Breaking down Subchapter V as a Bankruptcy Option for Small Businesses
By now, much of the insolvency and legal world has become familiar with leveraging Subchapter V as a fast-track way for a small business to get through bankruptcy. If you haven’t, Subchapter V, which went into effect in February 2020, was added to Chapter 11 of the U.S. Bankruptcy Code to make reorganization bankruptcies less expensive and more accessible to small businesses.
We recently sat town with Mark Taylor, Partner at national law firm Waller Lansden, and asked him to provide his insights and experience leveraging Subchapter V. Here are the questions we asked and Mark’s responses:
Q: What are the key benefits of Subchapter V vs. traditional Chapter 11?
A: Subchapter V is generally a faster and less expensive process than a Chapter 11. Additionally, it allows a business owner to retain ownership of the business without paying unsecured creditors in full, thus motivating business owners to try to restructure instead of just giving up. It allows for a business to repay its creditors over a 3-to-5-year period and permits administrative expenses (like professional fees) to be paid over time instead of on the effective date of the plan. Basically, there are fewer hurdles to reach confirmation of a plan.
Q: When is Subchapter V a good option?
A: This is a good option for businesses or individuals that cannot afford substantial up-front or quick plan payments as the payments are tied to projected disposable cash flow over a 3-to-5-year period. In a Chapter 11, there is the “Absolute Priority Rule” that requires creditors to be paid in full in order for the business owners to retain their ownership interest. However, in a Subchapter V, business owners can retain ownership because Subchapter V does not require compliance with the Absolute Priority Rule. Keep in mind, however, that the debtor still must comply with 11 USC Section 1129(a)(7), which requires that the plan payments provide at least as much as creditors would receive in a Chapter 7 liquidation.
Q: What are some examples of successfully using Subchapter V process for your clients?
A: We recently utilized Subchapter V to confirm a plan for an individual engaged in business in which the non-contingent debts were less than the $7.5 million cap, but the contingent debts (due to substantial un-triggered guaranty liabilities) were well in excess of the cap. With the assistance of Harney Partners, we developed cash flow projections and estimations of asset values and developed a plan for the client that provided for payments with a present value that exceeded the expected recoveries in a Chapter 7. This case involved some complex factual issues concerning the projections, allowed expenses, community property rights and the appropriate discount rate. It also presented several legal issues concerning the ability of creditors to require an increase in payments and whether the debtor could deduct capital expenditures and required investments in calculating cash flow. Subchapter V was a great option in this scenario.
Additionally, we recently used the threat of a Subchapter V filing to reach a favorable settlement in a case that likely would not have occurred without being able to demonstrate what could be done in a Subchapter V case compared to a Chapter 11.
Q: One of the main differences with Chapter 11 is the elimination of the unsecured creditors committee. The Subchapter V trustee was created to help facilitate the formation of a consensual plan. How has that process been working, especially in cases with numerous active creditors?
A: Really, given the size of most Subchapter V cases (even with the $7.5 million cap), these cases would not be the type in which you would necessarily see a committee appointed. That said, the Subchapter V trustee fees would likely be less than committee counsel fees in most cases. As for the Trustees, it really depends on the personality of the Trustee. I have seen active and passive Trustees. In the case I mentioned above, we had a very active creditor body and a very active Trustee. While I felt the Trustee was, at times, acting as a de facto committee counsel, in the end, the Trustee was helpful in getting the creditors on board and helping to facilitate a consensual plan after a lot of objections had been filed. I’ve also, however, seen Subchapter V cases where the Trustee has a very minimal involvement.
Q: How have you been getting the word out to struggling small business owners about the potential benefits of Subchapter V?
A: While our firm has done some lunch and web presentations, many businesses still don’t know about it. I think most small business owners have only a very vague idea of the benefits and availability of Subchapter V. Most discussions with our clients have happened when we are approached about a filing, so we then discuss whether a Subchapter V case could be beneficial.
Q: With it being a new subchapter, case law has slowly been developed. How has that hindered or helped you as an attorney?
A: At this point, it creates a lot of flexibility (or, on the flip side, uncertainty) because most of what we are doing is trying to apply the plain language of the statute, and analogize the statutes to similar and dissimilar provisions of Chapters 11, 12 and 13. For example, there is no express provision in Subchapter V for creditors to force a debtor to provide for an increase or increase plan payments if the reorganized debtor’s cash flow exceeds projections. At least one court has held that the lack of such a provision, particularly when compared to other Code provisions, allows a debtor to stick with the planned payment projections without increasing them.
There is also an ongoing dispute and split of authority concerning whether the business (or individual) must be operating at the time of filing, with some courts saying yes and others concluding that the business need not be operating to file.
Q: Is this a permanent change in the bankruptcy process for small businesses, and will we see it expanded to be available to more small businesses (the debt limit has already been raised from $2.5 million to $7.5 million until March 2022)? With the March 2022 pending expiration of the higher $7.5 million debt limit, might we see other reforms that will expand or enhance the subchapter V provisions?
A: Subchapter V was enacted as a permanent addition to the Code. At this point, I think what most attorneys are hoping for (and suggesting) is that the enhanced cap be made permanent, and maybe even increased slightly. There are a lot of small businesses that could benefit and might otherwise be pushed into a Chapter 7 because a Chapter 11 simply isn’t feasible.
About the author:
Mark Taylor is a partner at Waller Lansden. He has been practicing business bankruptcy and litigation since 1987. He served for several years on the Western District of Texas Bankruptcy Court Liaison Committee and is the former president of the Austin Bankruptcy Lawyers’ Association where he continues to serve as a council member. Mark speaks and writes extensively on bankruptcy issues and bankruptcy-litigation topics. He also represents clients in state and federal court in breach of contract disputes, real estate disputes, landlord-tenant disputes and other litigation matters and appeals. Mark earned his B.A. degree from Rice University and J.D. degree from The University of Texas School of Law where he was Articles Editor of The Review of Litigation.