The Small Business Reorganization Act: How it started and where it's going

The Small Business Reorganization Act of 2019 (SBRA), which took effect earlier this year, added a new Subchapter V to Chapter 11 of the Bankruptcy Code, intended to make Chapter 11 more affordable, efficient, and beneficial for small businesses (especially those whose owners might otherwise lose their equity in a traditional Chapter 11 case).

Just weeks after taking effect, the SBRA was amended by the CARES Act for one year, expanding Subchapter V eligibility to significantly more debtors by increasing the limitation on how much debt a business or induvial may owe to creditors and still qualify as a “small business debtor,” under the Bankruptcy Code.

In its first several months of life, early indications are that Subchapter V is gaining popularity. This article provides a brief overview of the SBRA and these first several months of its use — especially in light of the COVID-19 pandemic — concluding that in 2021, Congress should permanently adopt the CARES Act’s expanded definition of a “small business debtor,” as including businesses with up to $7.5 million in aggregate non-contingent liquidated debts.

By further expanding access to a streamlined Chapter 11 process, the SBRA will ensure that a wider array of debtors have the ability of reorganizing themselves, when Chapter 11 was previously too cost-prohibitive for such debtors.

Key features of Subchapter V

The SBRA was enacted to make the Chapter 11 process more affordable for small business debtors, both from a time and cost perspective. The SBRA also makes Chapter 11 a more attractive distress option small business debtors (and individuals) considering their options when facing a distressed business situation.

The SBRA seeks to achieve these goals by making significant changes to Chapter 11 for debtors who elect to proceed under Subchapter V. As a result of these changes:

1. Subchapter V debtors are not required to pay U.S. Trustee fees.
2. Creditors’ and equity committees are not required in a Subchapter V proceeding.
3. Subchapter V debtors are no longer required to file disclosure statements in conjunction with Chapter 11 plans.
4. Subchapter V debtors must file plans within 90 days of filing, reducing total time in Chapter 11.
5. Subchapter V debtors are the only party allowed to file a plan.
6. A Subchapter V trustee (similar to a Chapter 12 or 13 trustee) is appointed for every Subchapter V case, charged primarily with assisting the debtor in consensually confirming a plan (and not seizing control of the debtor’s assets and operations).
7. Subchapter V debtors no longer have to satisfy the “absolute priority rule,” when seeking to cramdown a plan over the objection of unsecured creditors, allowing equity to remain in place without contributing new value.
8. Professionals employed by a Subchapter V debtor may hold claims against the debtor up to $10,000 and remain “disinterested,” under the Bankruptcy Code.

In addition to these changes, Subchapter V debtors are required to make additional disclosures at the outset of their cases by filing financial reports such as recent balance sheets, statements of operations, cash flow statements, and recent federal income tax returns. Subchapter V debtors must also appear at a mandatory case status conference before the bankruptcy court, held 60 days after filing, at which the debtor presents a report on its progress toward confirming a consensual Chapter 11 plan.

Early amendment: CARES Act increased access to Subchapter V

Another key feature of the SBRA are its provisions governing the types of debtors eligible to elect to have a Chapter 11 case proceed under Subchapter V. Only a “small business debtor,” can elect to proceed under Subchapter V.

As enacted, the SBRA updated the Bankruptcy Code’s definition of a “small business debtor,” to be defined as: a business or individual whose “aggregate noncontingent liquidated secured and unsecured debts total less than $2,725,625. When the SBRA took effect in February of last year, this limitation went into effect, but its life was short.

As prefaced earlier, this provision underwent nearly immediate modification when the COVID-19 pandemic hit the United States. In March, when many states began instituting stay-home and shelter-in-place orders, Congress acted to provide broad relief to U.S. citizens and businesses under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). The CARES Act significantly increased the debt limits of the SBRA, allowing debtors to elect Sub-V treatment if their aggregate noncontingent liquidated debts did not exceed $7.5 million (an increase of more than 300%). As a result of this increase, a much broader group of debtors are currently eligible to elect Subchapter V treatment.

There is, of course, a catch: the CARES Act provisions expanding Subchapter V eligibility will sunset in March 2021.

The developing role of Subchapter V trustees

As noted above, each Subchapter V case is assigned a Subchapter V trustee, whose statutory role is primarily to assist the debtor in consensually confirming a chapter 11 plan. There has been a good deal of inquiry about the role these trustees will play in Subchapter V cases, and early indications are that Subchapter V trustees have approached this role from the perspective of a business coach or mediator as opposed to an operator, forensic investigator, or litigant, the way a “traditional,” Chapter 11 or Chapter 7 trustee might act.

For context on the general profile of Subchapter V trustees that have been appointed so far: the Office of the U.S. Trustee has appointed pools of Subchapter V trustees in many jurisdictions, generally comprised of business financial advisory professionals experienced in working with small and mid-size businesses.

The courts have also begun to weigh in on the role of Subchapter V trustees: in one opinion issued this summer, a bankruptcy judge rejected the proposition that a Subchapter V Trustee should employ counsel as a matter of course, further indicating that Subchapter V trustees are dissimilar from a “traditional,” Chapter 11 trustee or a Chapter 7 trustee, who routinely employ counsel and pursue litigation claims against various parties on behalf of a debtor’s bankruptcy estate. See, In re Penland Heating and Air Conditioning, Inc., Case No. 20-01795-5-DMW, 2020 WL 3124585 (Bankr. E.D.N.C. June 11, 2020).

The role of Subchapter V Trustees will certainly continue developing over time, but early indications are that their role is limited, and will hopefully assist in driving the efficiencies sought by Congress when enacting the SBRA.

As the pandemic’s economic effects deepen, more small businesses will elect Subchapter V

More than 1,200 small businesses have already elected to proceed under Subchapter V since February, and this number will continue growing as the pandemic’s economic effects deepen. Reporting from the American Bankruptcy Institute shows that more than 1,200 Chapter 11 filers have elected to proceed under Subchapter V since it took effect in February.

The most active jurisdictions for Subchapter V filings so far have been located in the Ninth, Eleventh, and Fifth Circuits — particularly in populous states where COVID-19 has hit particularly hard: California (126 filings); Florida (160 filings); and Texas (157 filings).

At the time of this writing, cases, hospitalization rates, and deaths from COVID-19 have spiked, and some states have already instituted more significant restrictions on social and commercial interactions to curb the spread of the virus and protect public health. And while these restrictions may be necessary (especially as we wait for vaccines to be administered across the country), their business impacts are costly, especially since it appears unlikely that the federal government will pass an economic relief bill to large enough to keep small businesses and individuals from avoiding bankruptcy, the way they may have been able to with the relief provided by the CARES Act. See, “Why the Biden Economy Could Be the Same Long Slog as the Obama Economy,” New York Times (Nov. 8, 2020).

For businesses that were likely already struggling in the Spring, they are likely to fall deeper into distress, and the relief afforded to them by Subchapter V may be exactly what they will need to survive the Winter. As such, these first 1,200 Subchapter V cases are likely the tip of a proverbial iceberg, and Subchapter V should remain available to as many businesses as possible into the future.

Congress should permanently extend increased debt limitations for Subchapter V elections

Many small businesses face economic headwinds even without the specter of a pandemic interfering with their day-to-day operations. But if these businesses are going to survive distressed situations, they should have a robust range of options available to them to deal with that distress.

Even in its infancy, Subchapter V has shown itself to be an attractive option for small businesses (and individuals) in need of relief. But the availability of that relief should not be curtailed simply because the CARES Act amendment to the SBRA is slated to sunset next year. If Subchapter V is going to maintain its relevance in the short and long term, it should continue to be available to as many business as possible; retaining the $7.5 million debt limit increase from the CARES Act is one way to do this.

This change will assist businesses in the short term as we all look toward the end of a pandemic, and it will also benefit small businesses in the long term. The economic aphorism that reorganization is economically and socially preferable to dissolution or liquidation holds true whether a debtor is a large or small business. By making Chapter 11 reorganization more affordable and viable to a broader range of debtors, all stakeholders can benefit.

By providing more small businesses the opportunity to reorganize, we increase the likelihood that they will continue their operations as employers and participants in local economies and communities. The changes made to Subchapter V by the CARES Act should be made permanent.

Jack O’Connor is a partner in the Restructuring, Insolvency and Special Situations group at Sugar Felsenthal Grais & Helsinger, LLP in Chicago. He can be reached at joconnor@sfgh.com.

This article appeared in The Bankruptcy Strategist, featuring the strategies and techniques devised by the country’s top bankruptcy lawyers and reports on innovative procedural techniques, legislative developments and recent judicial rulings — plus what they mean for you and your clients.