How Subchapter V Could Save Your Small Business

June 3, 2020
International Business Times
By Amy Fontinelle 

Declaring bankruptcy is never pleasant, but for small businesses it's often been disastrous. Filing under chapter 11 -- the method that allows a firm to re-organize -- was designed for large corporations. Technically, a small firm could do it, but the process was lengthy, costly, and creditor-friendly. As a result, insolvent small businesses often had to file for chapter 7, which meant closing shop entirely.

But now there's a new way to declare bankruptcy, a more debtor-friendly alternative: subchapter V. Created by the Small Business Reorganization Act (SBRA) of 2019, it became effective February 19, 2020. And then, a month later, it got even better, thanks to the CARES Act, which tripled the qualifying debt limit under this option.

Now, if you're a small business owner with less than $7.5 million in debt, and if you can demonstrate that staying open will generate enough money to repay your creditors over three to five years, you'll have a better chance at continuing to support yourself and serve your customers. 

Subchapter V: Are You Eligible?

The SBRA originally made subchapter V -- so-called because it's a clause under chapter 11 -- available to small businesses whose secured and unsecured debts combined totaled no more than $2,725,625. When the CARES Act became law on March 27, 2020, that limit increased to $7,500,000. This higher limit is set to expire after March 26, 2021. At least half of the debt must be business (not personal) debt.

One requirement to file for subchapter V is that the debtor (that is, you) be currently engaged in commercial or business activities. However, if your operation closed down when pandemic-induced stay-at-home orders went into place, here's the good news: Courts so far have taken a liberal view, ruling that businesses in similar situations are eligible to file.

When you file, you'll incur a $1,167 case filing fee and a $550 administrative fee. The court may allow you to pay in installments within 120 days of filing (roughly $430 per month) or 180 days of filing (roughly $286 per month). You may also incur fees for professionals such as attorneys, accountants, appraisers, and auctioneers.

How Subchapter V Works: Creating Your Reorganization Plan

Subchapter V is unlike a regular chapter 11 case in that it doesn't require an impaired class --like a creditor who won't receive everything you originally owed them -- to accept your reorganization plan. The bankruptcy court can approve it without their acceptance as long as your plan is fair and equitable.

"Fair and equitable" means your plan must provide for all of your disposable income to go toward repaying your creditors over the next three to five years. You'll be able to use some of your income to support yourself, support any dependents, and operate your business. You won't be taking any vacations, but you won't be homeless and you might not have to lay off your employees.

Your reorganization plan will include the information that would normally be included in a disclosure statement under regular chapter 11. This information includes a brief history of your business operations, a liquidation analysis, and financial projections for your business showing how you'll repay your creditors.

A liquidation analysis is a good faith estimate of what your business assets could be sold for in a chapter 7 bankruptcy where you closed your business. The court will want to see that if you choose subchapter V, your debtors will be better off than if you liquidated under chapter 7.

Unsecured creditors can really lose out in a liquidation bankruptcy, and even secured creditors may not recoup what they owe since it can be challenging to get the full value for assets sold in a distress sale. That said, if your business continues to struggle during your three to five years of payments, you may end up liquidating certain assets to pay your creditors, or even converting your case to chapter 7 and liquidating everything.

Filing for Subchapter V: Trustee Supervision

Filing for any type of bankruptcy provides an automatic stay that requires creditors to leave you alone. Once the bankruptcy court discharges your debts., creditors cannot try to collect them. You can't be sued or held personally liable for them. Discharge occurs either upon confirmation of a consensual plan -- before you start making payments to creditors who have agreed to your plan, or after you make all your payments under the plan, for a nonconsenual plan.

After you file, the U.S. Department of Justice will appoint a trustee to supervise your bankruptcy process. You'll give the trustee copies of your most recent tax return, statement of operations, cash flow statement, and balance sheet. They will help with your reorganization plan and attend your key court hearings.

If your creditors approve your plan, the trustee's job ends there. If not, the trustee will oversee the entire three- to five-year repayment process. The trustee will not take control of your assets and cannot sell your assets, but the trustee will collect your payments and distribute them to your creditors. They may also inspect your business premises, books, and records if they give you reasonable advance notice.

Who Should File Subchapter V?

Subchapter V offers many benefits to small businesses that are struggling under too much debt. Of course, if you can work something out with your creditors without filing for bankruptcy, that's always the preferable course, saving you a lot of money. Subchapter V is for when your creditors won't budge, because the court can approve your case against their will. It's also for when you've pledged your home as collateral for a business loan you can't pay and you don't want to lose your home.

If you think your business has a good chance to become profitable again and you don't want to close down for good, talk to a bankruptcy attorney about opening a subchapter V case.