Bankruptcy for a Small Business Under Sub-Chapter V

by | Jan 28, 2021 | Bankruptcy, General Legal

Bankruptcy for Small Business Owners

Bankruptcy for a small business or an individual engaged in business has never been an easy thing. Assuming that you want to stay in business and you need to reorganize in order to address overly expensive leases, over-extension of secured credit, unsecured bills that have piled up, or a host of other issues, the barrier to entry into the bankruptcy system has always been high.

In late 2019, Congress acted to create a new program to allow small businesses to reorganize under the Small Business Reorganization Act or Subchapter V of Chapter 11 of the Bankruptcy Code. This new option, which became effective in February 2020, offers a more cost-effective and efficient path to reorganizing a small business, combining some of the benefits of Chapter 13 practice with the more powerful toolset available to bankruptcy clients in Chapter 11.

New Jersey bankruptcy lawyers at the Law Offices of Wenarsky & Goldstein, LLC can help small business debtors get their businesses back on their feet. If you are struggling with a huge debt, we can come up with a repayment plan you can afford and build a more stable financial future.

The Differences Between Subchapter 5, Chapter 13, and Chapter 11 Bankruptcy

Previously, a Chapter 11 case required a debtor-in-possession to incur very high costs to accomplish a reorganization. Part of the reason for this is that Chapter 11 cases are almost always done at an hourly rate.

Unlike Chapter 7 or Chapter 13 cases, even the simplest Chapter 11 case can be fraught with motion practice and litigation. This drives costs up and forces attorneys to charge hourly in order to make the cases worth taking on from the attorney’s financial standpoint.

In addition in a traditional Chapter 11 case, the debtor must pay quarterly fees to the United States Trustee’s Office based on quarterly disbursement records – e.g. what you pay out in expenses every month creates a quarterly fee obligation. This is on a sliding scale, with quarterly fees increasing as quarterly disbursements increase.

Moreover, typical Chapter 11 bankruptcy cases require that a business immediately pay back all administrative expenses as soon as the reorganization plan is approved. On the other hand, Subchapter 5 allows owners of small businesses to pay administrative costs over the length of their plan. Subchapter V cases have several features that can bring down the cost of such matters significantly:

Simplified Plan Proposals

The actual preparation of the Plan of Reorganization can be a major source of cost in a Chapter 11 matter. In a traditional Chapter 11 case, the debtor is required to prepare a disclosure statement to accompany the Plan. This is a detailed explanation of how the Plan will work for each class of creditors, the background of the Debtor, and a host of other information. The best comparison for this would be that the Disclosure Statement is a prospectus for the Plan.

This increases the cost of any case by a significant amount. In Subchapter V there are no disclosure statements. In addition, the Plan is a form plan which will vary by district. The forms are still very detailed and require far more time to prepare than a Chapter 13 case, but the overall cost is far less than a traditional Chapter 11 case.

No More Absolute Priority Rule

The next issue with Chapter 11 is the “absolute priority rule” which gives any class of unsecured creditors the power to essentially hijack a plan that would “cram down” the secured claim of a creditor by requiring that if such a now unsecured creditor class objected to the Plan or voted to reject it, then no junior class (including the debtor) could retain any property.

This could allow a relatively minor player to effectively hijack the plan confirmation process. The absolute priority rule applies in both individual and corporate cases, many times needlessly complicating the process. In a Subchapter V case that is no longer an issue as the bankruptcy code explicitly states that the absolute priority rule is not applicable in these matters.

Consent of Secured Creditors is No Longer Necessary

In a traditional Chapter 11 case, you need to have at least one class of impaired creditors (creditors who are not getting paid their whole claim or who are having their rights modified) accept the Plan of reorganization, under the United States Bankruptcy Code (11 U.S.C. §1129(10)).

Subchapter V allows for a top-down confirmation of the Plan if “if the plan does not discriminate unfairly, and is fair and equitable, with respect to each class of claims or interests that is impaired under, and has not accepted, the plan” (11 U.S.C. §1191(b)). You get a five-year period to pay under the Plan if a Plan is confirmed by the bankruptcy code under §1191(b).

Other Useful Features of Subchapter V Cases

The Role of the Trustee

In Subchapter V cases a trustee is appointed.  In Chapter 7 cases, the Trustee’s role is one of administration and liquidation of the Debtor’s estate. In Chapter 13, the Trustee’s role is as the overarching supervisor of the system and administrator of payments or disbursing agent.

In a recent discussion I had with a bankruptcy judge in the Southern District of New York, he characterized the role of the Subchapter V trustee as more of a counselor and advisor to the Debtor, who is to help reorganize the debtor. Indeed, the Trustee’s role is statutorily defined to “facilitate the development of a consensual plan of reorganization.” 11 U.S.C. §1183(b)(7).

The Trustees on the panel have a wide range of industry and legal experience (if they are attorneys).  They are really there to help the debtor and management (if there is management) pull the Debtor out of its financial problems and successfully reorganize.  This is a vast difference from the adversarial role that is taken by the Trustee in other case types.

Counsel Fees

Lawyers want to get paid for their work.  In traditional Chapter 11 cases, the attorney cannot be owed money before the case is filed. The way that this is usually handled is with a large retainer that is billed against right before filing for all pre-petition work. In addition, all attorney fees earned during the case have to be paid either through periodic fee applications or at the confirmation of the plan. Subchapter V allows for up to $10,000 in pre-petition fees to get rolled into Plan payments without disqualifying the debtor’s counsel and for payment of post-petition fees through the Plan.

No Quarterly Fees

In a traditional Chapter 11 case, the debtor must pay a quarterly fee to the US Trustee’s office based on disbursements that the Debtor makes in the preceding quarter. Subchapter V cases do not require that. This can save thousands over the life of the case.

How Can an Attorney Help with Your Business Bankruptcy Case?

Small businesses that can’t handle their secured and unsecured debts may have to consider bankruptcy filing. Although the Subchapter 5 bankruptcy process seems straightforward, that’s not always the case, and it can carry certain complications.

If your business is struggling and could use a reset, please contact the Law Offices of Wenarsky & Goldstein, LLC to arrange a consultation to see if your situation is right for a Subchapter V case. You owe it to yourself and your business.

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