Increased Availability of Subchapter V Bankruptcy Under the CARES Act

The Small Business Reorganization Act of 2019 (“SBRA”), the first major amendment to the U.S. Bankruptcy laws since the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”), only become effective on February 19, 2020, but has already been amended in the face of the coronavirus pandemic.  The act is intended to make it easier and less expensive for small businesses to obtain relief under Bankruptcy Code.  As originally enacted, it defined “small business debtor,” with some exceptions, as “a person engaged in commercial or business activities (including any affiliate of such person that is also a debtor under this title and excluding a person whose primary activity is the business of owning single asset real estate) that has aggregate noncontingent liquidated secured and unsecured debts as of the date of the filing of the petition or the date of the order for relief in an amount not more than $2,566,050 (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 .”  11 U.S.C.§ 101(51D)(a).  The Coronovirus Aid, Relief, and Economic Security (“CARES”) Act of 2020 temporarily increases the eligibility ceiling to $7,500,000.

According to the Small Business Administration (“SBA”), which defines “small businesses for some purposes as those with 500 or fewer employees, small businesses make up 99.7 percent of U.S. employers and 49.2 percent of private-sector employment (2). It is impossible to tell how many of these will become eligible for relief under revised Subchapter V but it is not difficult to predict that the need will be great.

It was Thursday evening, March 19, when the governor of California announced the first state-wide shelter in place order.  “Nonessential” businesses such as bars, restaurants, gyms, and movie theaters had been ordered closed even earlier.  As of April 1, some 294 million people in at least 37 states, 74 counties, 14 cities, the District of Columbia and Puerto Rico have been told to stay home (3).  Initial unemployment claims hit 3.3 million in the week ended March 21 and 6.6 million for the week ended March 28 (4).

For small business debtors, Subchapter V is intended to provide a streamlined and less expensive path to relief. Although the filing fee for Subchapter V is the same as that for all other Chapter 11 cases (presently $1,717), an eligible debtor that elects treatment under Subchapter V need not pay quarterly U.S. trustee fees.  28 U.S.C. § 1930(a)(3) and (6). The subchapter V debtor is, however, expected to compensate the case trustee.  See 11 U.S.C. § 330(a)(1).
 
The debtor remains in possession of its assets upon the filing of a Subchapter V case, unless removed for cause.  Even so, a trustee is appointed in every case much like in a Chapter 12 or 13 case.  One of the most important duties of the subchapter V trustee is to “facilitate the development of a consensual plan of reorganization.”  11 U.S.C. § 1183(b)(7).  The U.S. Trustees for the various regions of the U.S. were able to appoint persons to serve as Subchapter V case trustees by the effective date of SBRA, but they could not have anticipated the increased filings that may be expected as the result of the raising of the debt ceiling by the CARES Act.

The court must hold a status conference no later than 60 days after the case is filed.  The debtor must file “a report that details the efforts the debtor has undertaken and will undertake to attain a consensual plan of reorganization” not later than 14 days before the status conference.  11 U.S.C. § 1188(c).  Failure to timely file the report may result in delay of the status conference or, in an egregious case, the removal of the debtor as debtor in possession.  See 11 U.S.C. § 1185(a).  

Under Chapter 11, the debtor has the exclusive right to file a plan of reorganization during the first 120 days the case is pending, unless the court shortens that period for cause.  Thereafter, other interested parties, such as a creditor or equity security holder, may file a plan.  Although it is unusual, it is possible for competing plans to be filed in Chapter 11 cases.  In Subchapter V, however, only the debtor may file a plan.  11 U.S.C. § 1189(a). 

The debtor must file a plan not later than 90 days after the petition is filed.  11 U.S.C. § 1189(b).  The court may extend this period “if the need for the extension is attributable to circumstances for which the debtor should not justly be held accountable.”  11 U.S.C. § 1189(b).

The debtor need not file a separate disclosure statement unless the court orders otherwise.  See 11 U.S.C. §§ 1181(b), 1187(c), and 1125(f).  The plan, however, must contain a brief history of the business operations of the debtor, a liquidation analysis, and projections with respect to the debtor’s ability to make proposed plan payments.  11 U.S.C. § 1190(1).  The elimination of the need for a separate disclosure statement significantly reduces the cost of the Subchapter V case.

Confirmation of the plan may be consensual or by cramdown.  11 U.S.C. § 1191.  A consensual plan is one in which all the requirements of section 1129(a) are met except section 1129(a)(15) (i.e., the absolute priority rule).  The absolute priority rule does not apply to individuals who reorganize under subchapter V.  11 U.S.C. § 1181(a).

A Subchapter V petition may be filed by an individual as well as by a business entity.  A plan proposed by an individual must propose that the debtor submit future earnings or income to fund the plan to the trustee.  11 U.S.C. § 1190(2).  Unlike in Chapter 13, the plan may modify the rights of the holder of a claim secured only by the debtor’s principal residence if the loan proceeds were not used primarily to acquire the property and were used primarily in connection with the small business of the debtor.  11 U.S.C. § 1190(3).

For individual Subchapter V debtors, discharge is entered upon confirmation of a consensual plan.  This is because section 1141(d)(5) (which delays discharge for individual debtors in chapter 11 cases) is one of the provisions excluded by section 1181(a).  This contrasts with Chapter 13 and non-Subchapter V Chapter 11 cases in which the individual debtor receives a discharge only upon completion of all plan payments.  If, however, the plan is confirmed by cramdown, discharge is delayed until “completion by the debtor of all payments due within the first 3 years of the plan, or such longer period not to exceed 5 years as the court may fix, unless the court approves a written waiver of discharge.”  11 U.S.C. § 1192.  Property of the estate includes post-petition property and earnings if the plan is confirmed by cramdown.  11 U.S.C. § 1186(a).

The services of the trustee are terminated upon substantial consummation of a consensual plan.  11 U.S.C. § 1183(c)(1).  The debtor must give notice of substantial consummation of its plan no later than 14 days after substantial consummation.  11 U.S.C. § 1183(c)(2).  As in all chapter 11 cases, “substantial consummation” means –

(A) transfer of all or substantially all of the property proposed by the plan to be transferred;

(B) assumption by the debtor or by the successor to the debtor under the plan of the business or of the management of all or substantially all of the property dealt with by the plan; and

(C) commencement of distribution under the plan. 11 U.S.C. § 1101(2).

The trustee continues to serve as disbursing agent for plan payments under a cramdown plan.  11 U.S.C. § 1194(b).

One area of concern for potential Subchapter V debtors is the need to compensate the trustee who is compensated as provided for other trustees and professionals at 11 U.S.C. § 330(a)(1). It remains to be seen how this requirement will impact the choice of small business debtors to pursue reorganization under Subchapter V of Chapter 11. 

According to the American Bankruptcy Institute, total commercial chapter 11 filings in February 2020 decreased 20 percent over the same period last year, and the February 2020 commercial chapter 11 filing total of 547 represented a 13 percent decrease over the previous month’s commercial filing total of 630 (5).  Subchapter V Chapter 11 cases were not separately reported. ABI Executive Director Amy Quackenboss suggested that the short-term decrease in filings did not reflect the ultimate expected increase in filings resulting from the pandemic. Bankruptcy filings naturally will lag behind the numerous small business closures resulting from the stay at home orders of the governors and mayors of the United States.  The CARES Act’s temporary raising of the debt ceiling for Subchapter V cases is expected to greatly increase the number of debtors who will choose that option.

Jennie D. Latta, J.D., Ph.D.,
US Bankruptcy Judge for the Western District of Tennessee
 

(1). Jennie D. Latta, J.D., Ph.D., is a United States Bankruptcy Judge for the Western District of Tennessee.
(2). SBA Office of Advocacy, “Frequently Asked Questions,” https://www.sba.gov/sites/default/files/FAQ _Sept_2012.pdf
(3). https://www.nytimes.com/interactive/2020/us/coronavirus-stay-at-home-order.html
(4). https://www.nytimes.com/2020/04/02/business/economy/coronavirus-unemployment-claims.html
(5). https://www.abi.org/newsroom/press-releases/february-commercial-chapter-11-bankruptcy-filings-drop-20-percent-ahead-of