Businesses and families continue to struggle with the crushing impact of inflation and higher interest rates. Bankruptcy statistics from across the country reflect that now more than ever, companies, especially small businesses, are seeking options for relief. Data collected by the U.S. bankruptcy courts shows a significant increase in commercial and personal bankruptcy filings in the first half of 2023 when compared to that same period in 2022. Per Epiq Global, overall commercial filings increased by 18%, while small business cases filed as Subchapter V elections within Chapter 11 increased by a surprising 55%.[1]

When advising a company facing financial distress, it is important to acknowledge both the eligibility qualifications and the potential benefits of various elections. This article explains some of the fundamental differences between small business cases filed under Subchapter V of Chapter 11, or “Sub V cases,” and traditional Chapter 11 cases. It then notes that Sub V cases are generally a superior option to traditional Chapter 11 cases for small businesses because they are faster and less expensive, providing more attainable relief for small or closely held businesses.

WHO CAN FILE?

To qualify as a debtor for a Sub V filing, a business must meet the eligibility requirements under 11 U.S.C. §1182(1). Primarily, it must engage in “commercial or business activities,” and at least 50% of its debt must arise from such activities.[2] The current debt limit is $7.5 million.[3] This assessment includes the aggregate noncontingent liquidated secured and unsecured debts of the potential debtor’s affiliates, excluding debts owed to insiders or affiliates.[4] Public companies (and affiliates of public companies) ^[5] and single asset real estate (SARE) entities are not eligible.[6] Eligibility is calculated as of the petition filing date.[7]

IS THERE A TRUSTEE?

Unlike traditional Chapter 11 cases, all Sub V cases employ a Sub V trustee.[8] Sub V trustees are unlike their Chapter 11 peers, which are sometimes appointed in the context of a traditional Chapter 11 case when a debtor-in-possession loses the right to manage its estate for cause. A Sub V trustee is tasked with facilitating the development of a consensual plan of reorganization and often aids the debtor in resolving creditor disputes.[9] The estate is responsible for paying the Sub V trustee a monthly fee.[10] However, these costs are offset by the fact that no quarterly U.S. trustee fees are charged in Sub V cases.[11]

WILL A CREDITORS’ COMMITTEE BE APPOINTED?

Traditional Chapter 11 cases generally have a committee appointed to represent the interests of general unsecured creditors who might otherwise lack the incentive or means to participate in a meaningful way.[12] However, in a Sub V case, though the court may order otherwise, there is no automatic right to the appointment of an unsecured creditor committee. As a result, the estate lacks the additional and often significant expense of paying professional fees for a committee, which include fees for attorneys and financial advisors.[13]

IS THERE A SPEEDY PROCESS?

There is no deadline to file a plan in a traditional Chapter 11 case (where the debtor is not a SARE). Sub V debtors, however, must file their plans within 90 days of the petition date.[14] Further, no disclosure statement is required, saving the debtor the cost of preparation and time required to seek approval of same,[15] and only the debtor may file a plan.[16] In a traditional Chapter 11 case, upon the expiration of the 120-day exclusivity period, a debtor must expend time and professional fees to seek extension of that protection or contend with creditors potentially filing competing plans. Also, while the Sub V debtor has 90 days to file a plan, there is no deadline under the Bankruptcy Code to confirm the plan, giving the Sub V debtor flexibility to work through issues with creditors without being pressured to proceed immediately to confirmation.

ARE THEY EASIER TO CONFIRM?

Sub V debtors can more easily confirm their plans because, unlike in traditional Chapter 11 cases, Sub V cases lack an absolute priority rule.[17] This rule prohibits junior creditors or equity holders from receiving distributions under a plan until all senior creditors have either been paid in full or have voted to accept the plan. Not having to comply with the absolute priority rule is especially helpful to closely held or family businesses that may struggle to pay all senior creditors their full claims, and retaining equity or ownership is of the utmost importance. For many family-owned businesses, this one crucial factor may determine whether reorganization is a realistic option. Furthermore, in Sub V cases, there is no requirement that any creditor vote to accept the plan.[18] In traditional Chapter 11 cases, there must be an accepting class if the debtor is attempting to “cram down” its plan over the objection of an impaired class of creditors.[19] A Sub V debtor need not spend the associated professional fees negotiating claim treatment with creditors to find an accepting class vote. To confirm a Sub V plan, the plan must satisfy a “fair and equitable” test,[20] distributing the debtor’s “disposable income” (income over and above the company’s necessary expenses)[21] to creditors over a three- to five-year period or distributing funds or property equal to that calculated amount of disposable income.[22]

ARE PREPETITION PROFESSIONAL FEES DISQUALIFYING?

Prepetition professional fees of up to $10,000 do not disqualify professionals from representing the debtor in a Sub V case.[23] In traditional Chapter 11 cases, debtors must ensure there are no outstanding fees owed to such professionals. Alternatively, the professionals must write off any prepetition balances to still be “disinterested” for case hiring purposes.[24] This is another way the Sub V law eases the path for small business debtors.

CAN DISCHARGE BE CHALLENGED?

Section 1192(2) provides that debts “of the kind specified in section 523(a) of this title” may not be discharged.[25] While Section 523 applies only to individual debtors, Section 1192(2) applies to both individuals and businesses. Because both individuals and businesses can file Chapter 11 under Sub V, this has caused some controversy. For example, while the 4th Circuit has held that Section 1192(2) makes Section 523(a) applicable to all Sub V debtors,^[26] various other district courts (and one bankruptcy appellate panel) have ruled that Section 523(a) does not apply to corporate Sub V debtors.^[27] This issue is currently on appeal at the 5th Circuit awaiting a ruling.[28] The majority of courts that have ruled on this issue have ruled that a corporate Sub V debtor’s discharge may not be challenged under Section 523(a).

CAN ADMINISTRATIVE CLAIMS BE PAID OVER TIME?

If a Sub V plan is confirmed under Section 1191(b) (a non-consensual plan), a debtor can pay administrative claims over time. This can be an extraordinary advantage over traditional Chapter 11 plans, where administrative claims, unless otherwise agreed to, must be paid in full on or before the effective date of the plan.[29]

ARE SUB V CASES MORE SUCCESSFUL?

Not only do Sub V cases provide strategic legal advantages for small businesses as described herein, they are also statistically more successful than traditional Chapter 11 cases.[30] When compared to traditional Chapter 11 cases over a two-year period, Sub V cases had double the percentage of confirmed plans, half the percentage of dismissals, as well as a shorter time to confirmation. Furthermore, of those Sub V cases with confirmed plans, nearly 70% were consensual.

For the foregoing reasons, the Sub V provisions of Chapter 11 have made reorganization a real option for many small businesses that previously had no choice but to close their doors. If you have a client in need of insolvency counseling, contact a restructuring professional to determine what options are most beneficial.

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ABOUT THE AUTHOR

Christina “Crissie” W. Stephenson is a shareholder in Crowe & Dunlevy’s Dallas office and serves as co-chair of the Bankruptcy & Creditor’s Rights Practice Group. She assists companies and individuals in restructuring matters including Chapter 11 reorganizations, bankruptcy-related litigation and appeals as well as out of court restructuring.

 

 

 

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ENDNOTES

[1] “Commercial Chapter 11 Filings Increased 68 Percent in the First Half of 2023,” Epiq (July 3, 2023), https://bit.ly/3u7xcxc; “U.S. Bankruptcy Courts—Business and Nonbusiness Cases Commenced, by Chapter of the Bankruptcy Code, During the 12-Month Period Ending June 30, 2023,” U.S. Courts, https://bit.ly/3R046co (last accessed Sept. 1, 2023).

[2] 11 U.S.C. §1182(1)(A).

[3] The Bankruptcy Threshold Adjustment and Technical Corrections Act reinstated the $7.5 million debt limit for small businesses wanting to file Chapter 11 under the Sub V election. This more generous limit will be sunset on June 21, 2024, without further action.

[4] 11 U.S.C. §1182(1)(A).

[5] 11 U.S.C. §1182(1)(B)(ii)-(iii).

[6] 11 U.S.C. §1182(1)(A).

[7] In re Free Speech Sys., LLC, 649 B.R. 729 (Bankr. S.D. Tex. 2023).

[8] 11 U.S.C. §1183.

[9] 11 U.S.C. §1183(b)(7).

[10] 11 U.S.C. §326(a), 330(a).

[11] 28 U.S.C. §1930(a)(6)(A).

[12] 11 U.S.C. §1102.

[13] 11 U.S.C. §1102(a)(3).

[14] 11 U.S.C. §1189(b).

[15] 11 U.S.C. §1190(a)(1).

[16] 11 U.S.C. §1189(a).

[17] 11 U.S.C. §1129(b)(2)(B)(ii).

[18] 11 U.S.C. §1191(b).

[19] 11 U.S.C. §1129(a)(10).

[20] 11 U.S.C. §1191(c).

[21] 11 U.S.C. §1191(d)(2).

[22] 11 U.S.C. §1191(c)(2).

[23] 11 U.S.C. §1195.

[24] 11 U.S.C. §327.

[25] 11 U.S.C. §1192(2).

[26] In re Cleary Packaging, LLC, 36 F.4th 509 (4th Cir. 2022).

[27] In re Hall, No. 3:22-AP-00062-BAJ, 2023 WL 2927164 (Bankr. M.D. Fla. Apr. 13, 2023); In re 2 Monkey Trading, LLC, No. 6:22-BK-04099-TPG, 2023 WL 3145124 (Bankr. M.D. Fla. Apr. 28, 2023); In re Lapeer Aviation, Inc., No. 21-31500-JDA, 2022 WL 1110072, at *2 (Bankr. E.D. Mich. Apr. 13, 2022); In re Rtech Fabrications, LLC, 635 B.R. 559, 564 (Bankr. D. Idaho 2021); In re Satellite Rests. Inc. Crabcake Factory USA, 626 B.R. 871, 876 (Bankr. D. Md. 2021); In re Off-Spec Sols., LLC, 651 B.R. 862, 864 (B.A.P. 9th Cir. 2023).

[28] In re GFS Indus., LLC, 647 B.R. 337 (Bankr. W.D. Tex. 2022), motion to certify appeal granted, No. 22-50403-CAG, 2023 WL 1768414 (Bankr. W.D. Tex. Feb. 3, 2023).

[29] 11 U.S.C. §1129(a)(9).

[30] Chapter 11 Subchapter V Statistical Summary, DOJ: U.S. Trustee Program, https://bit.ly/3MEeJi8 (last accessed Sept. 1, 2023).