In this COVID-19 environment, we are hearing one giant company after another (mostly retail-related) filing for Chapter 11 bankruptcy protection. Since Chapter 11 requires significant cash up-front and may take years and require costly professional service teams to implement, it is not often a viable solution to small-business organizations. In response to this dilemma and well before the onset of the pandemic in the United States, Congress passed the Small Business Reorganization Act of 2019 (the “Subchapter V” Act).

As small-business organizations throughout Michigan seek to identify avenues to survive the economic fallout from the pandemic, Subchapter V may provide a welcome lifeline that was not previously available.

Why is the Chapter 11 process not suited for small businesses?

A Chapter 11 bankruptcy is typically a “reorganization,” where the debtor company is able to shed certain debt and emerge from the bankruptcy process, at least theoretically, a stronger, leaner entity. In practice, the Chapter 11 process requires significant up-front cash or access to cash. Further, the road to a successful plan can take years, and the debtor entity can become financially swamped with professional fees, addressing priority issues, and making deals to achieve a plan. In fact, some studies suggest that Chapter 11 “success rate,” which is companies that emerge following a successful plan, is only about 10% to 15%.

Who would benefit from filing Subchapter V?

The Subchapter V Act applies to a person or entity, other than the owner of a single asset constituting real estate, who is engaged in commercial or business activities, and who has aggregate non-contingent, liquidated secured and unsecured debt of not more than $7.5 million. Originally, the debt limit was a little over $2.725 million, but the CARES Act increased the limit to expand the applicability of the Subchapter V Act due to the economic impact of the COVID-19 pandemic.

How does Subchapter V differ from Chapter 11?

The intent behind the Subchapter V Act is to streamline the Chapter 11 process for small businesses. While a Subchapter V debtor still has the benefit of a stay of actions, many of the typical deadlines are shortened, and certain obligations are lessened. For example, the deadline to file a plan is 90 days, compared with a typical Chapter 11, which allows for up to 18 months under certain circumstances. Further, the Subchapter V debtor will not have to deal with or pay for, a creditor’s committee, which often constitutes a major expense to a Chapter 11 debtor. Instead, a standing Chapter V Trustee is appointed. Finally, the Subchapter V debtor is not subject to the Absolute Priority Rule, which essentially requires more senior debtors to be paid before junior creditors, or agree to accept less. This is a huge benefit to a Subchapter V debtor, and provides for much more flexibility in dealing with creditors.

While the new Subchapter V is intended to provide a small business with flexibility and a more cost-effective means of reorganizing through bankruptcy, the devil is always in the details. This article only touches on a few of the key aspects of the new act. Get in touch with an attorney who specializes in bankruptcy to see if this option will work for you.