Congress to Expand Small Business Eligibility Limits to $7.5 Million

On March 25, 2020, the U.S. Senate passed the Coronavirus Aid, Relief and Economic Security Act” (CARES Act). The House is expected to pass the bill today. One provision of the bill increases the eligibility limits for small business debtors from $2.7 million to $7.5 million. The amendment will only apply to cases commenced after its effective date and will be subject to a sunset provision after one year.

Since many more businesses will be eligible to file under the small business provisions, it is worthwhile to review the pluses and minuses of falling within Subchapter V.  Subchapter V, which is titled Small Business Debtor Reorganization consists of 11 U.S.C. Sec. 1181-1195.

Eligibility

 Unlike the previous small business provisions of Chapter 11, Subchapter V is voluntary. An eligible debtor must opt in to participate. As amended by the CARES Act, a small business debtor is a person (a) engaged in commercial or business activities (b) but not a person whose business consists of owning single assets real estate (c) that has aggregate noncontingent liquidated secured and unsecured debts which do not exceed $7,500,000 not counting debts owed to affiliates. At least 50% of the person's debts must arise from business or commercial activities.  11 U.S.C. Sec. 1182(1).  

Example: A restaurant owes $50,000 to its employees, $5,000,000 to secured lenders and $1,000,000 in taxes. It is being sued for $10 million by a customer who became obese from eating too many nachos.   This company would be eligible because its noncontingent liquidated debts total $6,050,000 and they arose from commercial or business operations.

Example: A business owns three apartment complexes in different parts of Austin. It owes $7,000,000 in secured debts and $100,000 in tenant security deposits from tenants who moved out because the apartments were smelly. This debtor is below the eligibility limits. It is not a single asset real estate debtor because it owns three separate real estate projects.

Example:  A lawyer owes $100,000 on a business line of credit, $100,000 in payroll taxes,  and $500,000 on his home. He would not qualify because less than half of his debts arose from business or commercial activities (unless he runs his law practice out of his home).

Stricter Timelines

A plan must be filed within ninety (90) days from the petition date except that the court may extend this time "if the need for the extension is attributable to circumstances for which the debtor should not justly be held accountable." 11 U.S.C. Sec. 1189(b). I am trustee in a case where a debtor that sells chicken wings will be asking for an extension of time to file its plan because the shelter in place orders issued by the City of Austin have drastically limited its ability to do business. While I can't say how the court will rule, that seems like a pretty good case for an extension to me. On the other hand, if the reason for an extension is I need more time because I haven't filed tax returns in three years and I haven't hired an accountant to go through my ten boxes of unsorted receipts, that would probably not fly.

Easier Confirmation Standards

Subchapter V eliminates several requirements which make it difficult for small businesses to confirm a plan. First, there is not a separate disclosure statement. The plan must contain a brief history of the debtor, a liquidation analysis and projections. 11 U.S.C. Sec. 1190(1).

A plan may modify a loan on the debtor's principal residence if the loan was not used to acquire the property and was primarily used in the business. 11 U.S.C. 1190(3).  Assume that a debtor buys a home in 1990 for $100,000. By 2015, he has paid off the original mortgage and the property has accumulated in value to $1,000,000. The debtor takes out an $800,000 home equity loan and uses the money to purchase a solar powered car wash. That debt could be modified in a case under Subchapter V, but only if the debtor is a sole proprietor.

If a plan meets all the requirements for confirmation under 11 U.S.C. 1129(a) other than subsections (8), (10) or (15), it may be confirmed so long as it complies with an alternative test. 11 U.S.C. Sec. 1191.  Subsections (8) and (10) consist of the requirements that a plan be accepted by all impaired classes and that a plan be accepted by at least one impaired class.  Subsection (15) provides that an individual debtor must make payments of disposable income for five years if an unsecured creditor objects to the plan.

In place of these requirements, Subchapter V has the following:

First, for a secured creditor, the existing rules on cramdown still apply, which means that the debtor must either pay the value of the collateral at a market rate of interest, sell the collateral or provide the creditor with the indubitable equivalent of its lien.

Next, the debtor must make payments of projected disposable income for three to five years. Thus, a debtor may complete a plan by paying disposable income to unsecured creditors for as little as three years without satisfying the absolute priority rule.

Finally, the debtor must show that there is a reasonable likelihood that it will be able to make the payments and that there are adequate remedies for default.

So the tradeoff in Subchapter V is that a debtor does not need to get the votes of any classes of claims and need not meet the absolute priority rule so long as secured creditors get their existing treatment and unsecured creditors receive a minimum of three years of disposable income.

On the other hand, discharge does not occur unless the debtor completes its plan payments. 11 U.S.C. Sec. 1192. This is similar to the requirements under chapter 13 and individual chapter 11 plans.

Easier Employment of Professionals

One of the more interesting provisions of Subchapter V states that a professional holding a claim of less than $10,000 will be deemed to be disinterested. 11 U.S.C. Sec. 1195. What this does is keeps estate professionals from having to make the Hobson's choice of waiving their pre-petition fees or continuing to represent the debtor.

The Trustee

Finally, there is the trustee. Every case must have a trustee. 11 U.S.C. Sec. 1183. The statute provides that the U.S. Trustee can either appoint a standing trustee or appoint an individual in each case. In my U.S. Trustee region, there are a group of individuals who have been approved to serve as trustees and some of us have been receiving appointments. In most cases, the Subchapter V trustee will be responsible for monitoring the case, appearing at hearings and being an advocate for a consensual reorganization. Thus, a trustee has a role as an honest broker and a mediator. If the case is confirmed on a consensual basis, the trustee's service ends. On the other hand, in a cramdown case, the trustee is responsible for distributing all payments unless the parties agree otherwise.  11 U.S.C. Sec. 1194.

The trustee is compensated as a professional in the case as opposed to receiving a standard trustee's commission. Under Subchapter V, professionals, including the trustee, can be paid out over time. This eliminates the need for the debtor to make a big payment on the effective date and reflects the common practice in small cases. 

The trade-off for having to compensate another professional in the case is that U.S. Trustee fees are not payable in Subchapter V cases. In a typical small case, U.S. Trustee fees can run $325-$650 per quarter. While the fees of the Subchapter V trustee will likely be greater than this amount, they can be paid over the life of the plan rather than on a quarterly basis.    

Summary

Subchapter V is intended to be a fast moving process which makes it easier for debtors to get to confirmation. It is not well suited for a case which requires an extended period for the debtor to stabilize its business or pursue complex litigation. Subchapter V is a grand experiment at making reorganization easier for the smallest cases, and with the enactment of the CARES Act, not so small cases as well.  As a Subchapter V trustee, it is my fervent hope that there will be many cases where my role and my compensation remain limited.

Disclaimer:   I have attempted to describe Subchapter V and its pluses and minuses as best I can. However, this is my personal opinion and does not reflect the views of the U.S. Trustee program.