This article appeared in The Daily Business Review on March 25, 2021.
Commentary provided by Jaime Leggett.
Author Update: On Saturday, March 27, 2021, President Biden signed the “COVID-19 Bankruptcy Relief Extension Act” into law, which – among other things – extended the increased debt eligibility threshold until March 27, 2022.
“The COVID-19 pandemic has brought incredible difficulties to businesses across the nation. In an attempt to alleviate the pressure, Congress passed the 2020 CARES Act, which provided many forms of stimulus.”
One component of the act increased the maximum debt limit from $2,725,625 to $7.5 million for Subchapter V bankruptcy filings under the Small Business Reorganization Act. In other words, Subchapter V used to be available only to businesses with no more than $2.7 million in debt. The CARES Act raised that limit to $7.5 million, making Subchapter V available to millions of more businesses.
Subchapter V was designed to provide for a streamlined reorganization process that is easier and less expensive than a regular Chapter 11 case. It has proven to be a savior for many small businesses, with various courts around the country calling it a success. However, the debt ceiling is set to return to its original level on March 27, 2021, unless Congress acts. As such, many believe that a spike in Subchapter V filings may be coming this month.
Two senators (Dick Durbin (D-IL) and Chuck Grassley (R-IA)) recently introduced the COVID-19 Bankruptcy Relief Extension Act, to extend the increased debt ceiling for another year. Still, its passage is by no means certain. Its enactment may be complicated because the proposed legislation also seeks to amend the Bankruptcy Code to address other issues related to COVID-19 (to ensure that relief payments related to COVID-19 do not get treated as income and to permit Chapter 13 debtors to modify plans due to COVID-related financial hardships). It is also unclear whether Congress has the desire or the focus to act on this issue quickly. The Consolidated Appropriations Act that went into effect on Dec. 27, 2020, contained provisions relating to Subchapter V but neglected to extend the $7.5 million enhanced eligibility debt ceiling, suggesting that an entire category of smaller businesses may soon become ineligible to seek relief under Subchapter V.
Given the possibility that the debt ceiling may soon reset to $2,725, 625, many think that those struggling businesses affected by the change will evaluate their options and potentially file bankruptcy petitions before March 27, 2021. The window for this evaluation is swiftly closing given the lead time required for bankruptcy filings, but the potential benefits are clear. A Subchapter V filing has numerous advantages over a regular Chapter 11 case. To start, the proceeding can be substantially cheaper because there is no disclosure statement, no U.S. trustee fees, and no official committee of unsecured creditors (whose legal fees are otherwise paid from the bankruptcy estate). While some had questioned whether the Subchapter V trustees required by the Small Business Reorganization Act would be a burdensome administrative cost, most are finding that the trustees are beneficial to the process of formulating a plan of reorganization that is supported by creditors. The trustee’s independent role is intended to facilitate consensus building with creditors, permitting the trustee to function in some ways as a mediator. Next, the owners can maintain their ownership of the business. Normally, the “absolute priority rule” precludes equity from receiving anything on account of their interests until creditors are paid in full, with a notable “new value” exception where the equity holders provide a new capital contribution. In a Subchapter V proceeding, this rule has been eliminated. Finally, only the debtor may file a plan, effectively meaning that it determines what reorganization options shall be submitted to the court for approval. However, it must do so within the first 90 days after the bankruptcy filing. While the tight timeframe may be initially viewed as a burden, debtor’s usually benefit from a shorter reorganization process. In other words, the faster they can get out of bankruptcy the better.
Admittedly, there also are negatives of Subchapter V coming to light. Namely, the need to pay creditors using future “disposable income” has resulted in a level of uncertainty because that “disposable income” is determined by financial projections going forward three to five years and formulated by the debtor. Because of COVID-19 and its business impacts, it has become harder to determine what a given debtor’s revenues will be over the next year, much less the next three to five years, but these projections are key to determining how much money will be paid to creditors. Given that these projections are a necessary part of the plan, they must likewise be finalized on the same 90-day timetable. It is too early to tell how exactly bankruptcy judges will evaluate the feasibility of projections coming off a pandemic. However, it will likely be a case-by-case, fact-intensive analysis, which may open the door to costly legal disputes. Nonetheless, given the impending March 27 deadline, businesses with between $2,725,625 and $7.5 million in debt have a limited window available in which to evaluate the risks and rewards of a Subchapter V. If your business is struggling, now is a good time to check your balance sheet and call an experienced bankruptcy lawyer, before your options become more limited.