Small Business Bankruptcy: A Guide to Chapter 11, Subchapter 5
Congress signed the Small Business Reorganization Act (SRBA) in August 2019, and it went effective in February of this year. One slight detail congress overlooked was the impending COVID-19 pandemic.
Small businesses everywhere are now reeling. SRBA may be the boon these businesses need to continue operating. Discover what the new law means for you and how it affects small business bankruptcy.
Small Business Bankruptcy
Why It's Important
Subchapter V elections will likely surge after the pandemic. Lenders and creditors should prepare themselves for how the SRBA modifies the typical Chapter 11 procedure.
For many struggling businesses, the SBRA is a long-awaited life preserver. The SRBA may be the necessary change for companies deemed "too poor" to restructure with Chapter 11. Businesses hope it eliminates some of the bureaucratic pitfalls of The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA).
The BAPCPA was supposed to make filing for Chapter 11 easier. Instead, it included more reporting requirements and other burdens that bogged down the act and canceled out the benefits.
Subchapter V shares some similarities to the BAPCPA. Both have one-step confirmation, and both add new features that make filing for Chapter 11 easier for small businesses.
Non-Contingent Debt Limit
For the most part, Subchapter V small business bankruptcy only applies to a business debtor with non-contingent, secured, and unsecured debt up to $2,725,625. However, there is one exception. Businesses that derive nearly all of their income from a single property are ineligible regardless of their debt.
Most small businesses fall within the debt range, but some mom and pop shops who only own one store, and small companies who exceed that debt will struggle with the stipulation.
There is also some speculation that lenders may extend additional credit to borrowers on the cusp to disqualify them. On the other hand, desperate borrowers over the limit could qualify by characterizing much of their debt as contingent or disputed.
Many people believe the debt cap is too low. For example, the National Bankruptcy Conference wanted to raise the debt cap for Chapter 11 even before COVID-19.
In March, Congress temporarily addressed these concerns when they decided to increase the cap to $7,500,000 for the next year. The increase came as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act in an attempt to benefit not only small business owners, but also suppliers, customers, creditors, and employees.
It is unclear whether Congress will further increase the debt cap, or extend the increased cap longer.
Subchapter V allows debtors to spread their debt over 3 to 5 years. During this time, the debtor must devote their disposable income toward the debt. This model usually aids both parties involved.
The debtors have time to pay their debts and can spread them across a more extended period to avoid large sums. The creditors benefit because there is less a chance of debtors defaulting on longer-term payments.
Administrative expenses differ from Subchapter V to Chapter 11 cases. Debtors must pay administrative costs at plan confirmation in Traditional Chapter 11 cases. Debtors can pay Subchapter V administrative expenses over the life of the plan.
For both, however, debts are not discharged until the debtor completes all of its planned payments.
Subchapter V debtors must file their reorganization plan within 90 days of entering bankruptcy. This helps to keep cases moving quickly, which is especially vital during COVID-19.
If the debtor cannot commit to a reorganization plan within 90 days, the debtor may file an extension plea. The bankruptcy court decides on whether to approve or deny the extension plea. The Bankruptcy Council bases its decision on whether the circumstances were out of the debtor's control.
With COVID-19, the court is more likely to approve extensions.
Trustees only work on typical Chapter 11 cases for specific reasons. However, Subchapter V cases always use trustees. Subchapter V trustees' purpose is more for oversight than anything else, as the debtor retains control of their assets and operations.
Creditors' committees commonly occur in traditional Chapter 11 cases, but they need a cause in Subchapter V cases.
Subchapter V trustees' primary function is to create a standard plan with the debtor and creditor. They do have the authority to audit the debtor's finances, but their primary purpose is mediation.
The reason for this is Congress sees impartial third-parties' increasing the likelihood of a sound resolution among the debtor and its creditors. Unbiased third parties are especially useful for small businesses whose creditors are tentative as a result of COVID.
The Department of Justice oversaw the appointment of these impartial third parties, and approximately 250 Subchapter V trustees were selected out of over 3,000 applicants.
Subchapter V Incentives
Unlike traditional Chapter 11 filings, Subchapter V protects small business owners from various detrimental circumstances.
A few examples:
If the principal debtor used his/her primary residence as security for a loan to fund the small business, there are available loan modifications.
Subchapter V does not use the "new value rule." This rule requires equity holders to provide "new value" if they want to keep their equity interest in the business.
A Sign of the Times
COVID-19 is endangering businesses that once stood on solid ground. These small businesses now have to consider small business bankruptcy. In regular times, most companies only use chapter 11 as a final resort. But these times aren't normal.
It may be time for many small businesses to hit the pause button. All things considered, small business bankruptcy is the pause button. The time saved with small business bankruptcy gives companies room to negotiate with lenders, landlords, and other creditors.
These negotiations represent the most valuable resource: time. Normal operations can resume once the pandemic subsides.
However, small businesses should examine whether filing for Subchapter is the right decision. There are other options for small companies that need consideration. For example, the Borrower Application Form indicates that bankruptcy applicants are ineligible for the Paycheck Protection Program (PPP).
Another thing to consider is when to file for Subchapter V. Once the PPP runs out, businesses will more than likely flood the system with Subchapter V applications. This could put small businesses who are in desperate need of relief in a time-pinch.
Subchapter V Is Available to Individuals
Individuals may also take advantage of the new Subchapter V bankruptcy. In fact, it may help SBA personal guarantors who have pledged their house as collateral for an SBA loan. A small business debtor's plan may modify the rights of a holder of a claim secured by the principal residence of the debtor if the new value received in connection with the granting of the security interest was:
— not used primarily to acquire the real property; and
— used primarily in connection with the debtor's small business.
This means in the event of a defaulted SBA loan, you may be able to keep your house without having to pay the lender the full amount of the lien in a lump sum.
Small Business Questions Answered
In these trying times, it's important for small businesses to understand what solutions fit their models. Companies must strategize and prepare to weather the storm.
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$488,000 SBA 7A LOAN - SBA OHA LITIGATION
Clients personally guaranteed an SBA 7(a) loan. The SBA referred the debt to the Department of Treasury, which was seeking payment of $487,981 from our clients. We initially filed a Cross-Servicing Dispute, which was denied. As a result, we filed an Appeals Petition with the SBA Office of Hearings and Appeals asserting legal defenses and supporting evidence uncovered during the discovery and investigation phase of our services. Ultimately, the SBA settled the debt for $25,000 - saving our clients approximately $462,981.
$337,000 SBA 504 LOAN - SBA OIC CASH SETTLEMENT
Clients personally guaranteed SBA 504 loan balance of $337,000. The Third Party Lender had obtained a Judgment against the clients. We represented clients before the SBA and negotiated an SBA OIC that was accepted for $30,000.
$150,000 SBA 7A LOAN - SBA OIC CASH SETTLEMENT
Client personally guaranteed SBA 7(a) loan balance of over $150,000. Business failed and eventually shut down. SBA then pursued client for the balance. We intervened and was able to present an SBA OIC that was accepted for $30,000.