A Chit-Chat About Small Business Insolvency: A Deep Dive into Chapter 11, Subchapter 5

Hey, remember August 2019? It feels like decades ago, doesn’t it? Well, it wasn’t just the calm before the COVID-19 storm, it was also when the movers and shakers in Congress passed the Small Business Reorganization Act (SRBA) which kicked into gear in February 2020. Oops! I think someone forgot to forecast a looming pandemic.

It’s challenging all over right now, especially for our small business friends. Perhaps SRBA is the silver lining they need to keep the ship afloat. Let’s talk about what this fresh law entails and its impact on small business bankruptcy.

Small Business Insolvency: Why Should You Care?

When all this pandemic chaos subsides, we can expect an uptick in Subchapter V elections. Creditors and lenders, heads up! Be ready for a change in the typical Chapter 11 narrative because of SRBA.

Struggling businesses have been waiting for a lifeline like SBRA. It might be the game changer for the businesses who felt they were “too broke” to reorganize themselves through Chapter 11. They’re hopeful this could eliminate some of those annoying bureaucratic traps set by The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA).

BAPCPA was supposed to make filing for Chapter 11 a cakewalk. But alas, it ushered in more reporting hoops to jump through and other burdens that nullified any potential perks.

Subchapter V and BAPCPA share some common DNA. Both have a one-step confirmation and include new provisions that aim to make Chapter 11 filing an easier pill to swallow for small businesses.

Observations on Non-Contingent Debt Limit

For the most part, Subchapter V caters solely to a business debtor with non-contingent, secured, and unsecured debt totaling $2,725,625 or less. However, there’s an exception. Businesses that rely heavily on single property-based income are crossed off the list regardless of their debt numbers.

Most small businesses safely fall with that debt band, but a couple – perhaps the cozy mom-and-pop shops with a single store or small firms with intimidating debt numbers – could clash with this stipulation.

Let’s also consider lenders who might be tempted to hand out extra credit to borderline borrowers to effectively disqualify them. On the flip side, borrowers desperate to qualify might frame their debt as contingent or disputed.

There’s a consensus that the debt ceiling is set too low. Interestingly, the National Bankruptcy Conference were eyeing a higher debt cap for Chapter 11 even pre-COVID-19.

Congress offered a temporary solution to these worries in March by increasing the cap to $7,500,000 for the next year. This boost was bundled with the Coronavirus Aid, Relief, and Economic Security (CARES) Act and aimed to cater not just to small entrepreneurs, but also their suppliers, clients, creditors, and employees.

Right now, it’s anyone’s guess whether Congress will tweak the debt cap further or prolong the revised cap.

Insights on Debt Duration

This part is pretty cool. Subchapter V permits debtors to spread their debt across a 3 to 5 year timeline. So long as a debtor dedicates their disposable income to the debt within that period, all’s good. This setup aids both sides really.

Debtors get the luxury of time to settle their financial affairs and can spread their payments over a longer period, dodging hefty amounts. Creditors get a sigh of relief as debtors are less likely to default on longer-term payments.

The administrative expenses aren’t identical between Subchapter V and Chapter 11 cases. The upfront payment of administrative costs at plan confirmation is mandatory in traditional Chapter 11 cases. Meanwhile, Subchapter V enables the administrative expenses to be paid over the life span of the plan.

Whether it’s Subchapter V or Chapter 11, debt isn’t completely discharged till all planned payments are made by the debtor.

Gist of Filing Procedures

The rules state that Subchapter V debtors must submit their reorganizing strategy within 90 days of declaring bankruptcy. This encourages a quick resolution to the bankruptcy cases, which is crucial in our COVID-19 circumstances.

If a debtor can’t accommodate a reorganizing plan within 90 days, they can plead for an extension. The ‘yea or nay’ lies in the hands of the bankruptcy court. The court assesses if the circumstances were beyond the control of the debtor.

Given the pandemic, courts are more inclined towards approving extensions.

Trustees – Who’s In, Who’s Out?

Typically, trustees enter the picture only in particular Chapter 11 cases. However, for Subchapter V cases, they’re always on the roster. Subchapter V trustees’ job revolves primarily around oversight, while the debtor retains the reins of their assets and operations.

What About Creditors’ Committees?

In traditional Chapter 11, creditors’ committees are commonplace, but in Subchapter V they need a solid cause to justify their existence.

Subchapter V trustees mainly function to devise a standard plan in tandem with the debtor and creditor. Auditing the debtor’s finances is within their compass, but their foremost role is mediation.

Congress imposed this because they feel impartial third-party interventions increase the chances of a mutually beneficial resolution between the debtor and creditors. This is particularly beneficial for small businesses whose creditors may be on edge because of the pandemic.

Trust this task to the Department of Justice. They handpicked about 250 Subchapter V trustees from a pool of over 3,000 applicants.

Incentives Under Subchapter V

Unlike the usual Chapter 11 filings, Subchapter V offers protection to small entrepreneurs from a plethora of negative circumstances.

For instance, if the main debtor used their primary residence to secure a loan for their small business, options for loan modifications are available.

Plus, the ‘new value rule’ does not apply in Subchapter V. This rule demands equity holders to give ‘new value’ if they wish to retain their equity interest in the enterprise.

Adapting to Unprecedented Times

COVID-19 has put steady businesses off balance. It’s forcing small businesses into contemplating insolvency. In normal times, Chapter 11 is seen as the last-ditch effort. But these times are anything but normal.

Perhaps it’s time for many small businesses to press the pause button. And oddly enough, small business bankruptcy is that pause button. This breather allows more wriggle room to negotiate with lenders, landlords, and other creditors.

These negotiations buy a precious commodity – time. Everyday operations can resume once the pandemic is under control.

Still, small businesses should think long and hard before making this leap. Should they file for Subchapter or look at other available alternatives? This decision needs careful thought. Consider this, the Borrower Application Form clearly states that bankruptcy applicants don’t qualify for the Paycheck Protection Program (PPP).

Another important factor is timing. When PPP dries up, there’s likely to be a surge of Subchapter V applications. This sudden influx may strain small enterprises in critical need of timely support.

Subchapter V: An Option for Individuals

Good news is, individuals can also benefit from the new Subchapter V bankruptcy. If an SBA personal guarantor has pledged their house as a guarantee for an SBA loan, this could be a game changer. A small business debtor’s plan has the power to modify the rights of a holder of a claim secured by the debtor’s principal residence if:

— the new value didn’t primarily go into acquiring the real property; and

— the new value was invested mainly into the debtor’s small enterprise.

So, in case of a defaulted SBA loan, there’s a chance to keep your house without settling the full amount of the lien in a lump sum with the lender.

Help for Small Businesses: Clarifying Doubts, Providing Solutions

In such tough times, it’s crucial for small enterprises to pin down solutions that fit their situation. They need to be strategic and ready to ride out the storm.

Why Choose Lawscape and Lawscape to Help with Your Treasury or SBA Debt Issues?

We’ve successfully negotiated and resolved multi-million dollar SBA Debts through Offer in Compromise and Repayment Agreements, sparing our clients from resorting to bankruptcy and facing Home Foreclosure.

We’ve also successfully shielded clients from multi-million dollar Treasury Debts through AWG Hearings, Treasury Offset Program Resolution, Cross-servicing Disputes, Private Collection Agency Representation, Compromise Offers and Negotiated Repayment Agreements.

Our attorneys, authorized by the Agency Practice Act, are seasoned professionals who represent Federal Debtors nationwide before the SBA, The SBA Office of Hearings and Appeals, the Treasury Department, and the Bureau of Fiscal Service.