07.09.2020 | Articles

James M. Liston Summarizes New Small Business Bankruptcy Rules under C. 11

By James M. Liston

Subchapter V of Chapter 11 of the Bankruptcy Code took effect February 19, 2020 and covers businesses and individuals with secured and unsecured debts up to $2,725,625 at least 50% of which is commercial debt.

It appears to exclude any person whose primary activity is the business of owning single asset real estate. Its primary purpose is to eliminate certain expensive and time-consuming features of Chapter 11 that have made Chapter 11 unworkable for many small businesses.

Responding to the COVID -19 crisis, the CARES Act, made effective on March 31, 2020, amended Chapter V to increase the debt threshold by almost $5 million to $7.5 million for the next year. This increase, combined with some debtor-friendly features of Subchapter V and the limited time frame, will likely lead to many Subchapter V filings between now and March 2021.

Below is a summary of some of the main provisions of Subchapter V and ways in which creditors can oppose plans and gain leverage over Subchapter V debtors in restructuring debt.

  • The Debtor must file a plan within 90 days of a bankruptcy filing. The plan must provide for payments to creditors over a three to five-year period. The payments must equal the debtor’s “disposable income,” which is defined as all income not necessary for (a) support of the debtor and dependents; and (b) expenses of the business.
  • No disclosure statement is required.
  • No official creditors’ committee is formed.
  • Administrative expenses may be paid after a plan is confirmed over the term of the plan rather than in full at plan confirmation.
  • No U.S. Trustee fees.
  • The Debtor has an unlimited exclusive right to file a plan. No competing plan may be filed by a creditor.
  • Creditors do not get to vote on the plan but can object to the plan for reasons discussed below.
  • The Debtor can modify the terms of a mortgage on a principal residence where the mortgage loan funds were used in the business and not for the purchase of the property- e.g., when the proceeds of a HELOC loan are used for business purposes or a loan to a business entity is secured by a mortgage on its principal’s residence.
  • Unlike under Chapter 11, the Debtor may confirm a plan and retain equity in its business without the consent (vote) of at least one impaired class of creditors where creditors are not paid in full. The owner of a business may keep his/her equity in the business without contributing new value where creditors are not paid in full as there is no “absolute priority rule” in Chapter V.
  • Unlike Chapter 11, a trustee is automatically appointed upon filing. The trustee’s duties are normally ministerial, including assisting the Debtor in formulating a plan and collection and disbursement of funds.

Virtually all other requirements of Chapter 11 are incorporated in Subchapter V. These include:

  • Secured creditors must be provided “adequate protection” of their interests in collateral.
  • Debtors cannot use cash collateral without either the secured creditor’s consent or a court order.
  • A plan’s treatment of creditors may not be discriminatory and must be fair and equitable. Fair and equitable is defined to require that the length of the plan be no less than three years and no more than five years and that all of the Debtor’s disposable income during the term of the plan be dedicated to plan payments. Fair and equitable treatment of secured creditors also includes the usual Chapter 11 requirements that the plan provide for: deferred cash payments with a present value equal to the amount of the creditor’s secured claim; the creditor’s retention of its lien on the collateral or upon the sale proceeds of the collateral; or the “indubitable equivalent” of its claim.
  • The Debtor must establish that the plan is feasible.
  • The Debtor must show that the plan provides more to creditors than they would receive in a liquidation of the Debtor.
  • If the Debtor seeks to cram down the plan over the objection of the secured creditor, the secured creditor can make an election under Section 1111(b).
  • Creditors can challenge a debtor’s qualification to file a plan under Subchapter V.
  • Creditors can object to the Debtor’s plan on the grounds that the debtor is not using all its disposable income.
  • If the Court finds that the plan has only a reasonable likelihood of success, the plan must provide appropriate remedies, which may include the liquidation of nonexempt assets, to protect the holders of claims or interests in the event that the plan payments are not made.
  • A creditor can ask the Court to have a trustee assume greater power or control of operations in the event of a debtor’s fraud, dishonesty, incompetence, or gross mismanagement.
  • The Debtor does not receive a discharge until all plan payments have been made.

This communication is for informational purposes only and should not be construed as legal advice on any specific facts or circumstances.

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