Client Alert

Aaron D Werner - a man in a business suit, smiling at the camera
Aaron L. Hammer
Chair | Bankruptcy Group

New Subchapter V of the Bankruptcy Code May Be the Salvation for Small Businesses to Survive COVID-19

Aaron D Werner - a man in a business suit, smiling at the camera
Aaron L. Hammer
Chair | Bankruptcy Group
A Newton's cradle on a white background.

The Small Business Reorganization Act (SBRA) was enacted in February 2020 with no one anticipating the global pandemic. Today, the financial consequences have hit small businesses hard. The SBRA, commonly known as Subchapter V, may provide much-needed relief to small businesses as they struggle through the crisis. With the Subchapter V election likely to surge during and after the pandemic, lenders and creditors should know how Subchapter V alters the Chapter 11 landscape.

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The highlights of Subchapter V are as follows:

  • Only a business debtor with non-contingent, secured and unsecured debtors less than $7,5000,000 may elect Subchapter V treatment (one caveat: entities that substantially derive all of their income from operating single real property are ineligible).
  •  Subchapter V allows a debtor to spread its debts over 3-5 years, during which time the debtor must devote its projected disposable income to paying creditors. Unlike Chapter 11 cases where administrative expenses must be paid at plan confirmation, Subchapter V allows them to be paid over the life of the plan. However, debts will not be discharged until all of the plan payments are made. On the other hand, a debtor is discharged once a consensual plan is confirmed where administrative expenses are paid up front.
  • A Subchapter V debtor must normally file its plan of reorganization within 90 days after entering bankruptcy.  However, the Bankruptcy Court may extend this deadline “if the need for the extension is attributable to circumstances for which the debtor should not justly be held accountable.” Obviously, in the COVID-19 environment, courts may liberally grant extensions.
  • Under Subchapter V, a trustee is automatically appointed, but the debtor retains control of its assets and operations. Creditor committees, a staple in Chapter 11 cases, are formed only for cause. Although Subchapter V trustees have the authority to investigate a debtor’s financial affairs, their primary function is to facilitate a consensual plan among the debtor and creditors, almost like a mediator.
  • Subchapter V also cushions small business owners from certain adverse personal consequences. For example, a debtor may modify a loan if the debtor used his primary residence as security for the business loan.
  • Several common principles found in Chapter 11 cases don’t apply: (i) the “new value” rule, which requires equity holders to provide “new value” if they want to retain their equity interest in the business; (ii) the Absolute Priority Rule wherein equity interest holders cannot retain ownership interests in a debtor’s assets unless all creditor claims are paid in full; (iii)  the requirement that an impaired class of creditors accept a plan—a plan can confirmed without the vote of an impaired accepting  class provided the plan does not discriminate unfairly and is deemed “fair and equitable” as to each class of claims and (iv) preferences–before a preference claim can be pursued, a claimant must use “reasonable due diligence” in light of “the circumstances of the case” to consider “a party’s known or reasonably knowable affirmative defenses.” Further, a preference suit for less than $25,000 against a noninsider, involving a non-consumer debt, can only be brought in the district where the defendant resides.

This pandemic is unprecedented. Normally, businesses of any size are ill-advised to enter Chapter 11 without a well-planned exit strategy. Subchapter V may be the exception. It may allow small businesses time to address their obligations by negotiating with lenders, landlords and other creditors. And, hopefully, small businesses can resume normal operations once the peril of the pandemic calms down.

HMB Legal Counsel will continue to provide updates as the situation evolves. The ongoing issues related to the spread of the Coronavirus (COVID-19) have had and will continue to have a significant impact on individuals, families, businesses and markets. Visit our collection of resources providing guidance during these fast-changing circumstances. Please reach out to your lead team member to answer specific questions.

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