What Small Businesses Need to Know About Subchapter V Bankruptcy

What Small Businesses Need to Know About Subchapter V Bankruptcy

The Small Business Reorganization Act (SBRA), also referred to as Subchapter V is designed to serve as a streamlined bankruptcy process for small businesses...

The Small Business Reorganization Act (SBRA), also referred to as Subchapter V, took effect on February 19, 2020, and is designed to serve as a streamlined bankruptcy process for small businesses. The goal is to allow financially-distressed businesses to reorganize without the burden and expense of a Chapter 11 bankruptcy. In the two years since the law took effect, more than 3,000 Subchapter V cases have been filed, according to the American Bankruptcy Institute.

Subchapter V vs Chapter 11

A Chapter 11 bankruptcy allows businesses with significant debt the opportunity to reorganize and remain operational. However, small to medium-sized entities often avoid Chapter 11 bankruptcies, opting to use assignments for benefit of creditors instead, due to the costs inherent in the proceedings. The SBRA, also referred to as Subchapter V, is designed to make a similar yet more cost-effective process available to small businesses.

Under the SBRA, debtors are not subject to the more costly requirements in Chapter 11.  A committee of creditors will not be appointed unless ordered by the court for cause. The debtor will generally not be required to prepare a disclosure statement, and more important, only the debtor can file a plan of reorganization. These changes will prevent contested hearings that increase costs.

Chapter 11 bankruptcy cases are also costly because they take so long. To fast-track small business cases, the SBRA provides that an initial status conference be held within 60 days of filing the petition. The debtor must file a chapter 11 plan within 90 days from its filing of a bankruptcy petition. Much like in a Chapter 13 case, a standing trustee is appointed to oversee each case. The primary role of the  principal role is to “facilitate the development of a consensual plan of reorganization.” 

The SBRA also relaxes the requirements to confirm a plan. It eliminates the “absolute priority” rule, which requires that a Chapter 11 Plan be approved by all classes of creditors in order for business owners to retain their ownership interest.

Under the SBRA, equity owners can retain their ownership so long as the plan does not “discriminate unfairly” and is “fair and equitable.” It is also easier for the debtor to confirm a plan over creditors’ objections. Essentially, a plan will be confirmed so long as it provides that all of the debtor’s projected disposable income for three to five years will be used to make plan payments. Disposable income is defined as income that is available after the payment of ongoing business expenses. 

SBRA Debt Threshold

While Subchapter V has a number of significant advantages, it is important to recognize that eligibility is limited to debtors having liquidated debt of less than $3,024,725.00. As originally enacted, the SBRA defined a small business debtor as a person (1) engaged in a commercial business activity, excluding the ownership of single asset real estate as defined in 11 U.S.C. §101 (51B), (2) non-contingent liquidated secured and unsecured debt as of the date of the filing of the petition not more than $2,725,625.00 (excluding debts owing to affiliates and insiders), and (3) the majority of such debts must have arisen from the commercial or business activities of the debtor.

In March 2020, Subchapter V’s debt limit requirement was temporarily increased to $7.5 million as part of the CARES Act. While the provision was initially scheduled to sunset on March 27, 2021, the deadline was extended for another year under the Covid-19 Bankruptcy Relief Extension Act. While legislation was introduced to further extend the threshold, it has not yet been enacted. As of April 1, 2022, debtors eligible for Subchapter V must now have debts amounting to only $3,024,725 or less, which reflects an adjustment for inflation.

Bankruptcy Threshold Adjustment and Technical Corrections Act

The Bankruptcy Threshold Adjustment and Technical Corrections Act, which would restore the higher debt limit for Subchapter V, passed the Senate and is currently under consideration in the House. While the bill enjoys bipartisan support, its likelihood of passage will likely decrease if the House does not act quickly, as members of Congress will soon shift their focus to the upcoming midterm elections.

Key Takeaway for Small Businesses

The SBRA established a valuable tool for small businesses in financial distress. To determine whether a Subchapter V bankruptcy may be in your business’s best interests, we encourage you to contact David Edelberg at 201-896-4100 to review potential options.