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Small Business Reorganizations under New Subchapter V of Chapter 11 of the Bankruptcy Code
The purpose of this class will be to discuss the changes to the new Subchapter V of the bankruptcy code and its impact on small business reorganizations.
On August 23, 2019, President Trump signed into law the Small Business Reorganization Act of 2019 (“SBRA”), Pub. L. No. 116-54 (2019). Congress increased the cap to $7,500,000 for the next year as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act from $2,725,625.00.
SBRA became effective on February 19, 2020
These provisions are not a new chapter of the bankruptcy code, but a subchapter of chapter 11 of the bankruptcy code and the existing chapter 11 sections will apply unless otherwise modified by Subchapter V.
There are 3 chapters of the bankruptcy code that are used in this district and they are chapter 7, chapter 13 and chapter 11.
Subchapter V is a subchapter of chapter 11 and not a new chapter of the Bankruptcy Code
In the way of background, chapter 7 cases are liquidations for individuals or businesses, chapter 13 are organizations for individuals (not businesses) where the individual uses 3 to 5 years of future earnings (disposable income) to pay creditors and chapter 11 are reorganizations or liquidations for individuals or businesses.
As will be discussed below Subchapter V is a blend of chapter 11 and chapter 13 and the goal of the law is to make it easier and cheaper for small businesses to reorganize!
In this district, 90% of chapter 11 filings are unable to reorganize and those cases are converted to chapter 7 (closed by the Bankruptcy Trustee) or dismissed as “no asset” cases.
This change in the law is an attempt by Congress to simplify the reorganization process and reduce the cost of small business chapter 11 filings.
Subchapter V can be found at 11 U.S. Code sections 1182 through 1195.
I. Debtor. Section 1182(1) defines a Debtor (individual or business) as a person engaged in commercial or business activities that has aggregate noncontingent liquidated secured and unsecured debts as of the date of the filing of the bankruptcy petition of not more than $7,500,000 not less than 50 percent of which arose from the commercial or business activities of the Debtor.
A. Noncontingent liquidated debt, both secured and unsecured debt must not exceed $7,500,000.
B. 50% or more of the debt must have arisen from commercial or business activities of the Debtor. 1182(1)(A)
C. Non-contingent debt refers to a debt that is owed at present without any acts needing to occur first.
D. Contingent debt is one in which there is a 'triggering event' or some condition precedent for the debt to exist.
E. Subchapter V does not apply to publicly traded companies 1182(B)(ii)
II. Trustee. The United States Trustee (a government agency which is a component of the Department of Justice) shall appoint a standing trustee as a Trustee in a case filed under this chapter 1183(a)
A. What are the roles of a Trustee in Subchapter V?
1. Appear and be heard at the status conference before the Bankruptcy Judge assigned to the case
2. Attend plan confirmation hearing;
3. Ensure that the Debtor commences making timely payments required by a plan confirmed under this subchapter;
4. If the Debtor ceases to be a Debtor in possession, perform the duties specified in section 704(a)(8) and paragraphs (1), (2), and (6) of section 1106(a) of this title, including operating the business of the Debtor and
B. Facilitate the development of a consensual plan of reorganization-this is a new role for a Trustee. Developing a consensual plan is primarily the role of Debtor’s counsel.
C. If the plan is confirmed under the service of the trustee in the case shall terminate when the plan has been substantially consummated ⸹1183(c)(1)
III. Operation of the Business. The Debtor shall have the right to run its business ⸹1184.
IV. Removal of the Debtor ⸹1185. On request of a party in interest, and after notice and a hearing, the court shall order that the Debtor not be a Debtor in possession for cause, including fraud, dishonesty, incompetence, or gross mismanagement of the affairs of the Debtor.
V. Property of the Estate. If a plan is confirmed, property of the estate includes, includes property pursuant to section 541 of the Bankruptcy Code and (1) property that the Debtor acquires after the commencement of the case, (2) earnings from services performed by the Debtor after the date of commencement of the case but before the case is closed, dismissed, or converted to a case under chapter 7, 12, or 13 ⸹1186.
A. The Debtor shall remain in possession of all property of the estate ⸹1186(b).
VI. Status Conference ⸹1188
A. Not later than 60 days after the entry of the order for relief under this chapter, the court shall hold a status conference to further the expeditious and economical resolution of a case under this subchapter ⸹1188(a).
B. Not later than 14 days before the date of the status conference under subsection (a), the Debtor shall file with the court and serve on the trustee and all parties in interest a report that details the efforts the Debtor has undertaken and will undertake to attain a consensual plan of reorganization. ⸹1188(c)
VII. Filing of the Plan § 1189
A. Only the Debtor may file a plan under this subchapter. 1189(a)
B. The Debtor shall file a plan not later than 90 days after the order for relief under this chapter, except that the court may extend the period if the need for the extension is attributable to circumstances for which the Debtor should not justly be held accountable 1189(b).
VIII. Contents of Plan § 1190
(1) A plan filed under this subchapter shall include— (A) a brief history of the business operations of the Debtor; (B) a liquidation analysis; and (C) projections with respect to the ability of the Debtor to make payments under the proposed plan of reorganization;
(2) Shall provide for the submission of all or such portion of the future earnings or other future income of the Debtor to the supervision and control of the Trustee as is necessary for the execution of the plan; and
(3) Notwithstanding section 1123(b)(5) of this title, may modify the rights of the holder of a claim secured only by a security interest in real property that is the principal residence of the Debtor if the new value received in connection with the granting of the security interest was— (A) not used primarily to acquire the real property; and (B) used primarily in connection with the small business of the Debtor
⸹1190(3) allows a Debtor, pursuant to a confirmed chapter 11 plan, to modify a mortgage on the Debtor’s principal residence if the debt was not used to acquire the residence and used primarily with the operation of the Debtors small business-this is a major change in bankruptcy law since first mortgages on a Debtor’s principal residence cannot be modified.
IX. Confirmation of Plan § 1191
A. The Court on request of a Debtor shall confirm the plan if the plan does not discriminate unfairly, and is fair and equitable, with respect to each class of claims or interests that is impaired under, and has not accepted, the plan. 1191(b)
B. With respect to a class of secured claims (A) the plan provides that all of the projected disposable income of the Debtor to be received in the 3-year period, or such longer period not to exceed 5 years as the court may fix, beginning on the date that the first payment is due under the plan will be applied to make payments under the plan; or (B) the value of the property to be distributed under the plan in the 3-year period, or such longer period not to exceed 5 years as the court may fix, beginning on the date on which the first distribution is due under the plan, is not less than the projected disposable income of the Debtor. 1191(c)(2)
C. The Debtor will be able to make all payments under the plan 1191(3)(A)(i)
D. The term “disposable income” means the income that is received by the Debtor and that is not reasonably necessary to be expended— (1) for— (A) the maintenance or support of the Debtor or a dependent of the Debtor; or (B) a domestic support obligation that first becomes payable after the date of the filing of the petition; or (2) for the payment of expenditures necessary for the continuation, preservation, or operation of the business of the Debtor. 1191(d)(1) & (2)
X. Discharge. If the plan of the Debtor is confirmed, as soon as practicable after 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, the court shall grant the Debtor a discharge of all debts §1192
XI. Modification of Plan § 1193
A. The Debtor may modify a plan at any time before confirmation ⸹1193(a)
B. If a Plan has been confirmed under ⸹1191(a), the Debtor may modify the plan at any time after confirmation of the Plan and before substantial consummation of the Plan ⸹1193(b)
XII. Payments § 1194
A. Payments and funds received by the trustee shall be retained by the Trustee until confirmation or denial of confirmation of a plan. If a plan is confirmed, the trustee shall distribute any such payment in accordance with the plan. If a plan is not confirmed, the trustee shall return any such payments to the Debtor 1194(a).
B. The above payment mechanism is similar to chapter 13, where the Debtor makes monthly payments to the Trustee who in turn pays creditors.
C. Prior to confirmation of a plan, the court, after notice and a hearing, may authorize the trustee to make payments to the holder of a secured claim for the purpose of providing adequate protection of an interest in property. 1194(c)
D. ⸹1194(c) allows a secured creditor to make a motion before the Court for adequate protection payments if the Debtor is not making payments to the secured creditor, or the secured creditor does not have an “equity cushion”.
XIII. Transactions with professionals. A person is not disqualified from employment by the Debtor solely because that person holds a claim of less than $10,000 that arose prior to commencement of the case. § 1195
A. The above provision is helpful to professional(s) who are owed money by the Debtor (less than $10,000) who do not want to waive that claim (meaning they want to be paid by the Debtor) and they want to represent the Debtor in the Subchapter V proceeding.
XIV. Impaired Creditors. Subchapter V allows a Debtor to confirm a Plan without the need for obtaining the consent of a class of “impaired” creditors as is required under Chapter 11.
A. An impaired creditor is a creditor who is paid or accepts less than what they are currently owed.
XV. United States Trustee Quarterly Fees have been eliminated. Other than the initial filing fee, fees are essentially eliminated, making the process much less expensive to the petitioner.
XVI. Creditor committee requirement has been eliminated (only formed for cause in Subchapter V cases)
XVII. Cram Down has been simplified. In Subchapter 5, if the creditors can’t agree on the petitioner’s proposed plan, an application can be made to the Bankruptcy Court Judge to order the plan approved.
A. Cram Down standard-The success of the proposed plan need only be more attractive to the unsecured creditors than would a conversion to a Chapter 7 liquidation plan (creditors get $1 more under Subchapter V)
XVIII. Documents needed to file under Subchapter V-the entity will require the business’ most recent balance sheet, statement of operations, cash flow statement, a federal income tax return (or a sworn statement that such a document does not exist).
XIX. Plan must be submitted for approval within 90 days. However, the Bankruptcy Court may extend this deadline “if the need for the extension is attributable to circumstances for which the Debtor should not justly be held accountable.” (in the COVID-19 environment, courts are likely to grant extensions liberally)
XX. Disclosure Statement not required. The Act eliminates the requirement that a disclosure statement is filed, thereby reducing costs to the Debtor and streamlining the plan confirmation process. However, the Debtor must include in the plan certain information customarily included in a disclosure statement, such as a short history of the Debtor, a liquidation analysis, and financial projections reflecting the ability of the Debtor to make the payments required by the plan
XXI. Trustee-under Subchapter V, a trustee is automatically appointed, but the Debtor retains control of its assets and operations. trustees have the authority to investigate the Debtor’s financial affairs. The trustee’s primary function is to facilitate a consensual plan among the Debtor and its creditors, almost like a mediator would facilitate a settlement in litigation. The trustee’s duties will include facilitating the development of a consensual reorganization plan, appearing at major hearings in the case, and ensuring that a Debtor commences making timely payments under a plan.
A.Under the supervision of the Department of Justice, approximately 250 Subchapter V trustees – mostly attorneys and accountants – were selected out of over 3,000 applicants. Most Subchapter V trustees had recently received their first case assignments when the COVID-19 pandemic hit.
XXII. Timing of Subchapter V Filing. Small businesses should carefully consider the timing of a Subchapter V filing: the Borrower Application Form promulgated by the U.S. Small Business Administration indicates that applicants presently subject to a bankruptcy proceeding are ineligible for the Paycheck Protection Program (PPP).
XXIII. Plan Term -Consistent with current practice in Chapter 13 cases, a reorganization plan will customarily be three years in length but may be as long as five.
XXIV. Impaired Class. Under Subchapter V, a plan can be confirmed without the vote of an impaired accepting class, providing that the plan does not discriminate unfairly and is deemed “fair and equitable” as to each class of claims. To meet the “fair and equitable” requirement under the Bankruptcy Code, Subchapter V requires that all of the Debtor’s projected disposable income during the length of the plan be applied to plan payments.
XXV. Elimination of the Absolute Priority Rule. Subchapter V eliminates the Absolute Priority Rule, under which a Debtor cannot retain an ownership interest in its assets unless all creditor claims are paid in full or the Debtor contributes new value to fund the Plan. Under Subchapter V no “new value” contributions are required as a condition of the Debtor’s asset retention.
XXVI. Single Asset Real Estate Cases (“SARE”)-if a Debtor elects to file a bankruptcy case as a SARE, then they cannot also elect Subchapter V treatment. Single asset real estate is defined by the Bankruptcy Code as a single property or project that generates substantially all of the Debtor's gross income (§ 101(51B), Bankruptcy Code). If the Debtor's only business is operating the property and the property generates substantially all of the Debtor's income, a SARE typically includes the following types of properties: Shopping centers, Office buildings, Industrial and warehouse buildings and Apartment complexes.
XXVII. Bankruptcy Code Provisions-other sections of the bankruptcy code will apply to Subchapter V cases unless otherwise modified, amended or made inapplicable by Subchapter V
A. For example when a Subchapter V bankruptcy case is filed, all litigation pending against the Debtor is stayed pursuant to section 362 of the Bankruptcy Code.
Subchapter V Bankruptcy Provisions can be found at:
11 U.S. Code SUBCHAPTER V—SMALL BUSINESS Debtor REORGANIZATION BANKRUPTCY CODE CITES
1. § 1181. Inapplicability of other sections
2. § 1182. Definitions
3. § 1183. Trustee
4. § 1184. Rights and powers of a Debtor in possession
5. § 1185. Removal of Debtor in possession
6. § 1186. Property of the estate
7. § 1187. Duties and reporting requirements of Debtors
8. § 1188. Status conference
9. § 1189. Filing of the plan
10. § 1190. Contents of plan
11. § 1191. Confirmation of plan
12. § 1192. Discharge
13. § 1193. Modification of plan
14. § 1194. Payments
15. § 1195. Transactions with professionals
JHS
Through the World Wide Land Transfer
~ All of Their Classes are Complimentary
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