New Subchapter 5 Bankruptcy Proceeding Makes It Easier For Small Businesses to Reorganize While Continuing Operations

June 29, 2020 Published by

They have received little publicity, but recent changes to the U.S. Bankruptcy Code have made it easier for small businesses to restructure under Chapter 11 and discharge their debts while continuing their operations.

The first change was made by the Small Business Reorganization Act of 2019, which took effect on February 19, 2020, and added Subchapter 5 to Chapter 11 of the bankruptcy code. Subchapter 5 gives businesses with less than $2.75 million in debt, a bankruptcy option that is faster, less burdensome, and less expensive than reorganizing under Chapter 11.

The second change came through the federal Coronavirus Aid, Relief, and Economic Security (CARES) Act enacted on March 28, 2020. The Subchapter 5 provision of the CARES Act raises the amount of debt that may be discharged through Subchapter 5 bankruptcy to $7.5 million for one year. The debt increase was to accommodate the expected increase in small businesses bankruptcy filings the COVID-19 pandemic.

When a business files for bankruptcy using a traditional Chapter 11 proceeding, it often involves a long, expensive process of modifying or discharging its debts by negotiating a reorganization plan that provides for payments to creditors while the business continues operating. The reorganization plan must then be accepted by at least one class of impaired creditors before being approved Bankruptcy Court. Small businesses were often unable to afford the expense of a Chapter 11 proceeding and either continued operating without filing for bankruptcy or filled for a Chapter 7 liquidation instead.

Benefits of Filing for Subhcpater 5 Bankruptcy

  • Owners Continue Operating the Business. Equity holders will continue to own and operate the business as long as its unsecured creditors receive payments using the business’s disposable income under a reorganization plan that can run between three and five years.
  • 90 Days to File a Reorganization Plan. Within 90 days of filing for bankruptcy, the business must file a reorganization plan with the court. Also, unlike Chapter 11, only Subchapter 5 debtors are allowed to submit a plan.
  • Disclosure Statement not Required. Chapter 11 debtors are usually required to file a disclosure statement with the court that addresses topics like the history of the business, a liquidation analysis, and an analysis of the business’s ability to repay creditors under the plan. In a Subchapter 5 proceeding, there is no requirement that a disclosure statement be filed.
  • Creditors Need not Approve Plan. The court can confirm a reorganization plan without having received the approval of any class of creditors if the plan is found to be fair to each class of claims. Additionally, there is no requirement that a committee of creditors be appointed, like under Chapter 11.
  • Administrative Expenses Paid Over Length of the Plan. Under traditional Chapter 11 bankruptcy, claims for administrative expenses must be paid on the date the reorganization plan becomes effective. Subchapter 5 allows businesses to pay the expenses in installments over the term of the plan.
  • Special Subchapter 5 Trustee. While the owners keep operating the business while it is in Subchapter 5 bankruptcy, a trustee will be appointed to monitor its operations, evaluate its assets, assess its chances for success following the reorganization, and make recommendations related to the reorganization plan’s confirmation.

Who Qualifies for Subchapter 5?

To take advantage of Subchapter 5 bankruptcy proceedings, an organization must be pursuing business or commercial activities and cannot have aggregate noncontingent liquidated secured and unsecured debt in excess of $7.5 million ($2.75 million after March 2021). Its business activities may include those of an affiliate. The debt amount cannot include debts owed to insiders or affiliates. Additionally, at least 50% of the business’s debt must stem from business or commercial activities. Finally, the debtor business’s primary activity cannot be the ownership and operation of a single real estate asset.

Creditors Still Offered Some Protections

While Subchapter 5 eliminates several Chapter 11 requirements, creditors still enjoy some of the protections offered under Chapter 11. These include:

  • The requirement that the business’s reorganization plan satisfies the “best interest test” by offering creditors at least as much as they would have received under a Chapter 7 liquidation.
  • Secured creditors still have the right to elect to have their claim remain secured by collateral, even after the payment terms have been changed.
  • Secured creditors may still ensure their collateral is protected and may be granted relief from the automatic stay.
  • Claims for goods delivered 20 days before the bankruptcy, or less, will still be treated as claims for administrative expenses.

These provisions may be used by the business’s creditors to secure treatment that is better than what was offered the creditor under the reorganization plan.

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This post was written by Sean Allaband

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