When the CARES Act was signed into law in March, almost all of the media attention was devoted to the rollout of the SBA Paycheck Protection Program (PPP)—namely, how small businesses facing COVID-19 disruptions could access the forgiveable loan program and weather the lockdown storm.
But there was another important feature of the CARES Act that went largely overlooked: the large increase to the aggregate debt limit for small business Chapter 11 reorganizations under what is known as “Subchapter V” of the Bankruptcy Code a/k/a the Small Business Reorganization Act (SBRA). Specifically, the Act raised the maximum debt limit from $2,725,625 to $7,500,000 for new Subchapter V small business cases filed between March 27, 2020 and March 27, 2021.
For many owners of family and closely held businesses that now find themselves facing extraordinary pandemic-induced pressure from their bank lenders, vendors, landlords, and others, the concept of “bankruptcy” may seem like a non-starter and a path to nowhere. When we broach Chapter 11 as a possible strategy, the push-back arguments we hear most often are “Chapter 11 is only for large, public companies with tons of liquidity” and “I won’t be able to keep my equity in Chapter 11—the assets will be auctioned off and the bank and my trade creditors will end up with all of the proceeds.”
But these baseline assumptions have now become largely obsolete, as Subchapter V significantly tweaks a number of the “old school” Chapter 11 rules for the benefit of small business owners. And with the aggregate debt limit for new Subchapter V cases now increased to $7.5 million, business owners in peril should take stock of the key features of the statute that, in many cases, may afford the best path to retaining their hard-earned and multigenerational investments. Consider these highlights:
No More “Absolute Priority Rule”: You Can Keep Your Equity Without Paying Creditors in Full
In a traditional Chapter 11 bankruptcy, the debtor’s equity holders are not allowed to keep their equity under a plan of reorganization unless all creditors are paid in full (or creditors agree otherwise).
New Subchapter V waives this “absolute priority rule” requirement: as long as the company devotes its “disposable income” to fund creditor distributions under the plan (distributions in whatever amounts/percentages are feasible), the plan can be confirmed (approved) by the bankruptcy court and owners can keep their equity in the business without having to make any new capital contributions.
No Creditors’ Committee to Stall Your Reorganization Plan
If there is one single feature of traditional Chapter 11 that has discouraged small and middle market businesses from filing Chapter 11 cases, it’s probably the Bankruptcy Code’s requirement that an official committee of unsecured creditors be appointed to represent unsecured creditors (and in so doing, incur professional fees at the debtor’s direct expense). Creditors’ committees can be counted on to dispute and delay every aspect of a debtor’s effort to emerge from bankruptcy, whether via a plan of reorganization or an asset sale.
But Subchapter V disposes of this technical requirement: a creditors’ committee is no longer required to be appointed, except in extraordinary situations. The removal of this significant obstacle and source of cash burn means Subchapter V cases will move from petition filing to plan confirmation and exit much faster than traditional Chapter 11 cases. In fact, it is conceivable that Subchapter V cases filed together with the plan of reorganization on day-one could emerge (via plan confirmation) in as little as 30 days. This would almost never be possible with the presence of a creditors’ committee.
No Need for Creditors to Approve Plan
Subchapter V has also eliminated what has long been a major impediment to using Chapter 11 as a tool for restructuring small businesses: the requirement that at least one class of “impaired” creditors vote to confirm a plan of reorganization.
Under the traditional Chapter 11 plan confirmation rules, debtors are required to send out plan ballots to creditors and obtain at least a two-thirds majority (by dollar amount of claims) and simple majority (by headcount) vote to confirm (approve) the plan from at least one class of creditors who are not receiving 100% payment on their claims (an “impaired” class).
But new Subchapter V has dispensed with this onerous requirement altogether. As long as the plan meets certain technical requirements of feasibility, fairness, and non-discrimination (as to creditor treatment), the bankruptcy court can confirm a plan and facilitate the debtor’s exit without first obtaining any approving vote from creditors. In other words, Subchapter V strips unsecured creditors of what otherwise would be a significant source of leverage and control over the debtor’s ability to emerge from bankruptcy and continue operations.
Consulting with Experienced Restructuring Counsel is the Starting Point
Ultimately, the new Subchapter V rules for small business Chapter 11 cases are technically nuanced and require a case-specific analysis to determine if they will serve as a viable restructuring option to protect your investment. Consulting with Cavitch’s experienced bankruptcy and restructuring attorneys is a first step.
Stuart A. Laven, Jr.
is a bankruptcy and restructuring attorney in Cavitch’s Capital and Finance practice group. He represents troubled businesses and their owners, as well as senior lenders, asset buyers, and other significant stakeholders in all phases of the Chapter 11 process, as well as in non-bankruptcy and out-of-court restructuring alternatives. He has represented major constituencies in restructurings, asset deals and distressed financings in jurisdictions nationwide in a variety of industries, including health care, transportation, automotive, telecommunications, commercial real estate, retail, construction, and pharmaceuticals. Stuart can be reached at
slaven@cavitch.com
.
