Sub V: Sub-par or Superb?

Posted on: December 1st, 2021 by Michael A. Morris, ABLS Blog Contributor

Subchapter V (“Sub V”) of the Bankruptcy Code was created under the Small Business Reorganization Act (P.L. 116-54) to streamline bankruptcy cases and help more small business debtors successfully reorganize by lowering costs. Sub V was meant to strike a balance between Chapter 7 liquidation and Chapter 11 reorganization. Sub V created some significant benefits for debtors compared to previous options under Chapter 11 but also comes with some eligibility and plan requirements (some might say burdens) for interested debtors.

Eligibility

The SBRA became effective February 19, 2020, and shortly thereafter, the COVID-19 panic spurred Congress to increase the debt limit for Sub V from $2.7 million to $7.5 million. However, the debt limit is to return to its original level in March of 2022 unless Congress chooses to act. This debt limit only applies when the majority of the debt stems from business or commercial activity. Individuals can be eligible under Sub V if their debts are business-related, but the act primarily applies to small business debtors. Moreover, debtors who meet the Bankruptcy Code’s definition of “single asset real estate” are explicitly excluded from Sub V eligibility.

Mandatory Trustee

Sub V creates the position of a mandatory trustee to oversee the administration of the bankruptcy case. This trustee performs duties similar to Chapter 12 trustees, supervising the case while the debtor remains in control of their business operations. The trustee is intended to assist the debtor with their plan proposal, confirmation, and distributions. Furthermore, the Sub V trustee examines proof of claims and objects to improper claims. The Sub V trustee also retains standing to oppose the discharge when he or she chooses. Uniquely, Sub V trustees are meant to help facilitate a consensual reorganization plan and assist the debtor in guiding the business. Therefore, many Sub V trustees are businesspeople rather than lawyers.

Plan Requirements

Sub V has an accelerated timeline, including a status conference within sixty days of the order of relief. Debtors must file a reorganization plan in ninety days. However, debtors can obtain an extension of this deadline by requesting the court and showing that a plan could not be filed for circumstances beyond the control of the debtor. Experience has shown Sub V cases take longer than Congress expected. Courts often grant extensions beyond the ninety-day period. For example, in the 8th Circuit, the average time taken for a debtor to confirm a plan was about seven months. It appears the accelerated timeline of Sub V is more of a nominal requirement which may encourage the debtor to act quickly but from which courts have routinely relieved debtors upon request.

Sub V debtors must commit future projected income or its equivalent value (attained through the liquidation of estate assets) to the plan for a designated period of time. This is similar to the disposable income requirements of Chapters 12 and 13, and like in those chapters, the length of this period can range from three to five years. This requirement under Sub V presents less flexibility to the debtor than under traditional Chapter 11, and it presents the issue of determining projected disposable income despite that a business debtor’s disposable income may fluctuate greatly before filing bankruptcy.

Benefits

One of the biggest goals of Sub V was to reduce costs for the debtor, as traditional Chapter 11s are notoriously expensive. First, Sub V waives the U.S. Trustee’s fees otherwise required of Chapter 11 debtors, requiring instead that debtors pay the Sub V trustee’s fees. This is combined with an expectation that Sub V trustees generally will not incur much in fees. Second, Sub V does away with the establishment of a committee of creditors in almost all cases. This is significant because a debtor in a traditional Chapter 11 is responsible for paying professionals hired by the committee. Third, the debtor does not have to file a disclosure statement when filing under Sub V. A disclosure statement is necessary in traditional Chapter 11 plans to inform creditors of key provisions of the plan so that the creditors are able to vote on the proposed plan and potentially propose their own competing plans. However, under Sub V creditors can only object to a plan, like in a Chapter 12 or 13, rather than vote on it, like in a traditional Chapter 11, and the debtor is the only one who can propose a plan. This eliminates the costs of bankruptcy litigation when competing plans go before the court. Lastly, Sub V generally relaxes the requirements debtors face when drafting a plan. The plan must be nondiscriminatory and fair and equitable, but so long as the plan meets the Bankruptcy Code’s requirements, the court is likely to approve it.

In addition to reducing costs for debtors, Sub V allows owners of a debtor business to retain ownership without either paying all creditors in full or contributing new value to the business (in bankruptcy-speak, Sub V eliminates the absolute priority rule, which eliminates any fights about the new value exception). This allows a small business owner to reorganize the business, reduce debt, and maintain ownership. Since in small businesses ownership and management are often the same or have significant overlap, this helps preserve the business’s going-concern value.

How has it worked?

Sub V is very new, and much of the legal questions that have arisen from Sub V cases have yet to be completely resolved. However, data suggests that Sub V has become a popular choice for small business debtors. Nationwide about 23% of all Chapter 11 cases filed in 2020 were filed as Sub V cases, and between March 1, 2020 and June 30, 2021, about 45% of all Chapter 11 cases filed in the 8th Circuit were Sub V cases. While Sub V seems to have effectively lowered costs for debtors, the bankruptcy cases still can last a considerable amount of time. Like a traditional Chapter 11 case, a Sub V can be complicated, and the ninety-day period has proven to be too short to confirm most Sub V plans. Therefore, the goal of reducing attorney and other professional fees by shortening the period from a traditional Chapter 11 has not been as effective as anticipated. But fortunately, Sub V reduces debtors’ costs in other areas as well.

One concern about Sub V is that it harms creditors who now have no incentive to consent to confirmation of a plan. However, data from the 8th Circuit suggests that most Sub V plans are confirmed consensually and amended multiple times in response to creditor objections. This could be part of the reason why the 90-day plan proposal deadline is extended in so many Sub V cases—the extra time to consider the interests of creditors and amend plans may lead to plans that are more equitable and perhaps put debtors in a better position coming out of their reorganization.

Despite the benefits Sub V provides for debtors, the path to successful reorganization for a Sub V debtor is not easy. In the 8th Circuit, only about half of Sub V cases filed between March 1, 2020 and June 30, 2021 ended with confirmed plans while about 30% were dismissed or converted to Chapter 7 cases. The other 20% were still pending. This is not to say that Sub V is ineffective; the explanation might lie elsewhere. There are some debtors that simply cannot be reorganized. Sub V aims to give small business debtors a better chance at a fresh start, and it appears to be doing just that for many debtors across the country.