Subchapter V: A Big Deal for Small Businesses.

• Date: 01 January 2023
• Author: Stok, Robert A.,Sandler, Tuvia,Sachs, Sam
• Published date: 01 January 2023
• Author: Stok, Robert A.

The importance of the viability of small businesses to the national economy cannot be overstated. According to the U.S. Small Business Administration, "Small businesses are the lifeblood of the U.S. economy: they create two-thirds of new jobs and drive U.S. innovation and competitiveness... [accounting] for 44[%] of U.S. economic activity." (1)

Yet, until recently, small businesses facing financial challenges had little hope of survival. Reorganization through Ch. 11 of the Bankruptcy Code was not a realistic option due to its enormous cost. And liquidation in state court proceedings or bankruptcy would close the business. These important businesses could, therefore, not survive the economic turbulence larger companies could weather.

The recently enacted Small Business Reorganization Act (SBRA) (2) gives small businesses a new tool under the Bankruptcy Code to address financial challenges. The SBRA, which became effective February 19, 2020, added subchapter V to Ch. 11 of the Bankruptcy Code. (3) Subchapter V creates a streamlined process for small businesses to reorganize by creating a plan to repay creditors over three to five years, avoiding the liquidation of the business. The new subchapter V process removes many obstacles small businesses face under a Ch. 11 plan, making reorganization more affordable and realistic for smaller debtors.

At first, subchapter V could be used only by debtors with a maximum debt of $2,725,625. (4) Congress temporarily increased this limit during the COVID-19 outbreak to $7.5 million, (5) and ultimately amended Title 11 in June 2022, with the signing into law of the Bankruptcy Threshold Adjustment and Technical Corrections Act to make the increase permanent. (6)

This article discusses the background of subchapter V's enactment and contrasts traditional Ch. 11 and subchapter V cases from the perspective of debtors and creditors. It also contrasts subchapter V proceedings with Florida state court insolvency proceedings. Finally, the last section of the article questions the interpretation of subchapter V and poses some hypotheticals that courts and bankruptcy petitioners may have to resolve as subchapter V bankruptcy law begins to develop.

Purpose of Subchapter V

Many distinctions between traditional Ch. 11 cases and subchapter V cases are more easily understood with the backdrop of the purpose of subchapter V's creation.

Congress enacted subchapter V to "streamline the bankruptcy process by which small businesses debtors reorganize and rehabilitate their financial affairs." (7) Statements by members of Congress in the Congressional Record reflect this sentiment among the bill's backers. Citing economic data, Rep. Sheila Jackson Lee, DTexas, explained that "approximately 20[%] of small businesses survive the first year, but by the five-year mark only 50[%] are still in business and by the [10]-year mark only one-third survive." (8) Rep. David Cicilline, DR.I., stated, "It is essential that our bankruptcy system does not punish entrepreneurship and investment by foreclosing opportunities for small business to financially reorganize." (9)

These sentiments become apparent when reviewing the options available to small businesses before enactment of the SBRA. Before subchapter V was created, traditional Ch. 11 bankruptcy posed a very high financial barrier to a small business seeking to reorganize without liquidating, with one article estimating costs at between one to 5% of a debtor's total assets. (10) With the filing of a traditional Ch. 11, the debtor assumes responsibility for paying fees of not only its own bankruptcy counsel and other professionals, but also professionals of the unsecured creditors' committee that is automatically appointed in the case and any other official committee appointed in the case. (11) Similarly, the debtor must make quarterly payments to the U.S. Trustee ranging from $250 to $250,000, calculated based on the size of the debtor's disbursements in any quarter until the case is completed. (12)

Similarly, traditional Ch. 11 timelines typically hinge on a debtor's ability to garner consensus around a plan of reorganization. In traditional Ch. 11 cases, a debtor must propose a plan within 120 days of filing for bankruptcy (13) and confirm a plan within 180 days of filing. (14) The court can extend these deadlines. (15) Once the deadlines have passed, any other party in interest may propose a plan of reorganization. (16) Because of the multiple restrictions around confirming a nonconsensual plan, a Ch. 11 debtor usually must work diligently to formulate a plan that is accepted by all classes of creditors. This results in extensive negotiations with multiple parties and often causes the deadlines for plan confirmation to be stretched out for months and even years.

Finally, Ch. 11 constrains a debtor's ability to act independently. Once in bankruptcy, the court must authorize any transaction not within the course of the debtor's regular business. This includes everything from the sale of assets and the payment of debts to the taking on of additional debt and hiring of officers to assist in the restructuring. (17) A debtor must obtain court approval before it takes any of these steps, often resulting in extensive court briefing and hearings, all usually paid for by the debtor.

Thus, a company could only justify a traditional Ch. 11 filing if the expected refinancing or restructuring from the bankruptcy outweighs the costs and obstacles to routine business. These financial burdens make filing for Ch. 11 unjustifiable for small businesses. Struggling small businesses were, therefore, left with trying to reorganize their businesses while also fending off their creditors, each of which might bring its own lawsuit. Or they could liquidate their businesses through state court "assignment for the benefit of creditors" proceedings or under Ch. 7 of the Bankruptcy Code. Before proceeding to the intricacies of subchapter V and its significant benefits, an overview of non-bankruptcy proceedings available in Florida to a struggling business is in order.

Florida State Court 'Assignment for the Benefit of Creditors' Proceedings

Under F.S. Ch. 727, Florida law establishes a form...