On August 23, 2019, Congress enacted the Small Business Reorganization Act of 2019 (“SBRA”), which became effective on February 19, 2020.  The SBRA created what is known as Subchapter V of Chapter 11 of the Bankruptcy Code comprised of §§ 1181 through 1195 of the Code (“Subchapter V”).  For many years, financially distressed small businesses were unable to utilize Chapter 11 in the same way large businesses could because the process was too expensive, too lengthy, and simply not feasible.  The SBRA offers small businesses the same benefits larger debtors receive in a regular Chapter 11 bankruptcy including reducing liabilities, rejecting burdensome leases and executory contracts, eliminating debts, and selling assets. However, subchapter V made several substantive and procedural changes to the Code, which were intended to streamline the Chapter 11 process for small business debtors by streamlining the plan of reorganization process, enabling small businesses to successfully emerge from bankruptcy with a court-approved plan within 90 days after filing for bankruptcy.  

Some critical changes and benefits of Subchapter V include:

1. Streamlined Processes and Requirement to File the Plan of Reorganization

A Subchapter V debtor is not required to file an accompanying Chapter 11 disclosure statement, unless ordered by the bankruptcy court for cause. The elimination of the disclosure statement requirement significantly reduces cost of preparing a plan and expedites the confirmation process.  The § 1111(b) election deadline for creditors is shortened in our district to a mere ten (10) days by an order entered by the clerk at the onset of a Subchapter V case.  The deadline for filing proofs of claim is also shortened.  Both debtors and creditors need to pay attention and immediately participate in a Subchapter V case.

In a Subchapter V, debtors generally are required to file a plan within 90 days after entering bankruptcy, absent a showing of circumstances “for which the debtor should not justly be held accountable.” This expedited plan timeline may not be ideal for some debtors, but for many debtors it functions as a minor inconvenience given the more relaxed economic standards and factors discussed below.  The SBRA provides for a shortened timeline to file a plan:

• Not later than 60 days after the bankruptcy filing, the bankruptcy court will hold a status conference “to further the expeditious and economical resolution of a case under this subchapter.”

• Not later than 14 days before the status conference, the debtor’s bankruptcy counsel is required to file a report that details the steps the company and its advisors have taken to attain a consensual plan of reorganization.

• Unless the debtor requests an extension related to circumstances outside of its control, the Chapter 11 plan of reorganization must be filed not later than 90 days after the bankruptcy case is filed.

• Only a debtor may file a Chapter 11 plan in a Subchapter V case. This limitation allows Subchapter V debtors to focus on their plan without having to worry about exclusivity or the distraction posed by a competing plan proposed by creditors.

Once the debtor completes all payments according to the plan, the reorganized debtor will receive a discharge from all of its pre-confirmation debts.

Much like a Chapter 13 case for individuals with regular monthly income, Subchapter 5 allows a small business debtor to spread its debt over 3 to 5 years, which benefits both debtors (by allowing them to spread payments over time) and creditors (by allowing them a meaningful recovery from debtors who may not have much money on hand but have a realistic expectation of increased income in the future).  A plan of reorganization will generally be confirmed by the bankruptcy court so long as it provides that all projected disposable income of the debtor for 3 to 5 years will be used to make plan payments; or the value of property to be distributed under the 3-5-year plan, beginning on the date on which the first distribution is due, is not less than the projected disposable income of the debtor.  In a traditional Chapter 11 case, administrative expenses must be paid at plan confirmation; under Sub-Chapter 5, they may be paid over the life of the plan.

2. Eligibility for Subchapter V: Debt Amount and Recent Adjustments

To be eligible for Subchapter V, a debtor must (1) meet the definition of a “small business debtor”; and (2) elect to be treated as a debtor under Subchapter V. Prior to the COVID-19 pandemic, the Bankruptcy Code defined a small business debtor as a business “engaged in commercial or business activities . . . that has aggregate noncontingent liquidated secured and unsecured debts . . . in an amount not more than $2,725,625 (excluding debts owed to 1 or more affiliates or insiders) not less than 50 percent of which arose from the commercial or business activities of the debtor.”

As part of the Coronavirus Aid, Relief, and Economic Security Act of 2020, Congress temporarily increased the debt limit under this Bankruptcy Code section from $2,725,625 to $7.5 million until March 27, 2021. This increase made it possible for more substantial companies, with significant contingent and unliquidated debts that might otherwise be compelled to reorganize under the traditional Chapter 11 provisions, to qualify for Subchapter V’s more relaxed standards. On March 27, 2021, Congress passed the COVID-19 Bankruptcy Relief Extension Act, which extended the increased debt cap provision through March 27, 2022. Although Congress did not act immediately, on June 7, 2022, Congress subsequently passed the Bankruptcy Threshold Adjustment and Technical Corrections Act, which retroactively reinstated the $7.5 million debt threshold for an additional two years. Accordingly, until at least June 2024, Subchapter V will remain a viable option for a much larger pool of small and mid-sized businesses to reorganize.

3. Modification of the absolute priority rule 

The SBRA offers small business owners the opportunity to retain their ownership interest in the reorganized company.  In a regular Chapter 11 bankruptcy, the “absolute priority rule” provides that existing owners of a debtor may not retain their equity interest in the debtor over the objection of a class of unsecured creditors, unless the unsecured class is paid in full or the owners contribute material new value into the debtor.  In what is perhaps the single most important modification of the traditional Chapter 11 requirements to a non-publicly held company, that rule simply does not apply in a Subchapter V case — as long the plan provides that unsecured creditors will be paid the debtor’s “disposable income” for a period of three years (or up to five years if extended by the bankruptcy court). In that event, equity holders of a Subchapter V debtor may continue to own and manage their business, even when unsecured creditors are paid a de minimis sum and vote against the plan or object to confirmation.

4. Changes Related to Administrative Expenses and Reduced Creditor Involvement 

Subchapter V provides that an official committee of unsecured creditors will not be appointed unless ordered by the bankruptcy court for cause.  Therefore, in small business cases, the appointment of an official committee will be the exception, not the rule.  The elimination of a creditors’ committee significantly reduces administrative expenses and overbearing oversight that may sometimes scuttle traditional Chapter 11 cases. 

Relatedly, Subchapter V debtors are also excused from paying United States Trustee quarterly fees.  A Subchapter V debtor also may pay administrative expense claims over the term of the plan. In contrast, in traditional Chapter 11 cases, the debtor must pay administrative expense claims on the effective date of the plan or in the ordinary course of business. This allows a Subchapter V debtor to amortize some of the costs of filing bankruptcy.

5. Mortgage Modification and Protection

For many small business owners, obtaining start up financing requires personal sacrifice.  Many folks have to put up their personal residence as security for business debts.  Subchapter V makes it harder for creditors to take away a business owner’s residence pledged as collateral to support the business.  For example, if the owner of the small business debtor used his or her primary residence as security for a loan to fund the small business, the debtor can seek to modify the mortgage against the primary residence, provided that the mortgage loan was not used to acquire the real property but was used primarily in connection with the debtor’s business.

6. Appointment of Standing Trustee

In a regular Chapter 11 bankruptcy, a Chapter 11 trustee is appointed only for cause, such as fraud or gross mismanagement, and seizes control of the debtor’s operations. Under Sub-Chapter V, a “standing trustee” is automatically appointed, but the debtor retains control of its assets and operations.  The Sub-Chapter V trustee is similar to the trustee in a Chapter 13 individual debtor bankruptcy.  The Sub-Chapter V trustee’s main role is to facilitate a consensual plan among the debtor and its creditors, similar to a mediator.  This may be helpful in reaching a 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 light of the impending financial crisis.

Subchapter V is a powerful tool for small businesses to reorganize in a more cost-effective manner without having to contend with some of the substantial hurdles to confirmation imposed by traditional Chapter 11 cases. Recent changes in the debt threshold have opened Subchapter V to a much broader range of companies until at least June 2024.  Debtors should also be aware that while Subchapter V may create a clearer path to confirmation, they must comply with, the more stringent timing requirements, such as the requirement of filing a plan within 90 days after filing bankruptcy.  For struggling small businesses, Subchapter V may be an amazing tool for reducing debt in order to reorganize and turn their business around.

Nedda Ghandi, Esq., is the founding partner of Ghandi Deeter Blackham Law Offices. A Nevada native, Ghandi is a graduate of the University of Nevada, Las Vegas William S. Boyd School of Law and has practiced law in Las Vegas for 9 years. Ghandi has written numerous articles for publications concerning interesting developments in the law, and has been selected as a member of Nevada’s Legal Elite and as a Super Lawyer every year since 2013. Ghandi Deeter Blackham specializes in family law, bankruptcy, guardianship, and probate. Consultations may be scheduled by calling 702.878.1115 or visiting www.ghandilaw.com Nedda Ghandi, Esq., is the founding partner of Ghandi Deeter Blackham Law Offices. A Nevada native, Ghandi is a graduate of the University of Nevada, Las Vegas William S. Boyd School of Law and has practiced law in Las Vegas for 9 years. Ghandi has written numerous articles for publications concerning interesting developments in the law, and has been selected as a member of Nevada’s Legal Elite and as a Super Lawyer every year since 2013. Ghandi Deeter Blackham specializes in family law, bankruptcy, guardianship, and probate. Consultations may be scheduled by calling 702.878.1115 or visiting www.ghandilaw.com