The Small Business Reorganization Act of 2019 introduced Chapter V, Subchapter 5, within the Bankruptcy Code. This new addition offers a simplified reorganization designed to assist small businesses in recovering and continuing operations. The benefits of Subchapter V include incorporating many of the traditional Chapter 11 bankruptcy features but with modifications to make it easier, faster, and more affordable for small businesses.
Subchapter 5 Eligibility Criteria
To be eligible to qualify as a “small business debtor” under Subchapter V a debtor has to meet certain criteria.
- Commercial Activity Requirement: The debtor is required to be involved in commercial or business activity.
- Debt Limit: A debtor’s secured and unsecured noncontingent debts must not exceed $7.5 million. This amount does not include debts to insiders or affiliates.
The debt origin requirement is that at least 50% of it must be derived from commercial or entrepreneurial activities.
Originally the limit for debt was $2,725,625. However, Congress temporarily raised it to $7.5 Million in response to the COVID-19 pandemic, under the 2020 CARES Act. The current limit will revert to $3,024,725 by 2024 unless Congress acts to maintain the higher limit.
Reorganization That Is Cost-Effective and Efficient
Subchapter V is a simpler reorganization than Chapter 11 bankruptcy. Small businesses can reorganize their debts and manage them through a streamlined process, without having to go to a creditors committee or get the creditors to approve the plan. The process is quicker and cheaper, making it ideal for small business owners who want to keep their operations running with minimum disruption.
The Reorganization Plan initiated by the Debtor
In Subchapter 5, the debtor is the only one who can propose a plan of reorganization. In Chapter 11 cases the creditors are allowed to propose plans as well if the debtor does not submit one within a certain time frame. Subchapter V requires that the plan outline how the debtor intends to deal with creditors. This includes options for asset disposal and repayment schedules spread over three to five years. Many of the debts that arose before the plan was confirmed can be discharged once the plan has been completed. This allows the business to start fresh.
Discharge of Debts With Exceptions
Subchapter V provides relief from debts with certain exceptions. These are mainly found in Section 523. This section lists a number of debts which cannot be discharged. These include debts related to fraud, false statements, and other debts caused by misconduct. Section 523(a), however, is primarily applicable to individuals and not corporations. Recent court rulings raised the question of whether corporate debtors covered by Subchapter 5 are also subject to these exceptions.
Court Decisions on Debt Relief Under Subchapter V
Interpretation of Subchapter V’s debt discharge provisions has long been a source of controversy. Avion Funding LLC was the subject of a 2024 Fifth Circuit Court of Appeals case. In re GFS Industries LLC, the Fifth Circuit Court of Appeals ruled in 2024 that Section 523 (a) discharge exceptions apply to individual and corporate Debtors in Subchapter 5. This decision is in line with the Fourth Circuit’s ruling in 2022 that while Section 523 (a) and Subchapter 5 may appear complex, the Fourth Circuit intends to apply the discharge exceptions in all Subchapter 5 cases. Several courts disagreed with this ruling.
Leases That Have Not Been Repaid as Noncontingent Debt
The benefits of Subchapter V eligibility are based on the fact that a debtor’s non-contingent secured and unsecured liquidated debts cannot exceed a threshold amount. The courts have argued whether lease obligations are included in the calculation of debt. In a recent bankruptcy case, the United States Bankruptcy Court determined that the total lease obligation was non-contingent if the lease had been fully executed before the bankruptcy filing. These debts are included in the calculation of eligibility for Subchapter V. It may disqualify a debtor if lease obligations exceed the debt ceiling.
Lease Obligations: Options for Managing Them
Debtors in small businesses have several options for managing their lease obligations during bankruptcy. In this case, the debtor would have to pay all of the dues. The debtor may also reject the lease. This will limit the damages due to the lessor and keep the total debt under the Subchapter V limitation. This method gives debtors flexibility in deciding how they want to handle lease debts when reorganizing.
Small Business Debtors: Flexibility
Subchapter V is appealing because of its flexibility for small businesses facing financial problems. It streamlines the reorganization procedure and reduces the procedural requirements, allowing businesses to avoid the costly and lengthy nature of Chapter 11 filings. Subchapter V is more manageable for small businesses because of the debtor-driven plan and fewer reporting obligations.
Future of Subchapter 5 and Legislative Actions
In 2024, the debt limit for Subchapter 5 eligibility will drop to $3.024,725 unless Congress takes action to maintain the current $ 7.5 million limit. Many small businesses will no longer be eligible for Subchapter V bankruptcy and instead have to deal with the more complicated Chapter 11 bankruptcy process. This change could drastically alter the landscape of small business bankruptcy, reducing the number of businesses that can take advantage of Subchapter V’s streamlined benefits.
Summing Up!
The benefits of Subchapter V of the Bankruptcy Code make it a valuable tool for both small businesses and individual debtors. It provides a cost-effective and efficient way to reorganize and manage debt. Subchapter V is a lifeline for businesses that are facing financial difficulties. It allows debtors the ability to control their reorganization plans, avoid procedural hurdles, and discharge most of their debts after plan completion. Understanding eligibility requirements, debt-discharge provisions, and court decisions is important for anyone who considers filing under Subchapter V.
Here at Bruner Wright, we can help you with everything from reorganization to managing cross-border bankruptcy, to navigating complicated litigation. We tailor our approach to meet your specific needs, while also laying the foundation for your long-term success.
Contact us to set up a free consultation. We can help you take back control of the future of your company. Do not wait until it is too late to take proactive steps and secure your financial future. Our expert legal team can help.