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Good News / Bad News for Small Business Bankruptcies

If you are the owner of a small to medium-sized, financially-distressed business, the good news is that Congress has expanded eligibility to file a lower-cost, fast-track Chapter 11 reorganization.  Found at Subchapter V of Chapter 11 of the Bankruptcy Code, this streamlined process is now available for any business that has less than $7.5 million in debt. 

Expanded eligibility to file a Subchapter V is bad news for creditors.  Subchapter V makes it considerably easier for a business to confirm a plan of reorganization over the objections of creditors and eliminates many creditor protections that exist in the traditional Chapter 11 case. 

The Small Business Reorganization Act created Subchapter V.  The Act became effective in February of 2020.  Congress intended to benefit small, “mom and pop” businesses.  The debt cap was $2.75 million. 

Then COVID struck and, ironically, many small businesses found themselves too poor to file bankruptcy.  They had too much debt to qualify for reorganization under Subchapter V and could not afford a traditional Chapter 11.

In response, under the CARES Act, Congress increased the debt cap to its current level of $7.5 million.  Both unsecured and secured debt count toward the cap.  Disputed or contingent or unliquidated debt does not. 

Advantages for businesses that file for reorganization under Subchapter V of Chapter 11 include:

  • No creditors committee. Unsecured creditors lack group representation and the debtor is not saddled with paying the fees of the committee’s attorney. 
  • Creditors have no right to file their own plan. Usually, a creditor plan provides for liquidating the assets of the debtor and distributing the proceeds to the creditors. 
  • Subchapter V does away with the requirement that, to obtain court approval for a plan of reorganization over the objection of creditors, the owner of the debtor must infuse new capital into the business. 
  • Subchapter V eliminates the requirement that the debtor pay priority claims in full, up front. Instead, the debtor may spread out payment of these claims over the three to five-year term of the plan.

One important creditor protection that Subchapter V preserves is the so-called “best-interest-of-creditors” test.  Under this test, a plan will not be approved unless the debtor can prove to the court that creditors will be paid at least as much over the term of the plan as they would receive if the assets of the debtor were liquidated.

Whether Subchapter V is a boon or a bane is a matter of perspective.  The debate can rapidly become political.  But one thing is certain - whether you are a debtor or a creditor, good legal advice is essential.  If you have any questions about a Subchapter V reorganization, or a conventional Chapter 11, you are welcome to give me a call.

 

About the Author

David Orenstein is former Co-Chair of the Debtor/Creditor Remedies section of the Hennepin County Bar Association. He has been named a “Super Lawyer” by Minnesota Law & Politics ​magazine and has achieved an “AV Preeminent” Martindale Hubbell® rated attorney: the highest level of professional excellence, as determined by his peers.

Contact David by email or phone at 612.305.1494.

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