The CARES ACT, Small Business Bankruptcy, and Chapter 11 Subchapter V
Subchapter V of the Bankruptcy Code (the “Small Business Reorganization Act of 2019”) was passed to make small business bankruptcies faster and less expensive.
On March 27, 2020, Congress passed the Coronavirus Aid, Relief and Economic Security Act (CARES Act) to aid U.S. businesses following the economic impact of COVID-19. The CARES Act amends Subchapter V, and is effective for cases commenced within the twelve months following March 27, 2020.
UPDATE (3/29/2021): President Biden has signed the “COVID-19 Bankruptcy Relief Extension Act of 2021” which will extend the temporary bankruptcy relief provisions granted by the CARES Act for another year (until March 2022). The CARES Act’s amendments to Subchapter V have proven to be a powerful tool for small businesses, with 1400 cases filed within the past year, a third of which would not have qualified without the increased limits.
Temporary Increase in Debt Limit for Small Business Debtors
The CARES Act revised the definition of “small business debtor” to include a person engaged in commercial or business activities that has aggregate, non-contingent, liquidated, secured, and unsecured debts of not more than $7,500,000. This is an increase from the previous amount of $2,725,625. As a result, businesses with debts of less than $7.5 million are eligible to file a Chapter 11 case as a Small Business Debtor, and also, additionally may elect to proceed under Subchapter V provided that 50% or more of those debts arose from business or commercial activities. The following are benefits available to small business debtors filing under Subchapter V. It is important to note that there are benefits afforded to a Small Business Debtor even without a Subchapter V election, and that Subchapter V requires filing parties to move very quickly. Thus, careful consideration must be given into exactly how a business should proceed.
Debtor as Exclusive Plan Proponent
A small business debtor is the only party which may propose a plan of reorganization.
A Plan can be Confirmed Without the Vote of Any Impaired Consenting
A plan can be confirmed without the acceptance of an impaired voting class, provided that the plan does not discriminate unfairly and is deemed “fair and equitable” as to each class of claims. “Fair and equitable” essentially means that the business commit all its projected disposable income to payments under the plan.
- The reorganization plan must be filed within 90 days of the petition date and must include a brief history of the debtor’s business operations, a liquidation analysis, and projections relating to the debtor’s ability to perform under the plan. In order to obtain an extension of time to file the plan the debtor must show “the need for the extension is attributable to circumstances for which the debtor should not justly be held accountable.” 11 U.S.C. § 1189(b).
- The requirement of filing a disclosure statement in conjunction with the plan is waived.
- No later than 60 days after the bankruptcy filing, the Bankruptcy Court will hold a status conference to further the expeditious and economical resolution of a case under Subchapter V.
- Unlike a regular Chapter 11 plan, Subchapter V does not require that administrative claims to be paid in full on the effective date of the plan and can instead be spread over a period of time.
Exemption from Absolute Priority Rule
Small business debtors are exempt from complying with the absolute priority rule, which mandates that general unsecured creditors be paid in full before equity owners of the debtors are entitled to retain their interests.
Exemption from US Trustee Fees & the Subchapter V “Standing Trustee”
Small business debtors are exempt under Subchapter V from paying the quarterly United States Trustee fees (the U.S. Trustee still receives compensation from each plan payment made). However, Subchapter V created a new type of trustee referred to as a Standing Trustee. The appointed Subchapter V Standing Trustee is paid hourly for their work. As such, one consideration in determining whether or not to proceed under Subchapter V is to compare estimated Subchapter V Standing Trustee fees with estimated U.S. Trustee fees (which are based on a percentage of quarterly disbursements).
The Standing Trustee is different than a traditional Chapter 11 trustee, and serves a somewhat different role. For example, the Standing Trustee has a more active role in developing a plan of reorganization with the debtor. The Standing Trustee also performs traditional tasks such as collecting plan payments and disbursing payments pursuant to a confirmed plan. The trustee serves in a mostly supervisory role and is generally not involved in any operational aspects of the business.
Employment of Estate Professionals
Professional persons may be employed by a small business debtor even if they hold a pre-petition claim against the bankruptcy estate, as long as the professional is owed less than $10,000 prior to the date of the bankruptcy filing.
If a business owner pledged their residence as collateral to support their business, Subchapter V makes it harder for creditors to take away that residence. The small business debtor can modify a mortgage on a principal residence as long as the mortgage loan was not used primarily to acquire the residence.
The CARES Act and Small Business Reorganization Act of 2019 have significantly increased the debt threshold to qualify as a small business debtor, as well as added a number of business-friendly measures, making it a powerful option for small businesses to take advantage of in light of the current crisis.
Authors: Kristina Iliopoulos and Brandon Anand