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New Relief for Small Business 
Subchapter V

by | May 1, 2020

SMALL BUSINESS REORGANIZATION
As a result of the Small Business Debtor Reorganization Act of 2019, the provisions governing small business debtors under Chapter 11 were recently substantially amended as “Subchapter V” (Roman numeral 5) of Chapter 11 and are designed to provide a streamlined approach to reorganizing small business debtors. Now a small business debtor may elect to have the provisions of subchapter V of Chapter 11 apply to its case in order to achieve a cost-effective and timely reorganization of its business.

Advantages of Electing Small Business Debtor Provisions under Subchapter V

There are several advantages to electing to proceed in Chapter 11 under Subchapter V as a small business debtor. For instance, a Chapter 11 plan for reorganization filed by a Subchapter V debtor is easier to confirm because, unlike “normal” Chapter 11 cases, only the debtor can file a proposed reorganization plan. Furthermore, a disclosure statement is not required, a contested plan may be confirmed over an objecting impaired class, and the absolute priority rule does not apply.

The administrative fees in a Subchapter V reorganization are also less expensive because, unless the court orders otherwise, a creditors’ committee may not be appointed in a Subchapter V debtor case and Subchapter V debtors are not required to pay quarterly fees to the U.S. Trustee. Subchapter V cases also proceed faster than traditional Chapter 11 cases because the debtor’s reorganization plan must be filed within 90 days after filing for bankruptcy protection and a third-party trustee (similar to a Chapter 7 or 13 trustee) is appointed to oversee the case to ensure orderly confirmation.

Qualifying as a Small Business Debtor

A small business debtor under Subchapter V is a person (including individuals, partnerships and corporate debtors) or affiliate debtor that is engaged in commercial or business activities (excluding persons whose primary activity is the business of owning single asset real estate) whose aggregate noncontingent liquidated secured and unsecured debts as of the date of filing of the petition do not exceed $7,500,000 (excluding debts owed affiliates or insiders) not less than 50% of which arose from the commercial or business activities of the debtor.

Powers and Duties of Subchapter V Debtor

A Subchapter V debtor has all of the powers of a trustee serving in a case under Chapter 11. A Subchapter V debtor is authorized to operate its business during the case. It has the power to use, sell or lease estate property in the ordinary course of business without court approval and may use, sell or lease estate property outside the ordinary course of business with court approval. A Subchapter V debtor may use a creditor’s cash collateral to operate the business. “Cash collateral” is cash, deposits, accounts receivables, or other cash equivalents on which a creditor has a lien. A Subchapter V debtor also has the power to obtain unsecured and secured credit and employ attorneys, accountants, appraisers, auctioneers, real estate brokers and other professionals to represent or assist the debtor in performing its duties during the Chapter 11 case, even if that professional holds a prepetition claim of less than $10,000.

As mentioned above, a Subchapter V debtor has the exclusive right to file a plan for reorganization in a small business debtor case, but the plan must generally be filed no later than 90 days after filing the bankruptcy petition. A Subchapter V debtor may reject, assume, or assume and assign to a third-party executory contracts and unexpired leases. A Subchapter V debtor has the power to object to improper claims and to file proofs of claim on behalf of creditors. A Subchapter V debtor also has avoidance and recovery powers to (1) recover preferential transfers from the entity that received the transfer, (2) set aside fraudulent conveyances and recover the funds, (3) avoid certain kinds of transactions and statutory liens pursuant to the Code’s “strong arm” avoiding powers, (4) demand turnover of estate property, including estate property held by state court-appointed receivers, (5) set aside or avoid certain post-petition transfers, (6) recover improper setoffs, (7) “surcharge” a secured creditor’s collateral for the necessary costs and expenses of preserving or disposing of that collateral to the extent the secured creditor benefited, and (8) prevent utility companies from altering, refusing or discontinuing service to a Subchapter V debtor for unpaid prepetition utility bills, or discriminating against a debtor due to the bankruptcy filing.

Subchapter V debtors are given most of the duties of a Chapter 11 Trustee, including, (1) accounting for all property received in connection with the Chapter 11 case, (2) furnishing information concerning the estate and its administration as requested by parties in interest, and (3) filing information with the court, the U.S. Trustee and relevant taxing authorities.

A Subchapter V debtor must attend (through its senior management personnel) meetings scheduled by the court or the U.S. Trustee, including initial debtor interviews, scheduling conferences and § 341(a) meetings. All taxes entitled to administrative priority must be timely paid, and a Subchapter V debtor must maintain insurance customary and appropriate to the industry. All unfiled tax returns for any prepetition years must be filed by the debtor.

Subchapter V Debtor Reporting Requirements

In addition to the regular duties of a small business debtor in a Chapter 11, a Subchapter V debtor must satisfy certain reporting requirements, including providing its most recent balance sheet, a statement of operations, cash-flow statements, federal income tax return, and all schedules and statements of affairs. After commencement of the bankruptcy, a Subchapter V debtor must file post-petition financial reports, tax returns, and file a monthly operating report containing specified information, such as the debtor’s profitability, reasonable approximations of the debtor’s projected cash receipts and cash disbursements over a reasonable period, and comparisons of actual cash receipts and disbursements with projections in prior reports.

General Overview of Subchapter V Proceedings

As mention above, a disinterested third-person will be appointed to serve as trustee in the Subchapter V case. A trustee is appointed to oversee the estate and case proceedings and has similar powers and duties as the debtor, such as (1) account for property received by the estate, (2) examine/object to improper claims, (3) oppose a debtor’s discharge if appropriate, (4) respond to inquiries, (5) submit final report and account, (6) investigate a debtor’s financial condition, and (7) ensure a debtor makes plan payments. A Subchapter V debtor pays its plan payments to the trustee. Payments and funds received by the trustee are retained by the trustee until plan confirmation. If the plan is confirmed, the trustee will distribute any such payment in accordance with the plan. If the Subchapter V debtor’s plan is confirmed, the trustee’s appointment in the case will terminate when the plan has been substantially concluded.

No later than 60 days after filing for bankruptcy protection, the court will hold a status conference to further the prompt and economic resolution of the case. No later than 14 days before the date of the status conference, the Subchapter V debtor must file with the court a report detailing the efforts the debtor has undertaken and will undertake to attain a consensual plan of reorganization.

A debtor must also attend an initial interview with the trustee. At the initial small business case interview, the trustee will investigate the debtor’s viability, inquire about the debtor’s business plan, explain the debtor’s obligations to file monthly operating reports and other required reports, attempt to develop an agreed scheduling order, and inform the debtor of other obligations.

Plan Requirements

A Subchapter V debtor must file a Chapter 11 plan for reorganization no later than 90 days after filing its voluntary petition. A Subchapter V debtor’s plan must contain the following: (1) a brief history of the debtor’s business operations, (2) a liquidation analysis, (3) projections with respect to the ability of the debtor to make payments under the proposed plan, (4) submission of all or a portion of the debtor’s post-petition income from future earnings to the supervision and control of the trustee as is necessary for the execution of the plan, and (5) provide appropriate remedies, which may include liquidation of nonexempt assets, to protect the holders of claims or interests in the event plan payments are not made.

Aside from the mandatory provisions, a Subchapter V debtor’s plan may contain any additional provisions that are consistent with the Bankruptcy Code, such as modifying 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 to acquire the real property and was used primarily in connection with the debtor’s small business. This “lien stripping” is prohibited in “regular” individual Chapter 11 plans. Another benefit of the Subchapter V election is the ability to pay certain post-petition administrative expenses under plan. Under “normal” Chapter 11 rules, post-petition administrative claims must be paid in full in cash on the plan’s effective date. Subchapter V allows for a plan to provide for payment of trustee fees and “gap” claims through the plan.

Additional benefits of Subchapter V election are that a disclosure statement is not required in a small business debtor case, unless the court orders otherwise, and there is no specified confirmation deadline.

Plan Confirmation

In order to confirm a plan for reorganization, a Subchapter V debtor must satisfy certain plan confirmation requirements. For a consensual plan where all parties agree to the terms of a proposed plan, the court will confirm a Subchapter V debtor plan that meets the same confirmation standards applicable to reorganization plans in “normal” Chapter 11 cases. When a proposed plan is contested by a creditor, the court will still confirm a debtor’s plan as long as the proposed plan (1) does not discriminate unfairly and (2) is fair and equitable to each class of claims or interests that is impaired under, and has not accepted, the plan. This is because under Subchapter V, unlike a “normal” Chapter 11, a plan need not provide that all classes of creditors vote to accept the plan or not be impaired by the plan. Nor must it require at least one impaired class accept the plan. A proposed plan for reorganization under Subchapter V isn’t required to pay unsecured creditors in full and the “absolute priority rule” requiring a nonconsenting class of creditors or interest holders to be compensated in full before any junior class may receive or retain property under the plan does not apply, thereby making it more likely that a contested plan will be confirmed by the court.

A Subchapter V debtor’s plan is “fair and equitable” as long as all of the following requirements are met.

  • As to secured claims, the plan must provide one of the following options: (1) the secured creditor retains its lien on the property (collateral) and receives deferred payments until paid in full; (2) the property is sold free and clear of liens, with the creditor’s lien to attach to the sale proceeds; or (3) the secured creditor is provided with the “indubitable equivalent” of its claim.
  • The proposed plan must also provide that all of the debtor’s projected disposable income to be received in the 3-year period (or such longer period not to exceed 5 years) will be applied to make payments under the plan or the value of the property to be distributed under the plan period is not less than the debtor’s projected disposable income. “Disposable income” is income that is received by the debtor and that is not reasonably necessary to be expended for the maintenance or support of the debtor or a dependent of the debtor, or a post-petition domestic support obligation, or the payment of expenditures necessary for the continuation, preservation, or operation of the debtor’s business.
  • The proposed payments under the plan must also be feasible, meaning the debtor will be able to make all payments under the plan or there is a “reasonable likelihood” the debtor will be able to make all payments under the plan. The plan must also provide remedies, which may include liquidation of nonexempt assets, to protect the holders of claims or interests in the event plan payments are not made.
To better comprehend the significance and benefits of Subchapter V, it is important for potential debtors to speak with counsel to go over a strategy for reorganization. Subchapter V provides businesses with powerful tools to resolve their financial issues. For more information or any questions concerning your business’s current financial challenges, please contact Paul Kurtzhall at Hallstrom, Klein & Ward, LLP at (949) 450-8500.

For more information regarding Subchapter V reorganizations, click here.

I wish I have the right words to describe my exceptional experience with Grant Hallstrom and his incredible team. When time comes to count on someone reliable to understand your situation and help you going through challenges, Grant is the best ally. He was more knowledgeable and involved in my case that I could be myself, analyzing and anticipating every aspect of it in order to bring it to a great resolution. The level of expertise and professionalism reflect the outstanding result from a desperate situation to a life changing experience. I couldn’t be more grateful for what he did for my family and my business. Very humbly, thank you Grant.

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