One of the obstacles for small businesses attempting to reorganize their financial affairs through bankruptcy is that Chapter 11, the corporate reorganization section of the Bankruptcy Code, can be cumbersome and unwieldy, not to mention expensive, for a smaller business. In 2019, Congress enacted “Subchapter V” (also known as “Subchapter 5”), to provide a streamlined and cost-effective means for small businesses to restructure their debts, offering a simpler and faster option compared to the traditional Chapter 11 process. Learn more about Subchapter V bankruptcy and how it impacts both small businesses and creditors amidst debt collection relief and reorganization.
Who qualifies for Subchapter V bankruptcy?
Only small business debtors can file a Subchapter V case. To qualify, a debtor must have no more than $3,024,725 in aggregate, noncontingent, liquidated secured and unsecured debts, and 50% of such debts must come from commercial or business activities.
How long does Subchapter V bankruptcy take?
In order to streamline the reorganization process, Subchapter V requires that the debtor file its bankruptcy plan within 90 days of the petition. This rather short deadline is intended to move cases along, but can be daunting for the business owner, if the keys to reorganizing are not readily apparent, or are somewhat complex.
At the same time, the short timeline is important to creditors to ensure that their interests are considered and protected under the proposed plan. Under Subchapter V, only the debtor may propose a plan. While this protects the interests of the business owner in retaining ownership, failure to propose a confirmable plan may lead to dismissal of the case or conversion to Chapter 7 (i.e., liquidation).
How does Subchapter V bankruptcy differ from Chapter 11 bankruptcy?
There are several ways in which Subchapter V cases differ from Chapter 11 cases, including:
- Trustee oversight, not committee decision-making – unlike traditional Chapter 11 cases, in a Subchapter V case, there is no creditors’ committee appointed, which serves to reduce costs. Instead, in Subchapter V, a Trustee is appointed in every case to ensure the debtor remains on track, overseeing the debtor’s progress, monitoring its financial condition, and assisting parties in negotiating a plan. The Trustee’s role is primarily that of oversight, not to operate or liquidate the debtor’s business.
- “Fair and equitable” plans without required votes or disclosure statements – debtors may propose plans under Subchapter V that are advantageous to equity holders as long as they meet “fair and equitable” standards (see below). Additionally, these reorganization plans do not require votes or the filing and approval of a disclosure statement to accompany the plan.
- No absolute priority rule – in typical Chapter 11 cases, the “absolute priority rule” ensures claims of a higher priority are paid in full before lower priority claims can receive any recovery, and that all creditors must be paid in full in order for equity interest holders to retain any interest in the debtor. This rule does not exist in Subchapter V cases, meaning debtors can retain equity interest without paying claims in full to creditors.
Congress’ goal in enacting Subchapter V was to allow for faster, more successful reorganization of small businesses by limiting their time in bankruptcy. However, in doing so, it is perceived by many that creditors can be disadvantaged by this process.
Advantages of Subchapter V bankruptcy for small businesses
Beyond an expedited bankruptcy process, perhaps the other largest advantage of Subchapter V is that it puts small businesses in the driver’s seat, giving them the capacity to set up reorganization largely on their own terms.
A Subchapter V plan can provide for equity holders (i.e., owners) of the debtor company to retain their interests in the business. The plan is “fair and equitable” —without the need to infuse new value into the company, even while unsecured creditors are not fully paid on their claims—if:
- it provides that all of the debtor’s projected disposable income for the first three to five years of the plan (as set by the court) is applied to make payments to creditors under the plan, or
- the value of property distributed under the plan is not less than the projected disposable income. Under the Bankruptcy Code, disposable income is defined, in part, as income that is not necessary for the payment of expenditures necessary for the continuation, preservation or operation of the business.
As noted above, these plans do not require committee approval, i.e. votes, or several other Chapter 11 requirements to put them in motion.
Disadvantages of Subchapter V for creditors
In creating debtor-friendly provisions under Subchapter V, Congress noted that creditors often do not actively participate in smaller bankruptcy cases when the claims are not large enough to warrant their participation due to the required time, money, and effort. Thus, Subchapter V largely removes the requirement of creditor approval from the process.
Unfortunately for creditors in Subchapter V cases, this often means their claims are not paid in full, and they have a small window of time to object to a debtor’s plan. The burden is on creditors to timely object to the Subchapter V plan and to support their objections at the hearing on confirmation of the plan or risk the possible impairment of their interests. In this regard, a Subchapter V case is similar to a Chapter 13 case (generally used by individuals to reorganize). Creditors are obliged to review the plan and to object where their claims are unfairly addressed, or risk being bound to unfavorable treatment.
While Subchapter V is by and large advantageous to the debtor, standards like the “fair and equitable” requirement of the absolute priority rule and the right of impaired creditors to vote to reject a plan were developed to protect and creditor interests. Without these protections under Subchapter V, creditors need to be vigilant to ensure that their interests are not lost in the expedited process.
Legal support for Subchapter V bankruptcy
Subchapter V first became effective as of February 19, 2020, shortly before the onset of the COVID-19 pandemic. In response to the economic fallout suffered by many small businesses at the time, Congress briefly increased the debt ceiling for Subchapter V eligibility to $7.5 million. That increased debt limit expired as of June 21, 2024, but while in effect, the increased debt threshold provided an opportunity for a large number of small businesses to reorganize, demonstrating the efficacy of Subchapter V as an option during difficult times. Although the debt limit has been rolled back to pre-pandemic levels (and adjusted for inflation), Subchapter V still presents an efficient tool for owners to preserve and retain their small businesses.
Is your small business in need of debt relief and reorganization? Or perhaps you’re a creditor with interests in a Subchapter V case. Our experienced Bankruptcy Law attorneys in Allentown, PA practice regularly in bankruptcy courts. Contact us for help navigating the intricacies of your financial hurdles.
