In this age of COVID-19, the Small Business Reorganization Act (“SBRA”) is a game changer: Introducing Subchapter V. Help is here for our small and midsize businesses.
Effective mid-February 2020, prior to the COVID-19 crisis, small businesses with debt of $2,725,625 could take advantage of subchapter V of Chapter 11 of the Bankruptcy Code. In response to COVID-19, Congress expanded the debt ceiling to $7,500,000 (effective until March 27, 2021).
Until now, because of prohibitive administrative costs, it was impossible for many debtors to take advantage of the bankruptcy reorganization process. Subchapter V has changed that.
Take our hypothetical New Hampshire business with $1 million in unsecured debt, secured debt of $1,500,000, assets of $1,500,000, now confronting a lawsuit with a contingent liability of unknown proportions. The business has run out of cash, and considers the salutary effect of a Chapter 11 filing. It is, however, stopped in its tracks because of the hefty administrative costs including legal fees, filing fee, and quarterly fees.
Whether we call Subchapter V a “mini 11” or call it a “hybrid Chapter 13,” in some respects, it is both.
Subchapter V (“Sub V”) acts as a “mini Chapter 11” but is less expensive and more streamlined. The debtor retains more control, and more entities are eligible to file. A Chapter 13 debtor seeking reorganization must be an individual, but now, Sub V permits the small business debtor to be an individual or a business entity.
A Sub V debtor may have no more than $7,500,000 in total debt, with at least 50% of such debt arising from business activities. The aggregate debt includes non-contingent liquidated secured and unsecured liabilities, but excludes debts owed to affiliates or insiders. Also, the SBRA left intact the prohibition against a “single asset real estate” case but clarified that a Sub V debtor is eligible where its primary activity is owning or operating multiple real properties.
Subchapter V is similar to a Chapter 13 in that the plan period of time is 3 to 5 years, and makes clear that a mortgage debt secured by the debtor’s home may be modified if it was not used primarily to acquire the residence and that the money from the loan was used primarily in the business of the debtor. Query – what happens if the debtor borrows funds to purchase real estate with an upstairs apartment where he lives and a downstairs unit where he operates a business? Can that mortgage be modified – or can a portion of it be modified? Look for judicial decision in this area.
As opposed to traditional Chapter 11, the Sub V debtor has exclusivity to file its own plan of re-organization, and must do so within 90 days of the filing date. The court is required to conduct a status conference within 60 days, but may extend either of these deadlines upon a finding that such extension is “attributable to circumstances for which the debtor should not justly be held accountable.” Expect that debtors will seek not to be held “justly accountable” because of COVID-19, and won’t all debtors seek the same thing?
In a departure from traditional Chapter 11, within 14 days before the status conference, the debtor must file a report detailing its progress and efforts toward finalizing a consensual plan. Expect debtors’ counsel and creditors to communicate actively in the ongoing Sub V process. Also, instead of the traditional Chapter 11 debtor in possession administration, where the debtor in possession remains in control and management of its affairs (until it shows itself unable or unfit to do so), the Sub V proceeding will appoint a trustee. The trustee’s responsibilities include assistance in developing a plan, reporting fraud or misconduct, and monitoring plan distributions. In short, the Sub V trustee’s purpose is to assist the debtor in resolving creditor issues and keeping the debtor on track toward its plan of reorganization.
The United States Trustee for the District of New Hampshire reports that acts now as the Sub V trustee.
Additional financial benefits of Sub V include not requiring the appointment of a committee of creditors unless ordered by the court for cause, and not requiring payment of quarterly U.S. trustee fees.
Two separate, creditor-friendly amendments will deter bankruptcy estates from their former ability to recover preferential transfers. First, before commencing preference litigation, the plaintiff must conduct “reasonable due diligence in the circumstances of the case and also must predict and evaluate the defendant’s potential affirmative defenses.” Second, plaintiff may not automatically file preference litigation in the court where the Bankruptcy is pending. With the new legislation, the plaintiff must commence preference litigation in the defendant’s jurisdiction where claims are less than $25,000. Here is an opportunity for creditors to keep their preferential transfers more readily than prior to the amendment.
We may find debtors who are otherwise financially healthy suddenly confronted with the COVID world and being thrust into financial uncertainty and reversal. Usually, Chapter 11 is not entered into lightly. With these times, however, the Sub V proceeding could give debtors an opportunity to pause, catch a breath, and with the help of the Sub V trustee, confirm a plan to exit the COVID world of financial uncertainty. So too, bankruptcy avoidance is possible where creditors and debtors meet to discuss a consensual informal Chapter 11, making unnecessary an actual bankruptcy filing.