Subchapter V Eligibility: Recent Trends

The Small Business Reorganization Act (SBRA) became effective in February 2020.[1] The SBRA, or subchapter V, is intended to encourage small businesses to use the Bankruptcy Code to reorganize by reducing the costs and administrative burdens associated with a typical chapter 11 case. For example, a disclosure statement is not required unless the court orders it;[2] a trustee is automatically appointed to assist the debtor in developing a plan;[3] there are no quarterly U.S. Trustee fees;[4] only the debtor may propose a plan;[5] and there are strict timelines that require subchapter V debtors to move the case quickly toward confirmation.[6]

Recent articles analyzing the first year of subchapter V cases show that small businesses are taking advantage of this new law and the streamlined bankruptcy process it created. Indeed, there were approximately 1,537 subchapter V cases filed in the first year since the law took effect (through Feb. 18, 2021).[7] Originally, the debt limit for a debtor to elect subchapter V was $2,625,625 in aggregate noncontingent liquidated secured and unsecured debt.[8] However, the Coronavirus Aid, Relief, and Economic Security (CARES) act temporarily raised the debt limit to $7.5 million until March 27, 2021[9] — and the COVID-19 Bankruptcy Relief Extension Act recently extended this temporary increase to March 27, 2022.[10] This means that subchapter V will be a viable option for even more small businesses over the next eight months, so practitioners should be aware of the common objections to proceeding under subchapter V.

Recent Trends

Much of the litigation surrounding subchapter V deals with who may proceed — and when — under subchapter V. A debtor under subchapter V must be engaged in commercial or business activities and may not exceed the debt limit discussed above.[11] Additionally, at least 50 percent of the debt must arise from the commercial or business activities of the debtor.[12] Subchapter V is not available for single-asset real estate projects or entities subject to the reporting requirements under section 13 or 15(d) of the Securities Exchange Act of 1934.[13]

Initially, subchapter V case law focused on whether debtors could amend their bankruptcy petitions to elect treatment under subchapter V if their cases were already pending when the law took effect or whether a debtor could convert an existing case under a different chapter to subchapter V if the deadlines of subchapter V had passed. The majority of cases found that debtors could amend their petitions or elect to proceed under subchapter V.[14] However, in cases where the election was made well into the case, some courts emphasized the timing of the debtor’s election to proceed under subchapter V, noted the tight deadlines found in subchapter V, and found that an election made too late, if unjustified, would not be allowed.[15] Even now, more than a year after the SBRA took effect, courts are still grappling with iterations of this question, including whether to extend the tight deadlines in subchapter V to allow for more elections and/or conversions.[16]

Another question is whether hotels — which were devasted during the pandemic — constitute single-asset real estate businesses. This inquiry is critical, since single-asset real estate businesses may not elect subchapter V treatment. Indeed, creditors and other parties-in-interest may object to subchapter V treatment when there is an argument that the subchapter V debtor is a single-asset real estate business. This has led to several decisions analyzing whether certain small business debtors, like hotels, are single-asset real estate debtors, and further refinement of the term itself.[17]

Another area of eligibility dispute is whether a debtor must be presently engaged in business or commercial activities to elect treatment under subchapter V. Recent cases suggest that the answer is yes,[18] but there is not unanimity on this issue.[19]

Additionally, creditors and other parties-in-interest may object to a debtor’s election to proceed under subchapter V if they believe the debtor is over the debt limit or that 50 percent of the debt does not arise from the commercial or business activities of the debtor. In the COVID-19 legislation context, at least one court has found that a debtor’s obligation for funds received under the Paycheck Protection Program was contingent and unliquidated on the petition date, so it did not count toward the debtor’s debt limit and the debtor could proceed under subchapter V.[20] Another court found that a debt based on the settlement and distribution of marital property was not a business or commercial debt, so the debtor did not have at least 50 percent of his debt from commercial or business activities; consequently, the debtor could not proceed under subchapter V.[21]

These considerations are important to understand because even more small businesses will likely elect treatment under subchapter V as the temporary debt limit increases remain and the economy continues its post-pandemic recovery. Practitioners must be equipped to handle these questions and the various fact patterns that will arise under this new law.