To Choose Subchapter V, or Not to Choose Subchapter V? That is the Question

As most bankruptcy practitioners know, Congress adopted the Small Business Reorganization Act of 2019 (SBRA) in August 2019.[2] It took effect on Feb. 19, 2020, and is codified as subchapter V of chapter 11, title 11, U.S. Code, 11 U.S.C. §§ 1181-1195. The purpose of this article is to provide a brief summary of the factors weighing in favor of a prospective chapter 11 debtor’s choosing to file a subchapter V case, and a frame of reference for further exploration.

The SBRA affects many sections of the Bankruptcy Code (title 11, U.S. Code, the “Code” or the “Bankruptcy Code”). They are listed at 11 U.S.C. § 1181.[3]

• Section 1181(a) provides that the following Code sections do not apply at all: 105(d), 1101(1), 1104, 1105, 1106, 1107, 1108, 1115, 1116, 1121, 1123(a)(8), 1123(c), 1127, 1129(a)(15), 1129(b), 1129(c), 1129(e) and 1141(d)(5).
• Also, § 1181(b) provides that unless the court orders otherwise for cause, Code §§ 1102(a), 1102(b), 1103 and 1125 do not apply to subchapter V.
• Section 1181(c) provides that if a subchapter V plan is confirmed under § 1191(b), then Code § 1141(d) does not apply unless § 1192 provides otherwise.

All of the foregoing means simply that subchapter V is fairly self-contained.

Small Business Debtors

Who can proceed under subchapter V? A small business debtor.[4]

11 U.S.C. § 101(51D) defines what constitutes a small business debtor.[5] The definition was, in effect, amended by § 1113(a)(1) of the CARES Act,[6] but only as to cases commenced after the enactment of that statute (§ 1113(a)(3)). Section 1113(a)(1) amended 11 U.S.C. § 1182(1) to redefine “small business debtor” and raised the debt limit to $7,500,000. One year after the enactment of the CARES Act, 11 U.S.C. § 1182(a) will revert to its original definition under the SBRA.[7] Under either definition, the debt limit applies only to liquidated, noncontingent debts, so unliquidated and contingent debts are not included.

How Does One Become a Subchapter V Debtor?

Generally, a small business debtor becomes a subchapter V debtor by making an election in the petition.

The petition for nonindividuals is Form B 201.[8] Question 8 of the petition instructs subchapter V debtors as follows: “A debtor who is a ‘small business debtor’ must check the first subbox. A debtor as defined in § 1182(1) who elects to proceed under subchapter V of chapter 11 (whether or not the debtor is a ‘small business debtor’) must check the second sub-box.”

The petition for individuals, including those filing chapter 11’s, is Form B 101. Question 13 is where a small business debtor elects subchapter V.[9] There, the instruction says, “Are you filing under Chapter 11 of the Bankruptcy Code, and are you a small business debtor or a debtor as defined by 11 U.S.C. § 1182(1)? For a definition of small business debtor, see 11 U.S.C. § 101(51D).”

In addition to electing subchapter V upon filing the petition, the cases that have addressed a related issue[10] have held that a debtor that filed bankruptcy before the effective date of subchapter V (Feb. 19, 2020) can “convert” its case to subchapter V.[11]

Upon electing to proceed under subchapter V, the debtor must comply with 11 U.S.C. § 1116(1)(A) and (B),[12] as well as 11 U.S.C. §§ 308[13] and 1116(2), (3), (4), (5), (6) and (7).[14]

Factors Favoring Subchapter V

Why would a small business, as defined, choose to proceed under subchapter V? There are many reasons, all fostering the more streamlined, more expeditious, less expensive and less contentious confirmation of a chapter 11 plan.

• For the year following the enactment of the CARES Act on March 27, 2020, debtors with combined liquidated, noncontingent secured and unsecured debts of up to $7,500,000 can file under subchapter V. Debtors with debts up to that amount, with little income in light of the COVID-19 pandemic or other major setback (such as tornado damage), may find it advantageous to file in the near future.
• Unlike in a standard chapter 11 case, the debtor may continue to use its pre-petition counsel and other professional persons, even if the professional has not been paid in full pre-petition. Under 11 U.S.C. § 1195, a professional person may represent the debtor post-petition if it is owed less than $10,000 for pre-petition services.
• Under 11 U.S.C. §§ 1182(2) and 1184, the debtor functions as a debtor in possession unless removed by the court under § 1185. The debtor in possession has most of the powers of a trustee and can operate the business. § 1184. The grounds for removal of a debtor in possession are as one would expect: “for cause, including fraud, dishonesty, incompetence, or gross mismanagement ... before or after the date of commencement of the case,” or for failing to perform a confirmed plan. However, the debtor can seek, and may be granted, reinstatement as debtor in possession.[15] Under 11 U.S.C. § 1186(b), the debtor remains in possession of all of the property of the estate, unless otherwise provided under § 1185, or in a plan or an order confirming a plan.
• As in a standard chapter 11, the debtor must still deal with first-day motions, adequate protection and use of cash collateral. It may be hoped that these will be more streamlined than usual, since a plan must be filed sooner and confirmation requirements are more lenient, etc. Under 11 U.S.C. § 1194(c), the court may order that the trustee (see below) make the adequate protection payments. Presumably, the debtor in possession would argue that it should make its own adequate protection payments, as is usually the case in chapter 11.
• Under 11 U.S.C. § 1186, the property of the subchapter V estate is comparable to the property of the estate in a standard chapter 11 under 11 U.S.C. § 1115.
• By virtue of 11 U.S.C. § 1182(b), there are no creditors’, equity securityholders’ or other committees unless the court so orders.
• 11 U.S.C. § 1188(a) and (b) require a status conference with the court, within 60 days after the order for relief, unless the court extends this period due to circumstances for which the debtor should not justly be held accountable. The trustee (see below) attends the status conference, the purpose of which is “to further the expeditious and economical resolution of” the case. This allows the court to help tailor the case to the debtor’s particular circumstances. The conference should not be seen as a disadvantage to subchapter V, even though the debtor still must attend the initial case-management conference with the U.S. Trustee.[16] However, § 1188(c) requires the debtor to file, by 14 days before the status conference, a report “that details the efforts the debtor has undertaken and will undertake to attain a consensual plan of reorganization.” This must be served on the trustee and all parties in interest. Since discussions between a debtor in possession and other parties are often confidential, rather delicate, rapidly evolving, or all of the above, so filing and serving a “detailed” report could actually be a hindrance.
• In every subchapter V case, there is a trustee — either a standing trustee, or a trustee appointed by the U.S. Trustee.[17] Under § 1183(b)(3), the trustee has certain duties, primarily including:
  • to perform the duties listed in 11 U.S.C. § 704(a)(2), (5), (6), (7) and (9);
  • additionally, if the court so orders at the request of either a party in interest, the trustee or the U. S. Trustee, to perform the duties listed in 11 U.S.C. § 1106(a)(3), (4) and (7);
  • to appear and be heard in several instances: at the § 1188 status conference with the court (mentioned above), and hearings on valuation of encumbered property, plan confirmation, plan modification after confirmation, and sale of property of the estate;
  • to facilitate the development of a consensual plan;[18] and
  • if the debtor ceases to be a debtor in possession, to perform the duties listed in 11 U.S.C. §§ 704(a)(8) and 1106(a)(1), (2) and (6).[19]
• Only the debtor may file a plan.[20] Evidently, this is so even if the debtor has been removed as debtor in possession under § 1185. The debtor must do so within 90 days after the chapter 11 order for relief. If there is good cause for which the debtor should not justly be held accountable, the court may extend the 90 days.[21]
• As noted above, 11 U.S.C. § 1125, which requires that a chapter 11 plan be accompanied by a disclosure statement, does not apply, unless the court orders otherwise for cause.[22] If the court does order that § 1125 applies, then § 1187(c) provides that § 1125(f) (which otherwise applies in small business cases) applies. Under § 1125(f), a plan may itself contain adequate disclosure. The disclosure statement may utilize a standardized form. Final approval of a disclosure statement may be combined with confirmation of the plan, and the hearing on both the disclosure statement and plan confirmation may be combined. This would be likely to save a great deal of time and money in the confirmation process.
• 11 U.S.C. § 1190 lists what the subchapter V plan must contain, some of which would otherwise be in a standard disclosure statement. Under paragraph (1), the plan must include a brief history of the debtor’s business operations, a liquidation analysis, and projections to support the debtor’s ability to make payments under the plan.
• Similar to chapter 13 plans, the subchapter V plan must provide for all, or as much of the debtor’s future earnings or other income, to the supervision of the trustee (discussed below) as is necessary to perform the plan.[23]
• In an individual’s subchapter V plan, it is possible to modify the terms of a debt secured solely by the debtor’s residence. This is allowed if the new value received for the granting of the security interest was not used primarily to acquire the real property, and was used primarily in connection with the debtor’s small business.
• The requirements for confirmation in subchapter V are more lenient than in a standard chapter 11 case. 11 U.S.C. § 1191 sets forth the confirmation requirements. Section 1191(a) requires confirmation only if all the requirements of § 1129(a) are met, except for paragraph (15). Section 1191(b) provides that even if § 1129(a)(8), (10) and (15) are not met, the court, on the request of the debtor, shall confirm the plan if it does not discriminate unfairly and is fair and equitable to each impaired class that did not accept the plan. Thus, a plan can be confirmed without an accepting class that is normally required in a standard chapter 11. Subsections 1191(c) and (d) elaborate on § 1191(b).
  • Subsection (c) lays out what is “fair and equitable.” It incorporates § 1129(b)(2)(A) for treatment of secured claims, and it defines what must be paid out: either all the debtor’s disposable income for at least three years or up to five years from the first payment, or the value of the property to be distributed during such period if it is not less than such disposable income. The court must also find that the debtor will be able to make all of the payments, or at least that there is a reasonable likelihood thereof, and the plan must provide remedies in the event that payments are not made (such as liquidation of nonexempt assets with a description of how sale proceeds would be distributed, which would avoid conversion to chapter 7).
  • Subsection (d) defines “disposable income.” It is income that is not reasonably necessary for the support of the debtor or a dependent, a domestic support obligation, or payments necessary for the debtor’s business.
• Priority claims allowed under 11 U.S.C. § 507(a) can be paid through the plan, notwithstanding § 1129(a)(9)(A).[24]
• Since 11 U.S.C. § 1129(b) does not apply in subchapter V, the debtor can retain its interest in the business without contributing new value if the plan does not discriminate unfairly and is fair and equitable (per the above definition) as to each non-accepting class.
• What happens after confirmation?
  • Under 11 U.S.C. § 1183(b)(4), the trustee must ensure that the debtor commences making timely payments;
  • Generally, the trustee’s service terminates upon substantial consummation, unless the U. S. Trustee reappoints the trustee if needed to perform duties under § 1183(b)(3)(C) (post-confirmation plan modification) and 11 U.S.C. § 1185(a) (if the debtor was removed as debtor in possession);[25]
  • Within 14 days after the plan is substantially consummated, the debtor must file notice thereof and serve it on the U.S. Trustee, the trustee and all parties in interest;
  • Trustees will be paid under 11 U.S.C. § 330;
  • As provided in § 1194, the funds that the trustee receives before confirmation will be distributed according to the plan. If a plan is not confirmed, the trustee will return such payments to the debtor, minus certain deductions (administrative expenses, adequate protection payments and the trustee’s fee);[26] and
  • Unless otherwise provided in the plan or confirmation order, the trustee will make the payments to the creditors.[27] Presumably, most plans will provide that the reorganized debtor will make the payments in order to save ongoing fees to the trustee, especially since § 1183(c) states that generally, the trustee’s service terminates at substantial consummation. If the case has proceeded reasonably smoothly, it would not seem that the trustee’s services would be needed after that point, unless there is a post-confirmation modification. Reorganized debtors often make their plan payments.
• As with standard chapter 11 cases, a subchapter V plan can be modified before or after confirmation.[28]
  • Before confirmation, a plan can be modified so long as it meets the criteria of §§ 1122 and 1123, except for § 1123(a)(8);[29]
  • Likewise, if a plan has been confirmed, it can be modified before substantial consummation so long as it meets the criteria of §§ 1122 and 1123, except for § 1123(a)(8), and if circumstances warrant the modification and the court after notice and a hearing confirms the modified plan;[30]
  • The plan can be modified during the three- to five-year period of payments provided for in the plan if it still complies with § 1191 and if circumstances warrant the modification, and if the court after notice and a hearing confirms the modified plan.[31] As noted above, § 1191 sets the requirements for subchapter V plan confirmation. It lists subsections of § 1129 from which subchapter V is exempt and defines its own standard for what “does not discriminate unfairly and is fair and equitable” to nonaccepting classes, thus finessing the requirement that the debtor infuse new value in order to retain its ownership interest; and
  • Creditors and interest-holders are deemed to have accepted or rejected the post-confirmation modification in the same manner as they accepted or rejected the plan before confirmation, unless the holder changes the previous acceptance or rejection.[32]
• Under 11 U.S.C. § 1192, the debtor receives a discharge of all debts described in 11 U.S.C. § 1141(d)(1)(A), and all debts allowed under 11 U.S.C. § 503, after completion of payments during the three- to five-year period provided for in the plan. Exceptions are as follows:
  • The debtor has waived a discharge after the chapter 11 order for relief;
  • The last payment is due after the three- to five-year period provided for in the plan; and
  • The debt is nondischargeable under 11 U.S.C. § 523(a).
• Quarterly fees are not payable to the U.S. Trustee’s office.[33]

Other Choices

It bears mentioning in passing that a prospective debtor has another choice besides a standard chapter 11 and a subchapter V: A small business debtor, as defined in 11 U.S.C. § 101(51D), can file a small business case, which is defined in 11 U.S.C. § 101(51C). That section defines a small business case as a chapter 11 case in which the debtor has not elected subchapter V.[34]

Conclusion

For a small business that is within the prescribed debt limit either now or in a year, the factors weigh heavily in favor of utilizing subchapter V. The case is likely to proceed faster, with much less litigation and far less expense. Subchapter V should promote internal efficiency on the parts of the courts, staff and the U.S. Trustee program. It is likely that fewer professionals will have to be employed, saving vast expense. It is to be hoped that subchapter V trustees will be helpful in facilitating the expeditious administration of cases vis-à-vis the court and the U.S. Trustee, with the trustee’s fees at a reasonable level (partially offsetting the savings on the U.S. Trustee quarterly fees).