Subchapter V: The Streamlined Bankruptcy Reorganization for Small Businesses

The Small Business Reorganization Act of 2019 (“SBRA”)[1] became effective February 19, 2020, and its goal was to streamline the Chapter 11 process and reduce the costs for those debtors that qualify. A Chapter 11 filing provides financially distressed small businesses with the opportunity to reorganize their financial affairs while continuing their business operations. The aim is to emerge financially stronger with less debt load. The enactment of SBRA was well-timed for distressed businesses hit hard by the COVID pandemic and the resulting shelter-in-place orders. Even now, small businesses are still facing cash flow issues due to the lasting financial impacts of the pandemic and the recent economic downturn. Instead of closing their business, owners can utilize SBRA and opt to restructure their debts over time.

Traditional Chapter 11

As a little background, a traditional Chapter 11 is still available for individual sole proprietors and corporations. A bankruptcy debtor can make the election whether to go the traditional route or elect Subchapter V on the initial filed petition. Traditional Chapter 11 has various requirements and timelines such as the possible need to obtain immediate orders upon filing to continue operations and to allow the use of a bank’s cash collateral. The Chapter 11 debtor must then make decisions on assuming or rejecting leases, file monthly operating reports, and be transparent about its finances to both the court and creditors. After operating for several months and hopefully stabilizing cash flow, the Chapter 11 debtor then files a disclosure statement and a plan of reorganization. The disclosure statement is sort of like a prospectus, which details the various classes of creditors and how they will get paid along with substantial analysis of the company’s ability to fund its plan of reorganization and make payments over time. As part of the process, the company must solicit votes from creditors including getting one impaired class to vote in favor of the plan. The final hurdle is to get the bankruptcy court to confirm the chapter 11 plan after a hearing.

The problem with the traditional Chapter 11 process is that the entire process can last well over a year and cost thousands of dollars each month in administrative costs. Objecting creditors and other interested parties can easily complicate the entire process. The delays, risks and costs are sometimes too much for small businesses to handle.

Subchapter V

A “small business debtor” is currently defined as one that has aggregate, noncontingent, liquidated, secured and unsecured debts of no more than $7,500,000.[2] To be an eligible small business debtor, SBRA requires at least 50% of the small business debtor’s debts to have arisen from commercial or business activities.

SBRA has a streamlined plan confirmation process that is designed to promote consensual resolution of creditor claims and conserve administrative costs. Here are some of the new features of SBRA that aim to reduce the time and costs to be in Chapter 11:

  • A mandatory status conference before the bankruptcy judge that will occur no later than 60 days after the case is filed. Debtor must file a pre-conference status report at least 14 days before status conference. The report will detail the “efforts the debtor has undertaken and will undertake to attain a consensual plan of reorganization.”[3]
  • A standing Subchapter V trustee is appointed.[4] The trustee serves until substantial consummation of the plan, which is usually one month after plan confirmation if confirmation is consensual. Consensual means that all of the eligible classes of creditors voted in favor of the plan. If confirmation is non-consensual then the trustee will serve until completion of payments under the confirmed plan. In the non-consensual scenario, the trustee will make all payments to creditors under the confirmed plan. During the case the trustee will appear at the mandatory status conference, monitor the progress of the case, facilitate the development of a consensual plan of reorganization, and perform general duties like a Chapter 13 trustee.
  • Only a debtor will be able to file a plan and the plan must be filed no more than 90 days after the entry of order for relief.[5] Extensions of time are hard to obtain. The debtor no longer needs to file a separate disclosure statement.
  • No consenting impaired class is needed for confirmation so long as certain requirements are met and the plan does not discriminate unfairly and is fair and equitable as to each impaired, non-consenting class. A plan is “fair and equitable” as long as it meets certain requirements, including providing for application of all of the debtor’s projected disposable income for at least three years beginning on the date the first plan payment is due and the debtor will be able to make all plan payments.[6]

From a debtor attorney’s perspective, SBRA has set up an accelerated system that can facilitate a relatively quick Chapter 11 case. The key is preparation going into the filing and then speed once the case is filed. The longer the case festers under an unconfirmed plan, the more risk that the business will not make it out of Chapter 11. Having a knowledgeable and experienced Subchapter V trustee and getting that trustee on board with the proposed plan can be of immense benefit to the success of the case. The trustee is there to facilitate confirmation of the plan. Both creditors and judges will want to hear what the trustee has to say on certain issues as the case progresses and especially on confirmation of the plan.

Another benefit is that the Northern District of California bankruptcy courts allow for the use of a form Subchapter V plan. The form plan eliminates the time and cost of having to custom draft a disclosure statement and then the accompanying plan. SBRA has also eliminated the need to get consenting impaired class which by itself used to be the death knell for a lot of small businesses having only a few problematic large creditors.

Overall, SBRA can be a blessing for certain situations. Fundamentally, the business must have enough cash flow to sustain its operations and meet its obligations under the Chapter 11 plan. Proper recordkeeping and procedures must be in place. The business owner also must have the time and energy to take on the filing. With the right planning, SBRA is a great option that small businesses should look into to get back on track.

[1] 11 U.S.C. Section 1181 et seq.
[2] 11 U.S.C. Section 1182(1(B)
[3] 11 U.S.C. Section 1188(c)
[4] 11 U.S.C. Section 1183
[5]11 U.S.C. Section 1189
[6] 11 U.S.C. Section 1191(c)