Congress' Failure to Extend Subchapter V Debt Limit Hurts Small Businesses

Bankruptcy practitioners have long recognized that traditional Chapter 11 reorganizations are too complicated, too lengthy and too expensive for any but the largest businesses. Small, generally family-owned, businesses were simply priced out of the process. To remedy this, Subchapter V made some key changes to the Bankruptcy Code to make the process more efficient in smaller cases.

• Created the Subchapter V trustee: Unlike a normal bankruptcy trustee who takes over the assets or operates the debtor's business, a Subchapter V trustee assists the debtor in navigating the bankruptcy process. A Subchapter V trustee advises the debtor and helps to negotiate the plan of reorganization. He or she often acts as an informal mediator between the debtor and its creditors.
• No "absolute priority" rule: Typically in bankruptcy, assets are distributed in a strict hierarchy—secured claims, administrative claims, unsecured claims, and then equity. As a result, the owner may be more likely to lose the business. In Subchapter V, the owner generally retains ownership of the business.
• Streamlined the plan of reorganization process:
  • The debtor must file a plan of reorganization within 90 days.
  • While it must disclose its financial condition, the debtor is not required to file a formal disclosure statement. A disclosure statement is a complicated document (similar to a securities offering) that is distributed to the creditors before they vote on a plan of reorganization. The statement must be approved by the court in advance and is often the subject of extensive negotiation and litigation. By eliminating the disclosure statement, Subchapter V not only gets rid of an expensive document but also some collateral litigation.
• Allows non-consensual plans: Typically in bankruptcy at least one "impaired" class must vote in favor of the plan. An impaired class is one whose rights are modified by the plan—typically, by receiving less than the full amount of their claims. In contrast, Subchapter V allows a plan to be confirmed over the creditors' objections so long as the plan provides that the debtor will use all of its disposable income for a period of at least three years to make payments under the plan and provides some means of enforcement.
  • If the plan is consensual (all impaired classes vote in favor), then the debtor receives an immediate discharge. If not, the debtor's discharge is delayed until the debtor makes all payments required by the plan for a period of at least three years.

Eligibility for Subchapter V is limited. The debtor, which can be an individual or an entity, must be engaged in business or commercial activity and at least half of its debts must be from that activity. Public companies and their affiliates are ineligible as are entities that primarily hold a single real estate asset. The biggest limitation, however, is the amount of debt owed.

As originally passed, Subchapter V was limited to debtors who owed less than $2.7 million in total liquidated, non-contingent debt. While the debt limit is indexed to inflation, it is relatively low. Shortly after Subchapter V became effective, the COVID pandemic began. Due to the pandemic, Congress temporarily increased the debt limit to $7.5 million.