One size does not always fit all, especially in bankruptcy reorganizations. Chapter 11 was designed for administering complex business reorganizations which can impose high costs and procedural roadblocks for smaller businesses.
In August 2019, the Small Business Reorganization Act of 2019 (“SBRA”) was signed into law by President Trump. The SBRA took effect on February 19, 2020. It adds a new Subchapter V to Chapter 11 with the intention of leading to more successful restructurings, reducing liquidations, and increasing recoveries to creditors.
Eligibility and Election to Proceed Under Subchapter V
“Small Business Debtor” Defined. A “small business debtor” is a person or entity engaged in commercial or business activity with aggregate secured and unsecured debts not more than $2,725,625. 11 U.S.C. § 101(51D). Of the total debt amount, at least 50% must have arisen from commercial or business activities. See SBRA § 4(a)(1)(B). The only excluded activity for the small business debtor is operating “single asset real estate,” which is a debtor who derives substantially all its gross income from the operation of a single real property. 11 U.S.C. § 101(51B). Thus, a debtor whose primary activity is to own or operate more than one property is eligible for Subchapter V (assuming the debtor satisfies the debt limits).
Debtor Must Elect to Proceed Under Subchapter V. Upon filing, the small business debtor may “elect” to be a debtor under the new subchapter V (“Subchapter V”) or choose to reorganize under the prior requirements of chapter 11 more generally (“Chapter 11”). 11 U.S.C. § 1187(a). Neither the Bankruptcy Code nor Bankruptcy Rules specify when the debtor must elect to proceed under Subchapter V. For now, there appear to be few restraints on making this election, as some courts have allowed chapter 11 cases filed even before the SBRA was enacted to redesignate to Subchapter V. See In re Progressive Solutions, Inc., 2020 Bankr. LEXIS 467 (Bankr. C.D. Cal., Feb. 21, 2020) (holding a small business debtor who filed in 2018 may amend their petition under Bankruptcy Rule 1009 at any time to elect to proceed under Subchapter V so long as no vested rights of a third party were impaired).
Debtor May Still Reorganize Under Chapter 11 Outside Subchapter V. If the debtor does not elect to proceed under Subchapter V, the debtor may still reorganize as a small business debtor under Chapter 11 more generally. For these debtors, the 300-day deadline for filing a plan and disclosure statement and the requirement of confirmation within 45 days of any such filing still apply. 11 U.S.C. §§ 1121(e)(2); 1129(e).
Roles of Debtor in Possession, Trustees, Examiners, and Committees
Debtor in Possession Duties and Powers. A debtor in possession under Subchapter V shall have all the rights and powers of a chapter 11 trustee, other than the right to compensation under § 330, and must perform all applicable functions and duties of a chapter 11 trustee. 11 U.S.C. § 1184.
Debtor in Possession Can Be Removed and Reinstated. A debtor in possession may be removed for cause, including fraud, dishonesty, incompetence, or gross mismanagement of the debtor’s financial affairs either before or after the petition date. 11 U.S.C. § 1185(a). However, a debtor in possession may also be reinstated on request and after notice and a hearing. 11 U.S.C. § 1185(b).
No Chapter 11 Trustees or Examiners. Section 1104 does not apply to Subchapter V cases, which means that chapter 11 trustees and examiners cannot be appointed in Subchapter V cases. 11 U.S.C. § 1181(a). Instead, a standing trustee is appointed under § 1183 (discussed below).
Committees Are Possible But Unlikely. Generally, committees of creditors are not permitted in Subchapter V cases unless the court orders otherwise for cause. 11 U.S.C. § 1181(b) (making § 1102(a)(1), (2), and (4) inapplicable).
Proposing a Plan Under Subchapter V
Only Debtor May File a Plan. Only the debtor may file a plan in a Subchapter V case. 11 U.S.C. § 1189(a). Section 1121, which defines the exclusivity period in Chapter 11 cases, is inapplicable to Subchapter V cases. 11 U.S.C. § 1181(a).
Mandatory Status Conference Within 60 Days. Within the first 60 days of a Subchapter V case, the court must hold a status conference “to further the expeditious and economical resolution of the Subchapter V case.” 11 U.S.C. § 1188(a). The court may extend this deadline if the “need for an extension is attributable to circumstances for which the debtor should not justly be held accountable.” 11 U.S.C. § 1188(b). At least 14 days before the status conference, the debtor must file and serve on all parties a status report that details the efforts the debtor has undertaken and will undertake to attain a consensual plan of reorganization. 11 U.S.C. § 1188(c).
Plan Must Be Filed Within 90 Days. The debtor must file a plan not later than 90 days after the order for relief is entered (the petition date for voluntary cases). 11 U.S.C. § 1189(b). The court may only extend this period if “the need for the extension is attributable to circumstances for which the debtor should not justly be held accountable.” Id.
No Disclosure Statement Required. A disclosure statement is not required in Subchapter V cases because § 1125 is inapplicable in Subchapter V cases “unless the court for cause orders otherwise.” 11 U.S.C. § 1181(b). Instead, the plan must include (1) a brief history of the business operations of the debtor, (2) a liquidation analysis, and (3) financial projections demonstrating the debtor’s ability to make the plan payments. 11 U.S.C. § 1190(1). However, if the court orders the debtor to comply with § 1125, then the expedited procedures of § 1125(f) shall apply. 11 U.S.C. § 1187(c). Section 1125(f) permits: (1) determination by the court that the plan itself provides adequate information and that a separate disclosure statement is not necessary; (2) approval of a disclosure statement on standard forms approved by the court or adopted under 28 U.S.C. § 2075; or (3)(A) conditional approval of a disclosure statement subject to final approval after notice and a hearing, (B) solicitation of acceptances and rejections based on a conditionally approved disclosure statement, and (C) a single, combined hearing on the adequacy of the disclosure statement and confirmation of a plan.
Changes to Plan Contents and Plan Confirmation Under Subchapter V
New Disposable Income Definition. Under Subchapter V, disposable income has been redefined as the income that is received by the debtor and that is not reasonably necessary to be expended for: (1)(A) the maintenance or support of the debtor or a dependent of the debtor; or (B) a domestic support obligation that first becomes payable after the date of the filing of the petition; and (2) the payment of expenditures necessary for the continuation, preservation, or operation of the business of the debtor. 11 U.S.C. § 1191(d). This new definition does not reference § 1325(b)(2), unlike § 1129(a)(15), which means that small business debtors in Subchapter V will not be subject to the expense limitations imposed on above-median income Chapter 13 debtors.
Property of the Estate. Property of the estate includes all property specified in § 541. If a plan is confirmed without the consent of all impaired classes, then property of the estate in a Subchapter V case also includes (1) all property that the debtor acquires after the petition date but before the case is closed, dismissed, or converted, and (2) all earnings from services performed by the debtor after the petition date but before the case is closed, dismissed, or converted. 11 U.S.C. § 1186(a)(1), (a)(2). However, if a plan is confirmed with the consent of all impaired classed, then property of the estate is limited to the property specified in § 541. This definition is one of many provisions in Subchapter V aimed at encouraging consensual plans.
Modification of Liens on Debtor’s Primary Residence. Generally, Chapter 11 prohibits the modification of consensual liens (i.e. deeds of trust) against the debtor’s principal residence. 11 U.S.C. § 1123(b)(5). However, under Subchapter V, the debtor may now modify a consensual lien against the debtor’s principal residence “if the new value received in connection with the granting of the security interest was—(A) not used primarily to acquire the real property; and (B) used primarily in connection with the small business of the debtor.” 11 U.S.C. § 1190(3).
Payment of Administrative Expenses Through the Plan. Administrative expenses are claims that arose during the bankruptcy case, most notably legal fees, and are given priority treatment under the Code. 11 U.S.C. §§ 503(b), 507(a). In Chapter 11 cases, administrative expenses must be paid on the plan effective date unless the claimant agrees to other treatment. 11 U.S.C. § 1129(a). Under Subchapter V, however, the plan may provide for the payment of administrative expenses through the plan. 11 U.S.C. § 1191(e).
No Impaired Consenting Class Requirement. In Chapter 11 cases, a plan cannot be confirmed unless at least one impaired class accepts the plan. 11 U.S.C. § 1129(a)(10). This can be especially difficult in cases with few creditors. In Subchapter V cases, this requirement no longer applies, making plan non-consensual plan confirmation easier. 11 U.S.C. § 1191(b). But, as discussed elsewhere, Subchapter V also incentivizes consensual plan confirmation with favorable terms, including limiting the definition of property of the estate (§ 1186(a)(1)), shortening the term of the standing trustee (§ 1191(b)), and granting an entity (not individual) a discharge immediately upon plan confirmation (§ 1192).
Cramdown of Unsecured Claims Simplified. If a class of creditors does not consent to plan confirmation, the plan may still be confirmed if it is “fair and equitable” to that class. 11 U.S.C. § 1129(b). This is known as cramdown. In Chapter 11, the “fair and equitable” definition differs as to classes of secured claims, unsecured claims, and interests. In Subchapter V, the definition of “fair and equitable” as to secured claims remains the same. 11 U.S.C. § 1191(c). However, the definition of “fair and equitable” as to unsecured claims and interests was modified for the benefit of debtors. Previously, in Chapter 11, a plan had to satisfy the absolute priority rule, which said that equity could not maintain their interests if unsecured creditors were not paid in full. The “new value corollary” of the absolute priority rule allowed equity to keep their interests only if they contributed “new value” (i.e. new money) to the plan in exchange. Subchapter V eliminates the absolute priority rule (and the new value corollary) as to unsecured claims and interests by redefining “fair and equitable” as to those classes. Now, a plan is “fair and equitable” as to unsecured creditors if: (1) all of the debtor’s projected disposable income to be received in a 3-year period (but not to exceed 5 years) will be applied to make plan payments, and (2) there is a reasonable likelihood that the debtor will be able to make all plan payments and the plan provides appropriate remedies, including liquidation of non-exempt assets, to protect holders of claims or interests in case plan payments are not made. 11 U.S.C. § 1191(c).
Discharge Differs Under Consensual and Non-Consensual Plans. When a “small business debtor” is granted a discharge depends on whether it is an individual or entity. In Chapter 11, entities receive their discharge upon plan confirmation and an individual receives their discharge upon completion of all plan payments. 11 U.S.C. § 1141(d). In Subchapter V, these rules only apply to consensual plans (i.e. plans where all impaired classes accepted the plan). 11 U.S.C. § 1192. For nonconsensual plans, the “small business debtor,” whether it is an individual or entity, does not receive a discharge upon completion of plan payments. Id.
The Subchapter V Trustee
Selection and Appointment. The Office of the U.S. Trustee, part of the Department of Justice, appoints individuals to serve as standing trustees in Subchapter V cases. 28 U.S.C. § 586(b).
Duties of Standing V Trustee. Initially, the standing trustee performs a role more akin to a chapter 13 trustee than a chapter 11 trustee. For example, the standing trustee’s duties include (1) being accountable for all property received, § 704(a)(4), (2) examining proofs of claim and object to improper filings, § 704(a)(5), (3) opposing the debtor’s discharge, if advisable, § 704(a)(6), (4) furnishing information concerning the estate and the estate’s administration if requested by a party-in-interest, § 704(a)(7), and (5) making a final report and file a final account of the administration of the estate with the court and with the U.S. Trustee’s Office, § 704(a)(9). 11 U.S.C. § 1183(b).
Facilitate Development of Consensual Plan. The standing trustee must “facilitate the development of a consensual plan of reorganization.” 11 U.S.C. § 1183(b)(7). This is an unusual phrase that is not used elsewhere in the Bankruptcy Code and suggests that standing trustee should be much more involved in developing a plan than Chapter 13 trustees. See 11 U.S.C. § 1302(b)(4) (duty of Chapter 13 trustee to advise and assist the debtor in performing the plan).
Role at Hearings. The standing trustee must appear and be heard at the 60-day status conference and any hearing that concerns: (a) the value of property subject to a lien; (b) confirmation of a plan filed under Subchapter V; (c) modification of the plan after confirmation; or (d) the sale of property of the estate. 11 U.S.C. § 1183(b)(3).
Plan Payments. The standing trustee must collect and retain plan payments until confirmation or denial of confirmation of a plan. 11 U.S.C. § 1194(a). If the plan is confirmed, the standing trustee must distribute any such payment in accordance with the plan. Id. If the plan is not confirmed, the trustee shall return the payments to the debtor after deducting (1) unpaid administrative expenses, (2) adequate protection payments, and (3) any fee owing to the standing trustee. Id. If the plan is confirmed under section 1191(b) (i.e. without the consent of all impaired classes), the standing trustee must make all payments under the plan for the term of the plan, which must be at least 3 years and may be up to 5 years. 11 U.S.C. § 1194(b).
Adequate Protection Payments Prior to Plan Confirmation. Prior to plan confirmation, and after notice and a hearing, the court may authorize the standing trustee to make adequate protection payments to secured creditors. 11 U.S.C. § 1194(c).
Term of Service. The length of the standing trustee’s term depends upon whether plan confirmation was consensual or non-consensual. If the plan is confirmed with the consent of all impaired classes, then the standing trustee’s term ends upon substantial consummation of the plan. 11 U.S.C. § 1191(a). If the plan is confirmed without the consent of all impaired classes (i.e. through cramdown under 11 U.S.C. § 1191(b)), then the standing trustee continues to serve for the duration of the plan for the purpose of collecting and facilitating payments to creditors. 11 U.S.C. § 1194(b). The U.S. Trustee may reappoint the standing trustee as needed to appear and be heard at any hearing that concerns modification of the plan after confirmation or removal of a debtor for cause. 11 U.S.C. §§ 1183(b)(3)(C), 1185(a).
Standing Trustee Fees. The standing trustee will receive compensation identical to that of Chapter 13 trustees, which consists of a 5% fee from all payments received by such individual under plans in the cases under Subchapter V. 28 U.S.C. § 586(e)(2)(A), (B).
No U.S. Trustee Quarterly Fee. In Chapter 11 case, the debtor must pay a quarterly fee that is calculated based on the debtor’s total disbursements. 28 U.S.C. § 1930(a)(6)(A). The amount of the quarterly fee is calculated based upon the total amount of disbursements made by the debtor. Id. These quarterly fees not applicable to Subchapter V because the words “‘other than under subchapter V,” have been added following ‘‘chapter 11 of title 11’’ in 28 U.S.C. § 1930(a)(6)(A).
In sum, the SBRA is a welcome addition to Chapter 11 that provides an additional option for small businesses to reorganize. Subchapter V, like the other provisions of Chapter 11, is not a one size fits all. And there are many small businesses that may not benefit from Subchapter V and who should elect to proceed under Chapter 11. Every small business case is unique because every small business debtor is unique. If you would like to discuss the reorganization options for your small business, please give us a call to set up your free initial consultation.