The new Subchapter V of Chapter 11 of legislation known as the Small Business Reorganization Act of 2019 became effective on February 19, 2020. Shortly after the act was passed, the COVID-19 pandemic began to impact the country. In recognition of the pandemic, the Coronavirus Aid Relief and Economic Security (CARES) Act was passed on March 27, 2020. The CARES Act has increased debt limits for small businesses pursuing relief under Subchapter V. If you are a small business wner, consider the following options available to you for taking control of your business debt.

Who Qualifies as a Small Business Debtor?

The Bankruptcy Code defines a “small business debtor” as a person or any member of a group of affiliated debtors engaged in commercial activities that has aggregate noncontingent liquidated secured and unsecured debts of not more than $7,500,000. This amount excludes debts owed to one or more affiliates or insiders.

Before the Small Business Relief Act, a small business debtor included debtors engaged in commercial business activities with an aggregate noncontingent liquidated debt of not more than $2,725,625. 

Some of the reasons why businesses end up pursuing debt relief under the Small Business Relief Act include:

• The Small Business Relief Act provides for significant cost savings over Chapter 11 bankruptcy
• Neither a creditor’s committee nor associated professional fees arise under the Small Business Relief Act
• A debtor is not required to pay US Trustee fees
• Debt relief under the Small Business Relief Act is more streamlined for the person pursuing debt relief
• Plans of reorganization are less complex
• The Act allows equity interests to be maintained without creditor agreements
• The Act permits debtors to modify mortgage secured by a residence

The Nature of Subchapter V

A trustee is appointed under Subchapter V and will have the duty of facilitating a debtor’s plan. This means that the trustee will appear at hearings about asset sales and other matters. Trustees receive compensation from a debtor and are terminated after a plan is “substantially consummated.”  

Subchapter V plans that are filed by small business debtors should include several critical elements like a history of the debtor’s business operations, liquidation analysis, and projections addressing a debtor’s ability to make payments under the plan.

Another other critical issue involved with Subchapter V plans is that administrative expense claims must be paid throughout the term of a plan rather than on confirmation. 

The Role of Subchapter V Plans

Subchapter V of the Small Business Reorganization Act allows small business debtors to obtain a discharge on the effective date of plan provided that the plan was consensual and approved under section 1119 (a), which requires compliance with all consensual confirmation provisions in a chapter 11 case.

While they share some similarities, some substantial differences exist between a Subchapter V plan and a traditional Chapter 11 plan. These differences include:

• Under Subchapter V, a debtor must file a bankruptcy plan within 90 days. A debtor under Chapter 11 bankruptcy, however, has 120 days in which to plan at which times its “exclusive period” expires. This time can be extended by the court, though.
• No disclosure statement is required under Subchapter V. Section 1125 of Chapter 11, however, requires that a debtor provide a disclosure statement containing adequate information about the debtor’s business that would permit a hypothetical investor to make an informed decision about a plan.
• Administrative expense claims can be paid over the term of a plan with Subchapter V. Administrative expense claims under Chapter 11, however, must be paid on the effective date.

Reasons to Think Twice About Chapter V

Subchapter V plans have several attractive features, but also some notable setbacks which include:

• While discharge under Subchapter V provides relief to a debtor with business debts, to the degree that owners have any personal guarantees, they will remain liable for these amounts. Debtors also remain responsible for paying sales tax as well as other worker-related duties.
• The Small Business Relief Act made changes to how preferences are handled and requires that debtors exercise reasonable due diligence. If a preference claim is for less than $25,000, a lawsuit must be pursued in the federal district where the debtor resides.
• Debtors who pursue relief under Subchapter V are not always able to receive benefits under the Paycheck Protection Program. Courts have ruled differently on this issue. While some courts have issued temporary restraining orders under the Small Business Administration about acting on a Paycheck Protection Program loan application without first reviewing the debtor’s bankruptcy status, other courts have prohibited awarding the loans to debtors.
• While tenants remain liable for rent during the period that they pursue debt relief, the moratorium under Subchapter V, however, provides limited relief to tenants who are not able to make their rent payments.

Pursuing Chapter 7 Bankruptcy

Rather than pursue Subchapter V or Chapter 11, debtors also have the option of liquidating assets under Chapter 7. The liquidated assets are then used to pay as much of the debtor’s creditors as possible. Some of the critical issues to appreciate about Chapter 7 bankruptcy include:

• A trustee will be appointed to take control of a company’s assets. This means that no one at the company will retain decision-making abilities concerning the company’s assets. While the trustee will not operate the business, the trustee will perform the task of liquidating assets.
• Filing for Chapter 7 bankruptcy results in an automatic stay, which will prevent any creditors from foreclosing on the company’s assets as well as pursuing legal action.

Contact a Knowledgeable California Bankruptcy Lawyer

Bankruptcy is a complex process, but a skilled attorney can help to navigate the process. Contact attorney Melanie Tavare to schedule a free case evaluation.