What Types Of Business Debtors Are Eligible To File A Subchapter V Bankruptcy?

Let’s first review a few basics. In February of 2020, the Small Business Reorganization Act was enacted. It created a new subchapter V within the existing Chapter 11 framework for small business filings under Chapter 11 of the United States Bankruptcy Code referred to as Subchapter V. The goal was to give businesses with debts within a certain threshold a more streamlined and less expensive option for reorganizing within Chapter 11 to minimize the high cost and complexity of Chapter 11 increasing the odds for small businesses to successfully reorganize.

A business to qualify as a Subchapter V Debtor must fit within the definition in the Bankruptcy Code under Section 101(51)(d) as a person currently engaged in commercial business activity with not more than $7.5 million in total secured and unsecured debt with 50% of the debt arising from commercial or business activities of the debtor. On March 27, 2021, the debt limit will be reduced to $2.75 million unless extended by Congress. Further, entities that are “single-asset real estate”, meaning their sole purpose is to own and manage real estate are excluded from Subchapter V. That type of entity is not eligible to be a debtor under the Small Business Reorganization Act. There are some legal challenges to the definition of the term “currently engaged in business”. Some of the courts have been fairly liberal evaluating this standard. The case law will evolve as new cases filed under Subchapter V of Small Business Reorganizations proceed in Chapter 11 as interpreted by the Bankruptcy Courts.

How Important Is The Pre-Petition Planning Part Of The Bankruptcy For A Subchapter V Plan Of Reorganization? What Can I Do To Help My Attorney With This Process?

Because the Small Business Reorganization Act is a streamlined process, the ability of the debtor to successfully reorganize their affairs is entirely dependent upon how organized they are, what their financial circumstances are, and if the debt situation is manageable. It can be problematic attempting to exit Chapter 11 without having a financial outline of a plan prior to case filing. In Small Business Reorganization cases, there is a strict deadline to file a plan within 90 days after the date of the case filing. In a Small Business Chapter 11 a status conference in the case is required 60 days after the filing. A significant part of the mandatory topics to be addressed with the court are the essential terms of the proposed plan of reorganization under review with Debtor’s counsel and the Sub Chapter V Trustee. Therefore, successful completion of a Subchapter V case in Chapter 11 is dependent upon a projected outcome even before you ever file due to the strict timelines moving forward.

Will A Subchapter V Plan Of Reorganization Wipe Out All Of Our Debts, Both Secured And Unsecured?

A Subchapter V plan of reorganization successful can result at confirmation for the discharge of creditor claims. However, the confirmation depends upon the plan terms and if creditors vote in favor of a Plan that devotes an entities “projected disposable income” to payment of creditors debt over a 3-to-5-year term. A plan of reorganization is a contract with creditors. For example, the debtor may confirm a plan paying unsecured creditors 50 cents on the dollar over 3 years. If the creditors support the Plan and vote in favor of the plan, 50% of the debt would be discharged at the time of confirmation. Nonetheless, the other 50% of the debt would not be discharged because that debt is to be repaid by the reorganized debtor pursuant to the plan of reorganization.

Secured creditors will retain their liens in these cases. One significant change to the law in Subchapter V is that secured parties holding a security interest in the debtor’s principal residence can have their claim modified if the security interest was not used to acquire the property but was used primarily for the debtor’s business. This scenario may arise where there is a second lien against the owner of a company’s home undertaken in order to finance the business. The lien subject to modification cannot be a purchase-money mortgage, where an individual borrows money to first acquire a home. The lien that potentially can be modified must derive from the financing of the business. When the valuation of a home at a fair market price is considered after subtraction of the total amount owed to all secured claims, some portion of that secured claim can be reclassified an unsecured claim to be addressed in the plan.

Will A Subchapter V Plan Of Reorganization Take Care Of Our Business Tax Obligations?

Tax debts owed by a debtor have certain categories of priority under the Bankruptcy Code. This is complex area. However, claims for withholding taxes—what are known as 941 taxes for withholding for employees, or sales tax obligations under state law—are non-dischargeable claims. There may be flexibility in addressing how those claims are paid through the plan. Sometimes, those are secured tax claims, which have to be paid with some market rate of interest. It is unlikely, however, that most business tax obligations, which often fit into the category of non-dischargeable debts, would be eliminated. The resolution of tax claims can be mitigated through payment in a plan over a five-year period, which is a fairly standard period for these claims to be addressed.

It is important to emphasize that a debtor in Chapter 11 must remain current with all post filing expense obligations. These are administrative claims to be paid during the pendency of the Chapter 11 case.

For more information on Small Business Reorganization Act, an initial consultation is your next best step. Get the information and legal answers you are seeking by calling (908) 373-8500 today.