A traditional Chapter 11 bankruptcy reorganization case can be time-consuming and expensive for small and medium sized businesses. These shortcomings often leave smaller distressed businesses without viable restructuring options. To address this, Congress enacted the Small Business Reorganization Act (“SBRA”), which took effect February 19, 2020. The SBRA added the new subchapter V to Chapter 11 of the Bankruptcy Code. Subchapter V provides small businesses with aggregate liabilities of up to $7,500,000 (through June 21, 2024) with an opportunity to resolve outstanding liabilities in what is meant to be a streamlined and cost-effective Chapter 11 bankruptcy proceeding.
As with all new undertakings, the subchapter V process requires some tweaking to ensure that the SBRA’s objectives are met, such as offering a more cost-effective reorganization process. Nonetheless, subchapter V eliminates some of the administrative burdens imposes by the Bankruptcy Code on debtors and removes the absolute priority rule as well. The absolute priority rule often requires existing equity owners to either relinquish ownership of the business or buy back their interest in the company. For small businesses, the requirement that they invest additional funds to buy back their ownership interest in the company could be incredibly burdensome.
Subchapter V has many notable distinctions from a traditional Chapter 11. In a subchapter V case, a subchapter V trustee is appointed to aid in the smooth administration of the case. If the court finds that a debtor has acted dishonestly, fraudulently, or incompetently, the court may order the subchapter V trustee to step into the shoes of the debtor’s management and run the business for the duration of the proceeding. Additionally, an official creditors’ committee is not appointed in subchapter V cases unless by court order. This spares the debtor on the costs associated with a creditors’ committee, such as additional fees for compensation of the committee’s professionals. Also, the debtor is not required to file a disclosure statement with its plan of reorganization, and the debtor has the exclusive right to file a plan, which is not the case in a traditional 11.
In order to file a petition under subchapter V of Chapter 11, a debtor must satisfy certain eligibility requirements. For example, a debtor must be engaged in commercial or business activities other than owning single-asset real estate. The debtor may not have more than $3,024,725 in noncontingent, liquidated, secured, and unsecured debts. Note that this debt cap was increased in March 2020 to $7,500,000 as previously mentioned until June 21, 2024. Of this debt cap, at least 50% must have arisen from commercial or business activities, excluding debts owed to affiliates or insiders.
Small business debtors may choose between a small business case or a subchapter V case. Small business debtors should consult with experienced counsel to consider the advantages and disadvantages of a subchapter V proceeding. The basic advantages of a subchapter V include retention of ownership interest at no cost, assistance from a subchapter V trustee, the exclusive right to file a plan, and ability to pay administrative expenses over time, including fees for post-petition goods, services, and professional fees. Some disadvantages of a subchapter V case include the appointment of a subchapter V trustee, which adds expenses, and a shortened timeframe to file a plan.
Contact KI Legal’s bankruptcy and restructuring attorneys to explore whether a subchapter V bankruptcy is the best option for your business. Call (212) 404-8644 or email email@example.com to schedule a free consultation today.
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