The Small Business Reorganization Act of 2019 (the “SBRA”), enacts a new Subchapter V (Sub V) of Chapter 11 of the Bankruptcy Code. The SBRA seeks to address problems encountered by small business debtors in reorganizing under the provisions of the United States Bankruptcy Code.  The existence of two sets of provisions in Chapter 11 for small business debtors requires terminology to distinguish them.  It has been proposed to call cases under the existing provisions “small business cases” and to call cases of electing debtors “cases under subchapter V of chapter 11.”  The Bankruptcy Bar will inevitably adopt its own slang to distinguish the different types of cases that are now possible under chapter 11:  a non-small business case; a subchapter V small business case for a debtor who elects it; and a non-subchapter V small business case for one who does not.  For the purposes of this article we will simply refer to this new chapter as “Sub V.”

A Sub V case could be described as either parsed down Chapter 11 or, as one trustee from the US Bankruptcy Court from the Eastern District of Pennsylvania has described, a stepped- up Chapter 13.  In reality, Sub V resembles Chapter 12 ( the bankruptcy chapter for Family Farmers and Fisherman).  It provides for a trustee while leaving the debtor in possession of assets and control of the business. The trustee has oversight and monitoring duties and the right to be heard on certain matters.  In some cases, the trustee may make disbursements to creditors. However, Sub V differs from Chapter 12. Whereas Chapter 12 confirmation standards are similar to those in Chapter 13, Sub V confirmation requirements incorporate most of the requirements of Chapter 11.  Unlike Chapter 12 or Chapter 13, Sub V does not provide for a codebtor stay.  This co-debtor stay only applies to an “individual” (i.e. a human being) and not a business entity.  This may be a disadvantage of filing under Sub V if, like many small businesses, there is often a cross-collateralization of business and personal debt obligations.  Sub V does not repeal existing provisions that govern small business debtors in chapter 11 cases, and those provisions continue to apply to small business debtors who do not elect to proceed under Sub V.  

Sub V aims to make small business bankruptcy proceedings more expeditious and less costly. Whether this is true or not, only time will tell. It also may reduce a creditor’s leverage and require their greater vigilance in a small business case. The key components of Sub V are the following:

Small Business Reorganization Act of 2019 Eligibility

To be eligible under Sub V, a debtor (whether an entity or an individual) must be:

• engaged in business and have total debt, secured and unsecured, not exceeding $2,725,625 and does not include “contingent” or “unliquidated” debt.

(*Update: The recently enacted CARES Act, designed to aid businesses suffering the effects of the coronavirus, increases the debt limit to $7,500,000 for one year, which will enable a far greater number of companies to take advantage of the SBRA.)

• One-half or more of the debt must have arisen from business, as opposed to personal, activities.
• Single asset real estate debtors are ineligible under Sub V.

Appointment of a Trustee

While the debtor remains in possession of its property as a debtor-in-possession, the United States Trustee, is required to appoint a trustee to oversee the case (the Sub-V Trustee). The Sub-V trustee’s powers will be far less broad than those of a Chapter 7 trustee or a Chapter 11 trustee. The Sub-V trustee will have neither “possession” of a debtor’s assets nor the ability to sell those assets. Rather, the trustee’s duties will include facilitating the development of a consensual reorganization plan, appearing at major hearings in the case, and ensuring that a debtor commences making timely payments under a plan.

Initial Documentation Required at the Commencement of Sub V

Much like any Chapter 11 case, Sub V cases still require the customary “First Day Motions.”  These may include Motions to Use Cash Collateral, Retain Professionals, etc.  They also require a Sub V debtor to file at the commencement of the case, or very soon thereafter, the following documents:

• Initial Monthly Operating Report
• Cash Flow Projections For The 12 Month Period
• Schedule of Retainers Paid To Professionals
• Small Business Monthly Operating Report
• Schedule of Professional Fees And Expenses Paid
• Post-Confirmation Quarterly Summary Report
• Post-Confirmation Balance Sheet

Within several days after commencement of the Sub V case, debtors should expect to appear and be examined by the U.S. Bankruptcy Trustee for the “Initial Debtor Interview (IDI).” Prior to the IDI, debtors will have to submit the list of documents mentioned.  For this reason, serious thought and plan should be undertaken before filing a Sub V and unlike a Chapter 7 or 13, emergency filings should be highly discouraged.  If you are thinking of filing for a small business bankruptcy do not file on the eve of a court date, repossession or sheriff sale.  Plan accordingly and meet with qualified bankruptcy counsel far in advance.

No Creditors’ Committee

A big departure from the standard Chapter 11 case is dispensing with the requirement of having a creditor’s committee.  In a Sub-V case, unless otherwise ordered by the court, no creditors committee is formed. As a debtor is generally obligated to pay committee expenses, the appointment of a committee and the resulting expense of the retention of committee professionals often hinders the debtor’s ability to reorganize. This clearly will make the Sub-V case far less expensive that a standard Chapter 11 case.

Filing a Plan

Sub V provides that only a debtor may file a plan of reorganization. This differs from practice in other Chapter 11 cases where, after a debtor’s time to file a plan has expired, creditors or other parties in interest may file a plan. Sub V requires that a plan be filed within 90 days after the entry of an order for relief.

No Disclosure Statement Required

Sub V eliminates the requirement that a disclosure statement be filed, thereby reducing costs to the debtor and streamlining the plan confirmation process. However, the debtor must include in the plan certain information customarily included in a disclosure statement, such as:

• a short history of the debtor
•  a liquidation analysis
•  financial projections reflecting the ability of the debtor to make the payments required by the plan

Plan Term

Consistent with Chapter 13 cases, a reorganization plan will customarily be three years in length but may be as long as five.  (Update:  Due the COVID-19 pandemic, the CARES Act has expanded the plan term in Chapter 13 to 84 months for debtors that have been impacted by COVID-19.  No specific guidance has emerged whether this also extends to Sub V.)

No Impaired Class Required

Under existing Chapter 11 bankruptcy proceedings, at least one impaired class must accept a plan to render the plan confirmable. Under Sub V, a plan can be confirmed without the vote of an impaired accepting class, providing that the plan does not discriminate unfairly and is deemed “fair and equitable” as to each class of claims. To meet the “fair and equitable” requirement under the Bankruptcy Code, the Act requires that all of the debtor’s projected disposable income during the length of the plan be applied to plan payments.

Sub V defines “disposable income” as income received by a debtor and that is not reasonably necessary to: (1) maintain and support the debtor or a dependent; (2) satisfy domestic support obligations that first become payable after the bankruptcy case is filed; or (3) continue, preserve, or operate the business. This contrasts with other Chapter 11 proceedings, which do not require that all projected disposable income be applied to pay creditor claims.

Elimination of the Absolute Priority Rule

Sub V eliminates the Absolute Priority Rule, under which a debtor cannot retain an ownership interest in its assets unless all creditor claims are paid in full. However, courts have held that a debtor can retain an interest in its assets if it contributes “new value,” generally in the form of capital, to fund a plan. Under Sub V, no “new value” contributions are required as a condition of the debtor’s asset retention. This provision substantially benefits a debtor, who often must defend against assertions by a creditor objecting to plan confirmation on the basis that the proposed “new value” is inadequate.

Administrative Claims

Under Chapter 11, all administrative claims (which generally include claims that accrue post-petition and, in limited circumstances, reclamation claims arising from goods shipped to the debtor within 20 days of the bankruptcy filing) must be paid in full as a condition to confirmation. Sub V eliminates this requirement, and claims may be paid over a period of time. This provision may be of concern to creditors who do business with a debtor post-petition and expect to be paid, if not in the ordinary course of business, then upon plan confirmation, as is currently required in Chapter 11 cases.

Modification of Loans Secured by the Principal Residence

Under existing law, loans secured by a debtor’s principal residence may not be modified under a plan. Under Sub V, if the proceeds of the loan were used to finance a debtor’s business, the loan may be modified. The claim of a first position secured creditor who loaned money to a debtor, the proceeds of which were used primarily to acquire the debtor’s residence, may not be modified; it continues to have the same protections as in other Chapter 11 cases. Thus, creditors who extend mortgage loans to a debtor must scrutinize how the proceeds will be used, in order to avoid the possibility of an involuntary loan modification in a borrower’s bankruptcy case.

Discharge

If the court confirms a consensual Sub V plan, a debtor is entitled to a discharge upon confirmation. If the court confirms a nonconsensual plan, a debtor receives a discharge after completing all payments due within the first three years of the plan, unless otherwise ordered. If all such payments are made, the debtor would be relieved of liability except for future payments due under the plan. 

Sub V holds the promise of improving the likelihood of reorganization for a viable small business debtor by reducing the time, expense, and eliminating certain legal impediments to confirmation of a Chapter 11 plan. From a creditor perspective, lenders need to consider the provisions of Sub V in underwriting loans, given the possibility of loan modifications when loan proceeds are utilized for personal and business purposes. Creditors who sell goods or provide services to a debtor post-petition must be cognizant of the possibility that a debtor may propose an extended payout of their claims. 

Time will tell whether Sub V will result in increasing the percentage of small business debtors who successfully emerge from bankruptcy and in significantly reducing the expense of small business bankruptcy generally.

If you have any other questions or interested in discussing whether bankruptcy may be an option for you, please call (610) 255-7500 or email us at msiddons@siddonslaw.com. 

Legal Disclosure:  The information contained herein, is not intended to – and does not – create an attorney-client relationship. This article is not intended to provide legal advice, and readers should refrain from acting on information contained herein without seeking specific legal advice from individually qualified counsel.