888-867-8165 for further information.