Published in NH Bar News (7/15/2020)
Chapter 11 of the Bankruptcy Code was enacted to provide financially troubled businesses an opportunity to reorganize by restructuring bank debt, discharging trade debt, and rejecting burdensome contracts and leases.
Over the years it became clear that, while the statute worked well for large enterprises, chapter 11 was simply too expensive for small businesses to utilize effectively. The reporting obligations, statutory hurdles to confirm a plan, and litigious nature of the process caused many small businesses to avoid filing for bankruptcy and, for those who did file, made successful reorganization an expensive and uncertain prospect. This explains, in part, a dramatic decline in the number of chapter 11 cases filed. Forty-two chapter 11 cases were filed in NH and 323 in Massachusetts in 1997, whereas only 16 chapter 11 cases were filed in New Hampshire and 105 in Massachusetts in 2017.
Recognizing that chapter 11 was not an effective resource for small business debtors, Congress enacted the Small Business Reorganization Act (“SBRA”) which added subchapter V to chapter 11, effective February 19, 2020. See, 11 U.S.C. §§1181-1195. A subchapter V small business debtor can be an entity or an individual (i.e., sole proprietorship). As originally adopted, the subchapter V was available to debtors with aggregate non-contingent liquidated secured and unsecured debt of up to $2,725,625, not less than 50% of which arose from commercial or business activities. See, 11 U.S.C. §101(51D). The recently adopted CARES Act increased the threshold to $7,500,000 until March 26, 2021.
Subchapter V gives a debtor more control of the chapter 11 process, shortens the time to confirmation of a plan, and eliminates statutory hurdles; all of which makes the process much less costly to utilize. A trustee is appointed in each case, but his or her role is to facilitate the development of a consensual plan of reorganization. The small business debtor remains in possession of, and operates, its business as the case proceeds.
Some of the benefits of new subchapter V include:
- No creditors’ committee is appointed unless the court orders otherwise for cause. This unburdens the debtor from the cost of committee professionals and devotion of valuable time and resources to responding to committee requests for information and often litigious activity.
- Administrative expenses that accrue during the case can be paid over time through the plan without creditor consent.
- A disclosure statement is not required unless the Court orders otherwise for cause. Valuable time and resources required to prepare and seek approval of a disclosure statement can be focused on the plan.
- The so-called “absolute priority rule” does not apply in subchapter V cases, making it more likely that the owners can retain an interest in the reorganized debtor.
- No quarterly fees are payable to the United States Trustee avoiding what can be a significant drain on the debtor’s cash flow during the pendency of a case.
- If the debtor operates as a sole proprietorship, a mortgage secured by the debtor’s personal residence can be modified if the loan proceeds were used primarily for business purposes.
Most importantly, the SBRA modified plan approval requirements in ways that greatly enhance the prospect of confirming a plan and successfully reorganizing. Only the debtor has the authority to propose a subchapter V plan of reorganization and the plan can be approved without the consent of a class of impaired creditors. This materially changes the dynamics of plan negotiations. Impaired creditors can no longer leverage their vote and the threat of a competing plan to force the debtor to make concessions that threaten the viability of the plan.
A plan must still be “fair and equitable” to be confirmed. To meet this standard in a subchapter V case, the small business debtor must commit all of its projected disposable income over the life of the plan (3-5 years) to its creditors. Disposable income is defined to mean income received by the business not reasonably necessary to be expended for the continuation, preservation, or operation of the business. The intent is to enable a business owner to retain ownership in the business, earn a reasonable living, and responsibly run the business in return for which it must pay its net income to its creditors. As case law develops, the parameters of the definition will undoubtedly be developed.
While oftentimes legislation is adopted as a response to a crisis, in this instance it came at just the right time. According to the American Bankruptcy Institute, in the first four months since the effective date of the SBRA, more than 470 cases were filed under subchapter V nationwide. Through June 24, 2020, fewer than a dozen cases had been filed in Maine, New Hampshire, and Massachusetts, but that number will surely increase in the coming months. Time will tell, but Subchapter V should make reorganization under the Bankruptcy Code more accessible and achievable for small businesses.
Joe Foster chairs, and Christopher Dube is a member of, McLane Middleton’s Bankruptcy Practice Group. Joe can be reached at 603-628-1175 or [email protected]. Christopher can be reached at 603-628-1437 or [email protected].