Litigation and Restructuring Lawyers

Small Biz Hurt by Pandemic Face Looming Deadline on Subchapter V of Bankruptcy Code

We are living in uncertain times. The global pandemic has disrupted nearly every aspect of our lives. And these disruptions have come at a cost, particularly for small businesses and consumers. According to a recent survey conducted by NPR, the Robert Wood Johnson Foundation and the Harvard TH Chan School of Public Health, nearly 40% of U.S. households have faced serious financial problems, including struggling to afford medical care and food.

Exacerbating these issues for small businesses are disruptions to the global supply chain. Shortages of components and raw materials, together with rising energy costs, are forcing manufacturers into bidding wars to get space on shipping vessels, pushing shipping costs to record levels, which in turn are causing spikes in prices for goods, or simply cancellation of shipments altogether because of the rising costs, according to a recent article in Bloomberg.

Rising costs for crude oil and certain food staples are, among other factors, causing institutions like Goldman Sachs to cut its U.S. economic growth projections for both the remainder of 2021 and into 2022.

But American small business has a powerful tool at its disposal to help protect it from this economic uncertainty. In a rare bipartisan move, Congress passed the Small Business Reorganization Act, or SBRA, in 2019, creating Subchapter V of Chapter 11 of the U.S. Bankruptcy Code, 11 U.S.C. Sections 1181-95. That additional protection will expire in the spring unless Congress acts. Soon.

Subchapter V was intended to streamline the Chapter 11 bankruptcy process for small business debtors, providing an alternative to the more time-consuming and costly reorganization of a traditional Chapter 11 case. It does so by employing a shorter timeline for plan filing and confirmation, imposing fewer burdensome requirements, like the payment of quarterly U.S. Trustee fees, and creates an easier and smoother path to confirmation of a Chapter 11 plan. See, generally, In re Ellingsworth Residential Community Association, 619 B.R. 519 (Bankr.M.D.Fla 2020). While the SBRA was likely needed anyway to address significant deficiencies and gaps in the bankruptcy code for small business debtors, it fortuitously went into effect in February 2019, right at the beginning of the economic shutdown.

At that time, businesses with $2,725,625 million in debt qualified for filing under Subchapter V of the bankruptcy code. However, with the economy in the grip of a crippling pandemic that ground the U.S. economy to a virtual halt, Congress enacted the Coronavirus Aid, Relief and Economic Security Act of 2020, commonly known as the CARES Act. Among other things, the CARES Act temporarily raised Subchapter V’s debt limits to $7.5 million for one year. For an interesting twist on how creative counsel can squeeze companies with potentially much more than $7.5 million in debt under the Subchapter V debt threshold, see In re Parking Management, 620 B.R. 544 (Bankr.D.Md 2020).

How does Subchapter V make it easier for small business to restructure? Subchapter V allows a small business to spread its debt over three to five years, during which time the debtor must devote its projected disposable income to paying creditors. In many cases, this model benefits debtors by allowing them to spread payments over time. It also benefits their creditors by allowing them a meaningful recovery from debtors who may not have much money on hand but have a realistic expectation of income over time. In a traditional Chapter 11 case, the fees of attorneys and other professionals must be paid at plan confirmation, but under Subchapter V, they may be paid over the life of the plan. Debts are not discharged until the debtor completes all of its plan payments.

Delays and the slower pace of regular Chapter 11 tends to drive up restructuring costs in regular Chapter 11. Not so in Subchapter V, which moves very quickly, requiring the debtor to file its plan within 90 days after entering bankruptcy.

Like regular Chapter 11, the debtor retains control of its assets and operations. Creditors’ committees—a staple in traditional Chapter 11 cases—are formed very rarely, and only for compelling cause. In regular Chapter 11, a bankruptcy trustee may be appointed to address fraud or gross mismanagement. When this occurs, that trustee usually seizes control of the debtor’s operations, ending any restructuring efforts.

Under Subchapter V, however, a trustee is automatically appointed, but the role of the Subchapter V trustee is very different than in regular Chapter 11. Their primary function is to facilitate a consensual plan among the debtor and its creditors, almost like a mediator would facilitate a settlement in litigation. See In re Penland Heating and Air Conditioning, 2020 WL 3124585 (Bankr.E.D.N.C. 2020). The involvement of this impartial, third-party increases the likelihood of a fair and equitable resolution among the debtor and its creditors, and may be particularly useful for a small business whose creditors are unwilling to make reasonable concessions in the face of an impending financial crisis for the debtor.

Subchapter V also cushions small business owners from certain adverse personal consequences that might otherwise disincentivize a Chapter 11 filing. For example, if the debtor’s principal used his primary residence as security for a loan to fund the small business, the debtor’s plan may modify that loan, something found nowhere else in the bankruptcy code. Additionally, Subchapter V eliminates the so-called “new value rule,” which normally requires the business owner to infuse new cash or other consideration into the case if they want to retain their equity interest in the business.

As the pandemic has lingered, Congress acted again, extending the $7.5 million debt limit in March 2021, but only days before those debt limits were set to expire. We are once again looking at a March 27, 2022, deadline on the increased debt limits for eligibility under Subchapter V. If Congress fails to act, then the debt limit eligibility will return to $2,725,625. And that could spell doom for small businesses needing bankruptcy protection.

According to a report from the U.S. Small Business Administration, small businesses create two-thirds of net new jobs and drive U.S. innovation and competitiveness. That SBA report indicates that small businesses account for 44% of U.S. economic activity, and small businesses are at the forefront of driving innovation, jobs and economic growth. If you are reading this, chances are you are either employed by a small business or a small business owner. Ensuring broader access to the significant protections provided by Subchapter V will be a critical piece in guiding our nation back to economic stability once the pandemic subsides for good. Restricting access to Subchapter V to businesses with only $2,725,625 in debt will deprive a large segment of U.S. small businesses of the ability to cost-effectively restructure their obligations in these uncertain times.

Reprinted with permission from the Oct. 28, issue of the Daily Business Review© 2021 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.

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