Subchapter V Bankruptcy Becoming More Common

Subchapter V small business bankruptcies are up 43% year-over-year in August, the 13^th consecutive month of increase. This upward trend is likely to continue through the rest of the year and beyond, said Andrew Behlmann, partner at Lowenstein Sandler LLP (Roseland, NJ).

"Small businesses aren't able to go avail themselves of the capital markets to get liquidity," he added. "Small Business Administration (SBA) loans aren't as readily available and small business lending is generally becoming more difficult to acquire. Many small businesses that survived through the pandemic with the help of stimulus programs and cheap money are reaching a point where they need to restructure and Subchapter V is their last resort."

Subchapter V, which took effect in February 2020, is for small-business debtors whose total debts do not exceed $7.5 million (not less than 50% of which must be business-related). Two in every five creditors do not know what percent of their portfolio is made up of customers who qualify for Subchapter V bankruptcy, according to an eNews poll—and the 31% who do know the answer say 10% or more of their portfolio qualifies for Subchapter V.

Subchapter V was designed to streamline the bankruptcy process and make it more cost-effective for small businesses. "Before Subchapter V existed, small business Chapter 11 bankruptcies were not working," said Bruce Nathan, Esq., partner at Lowenstein Sandler LLP (New York, NY). "Instead, small businesses were resorting to state court receiverships, assignments for the benefit of creditors (ABC), or UCC Article 9 sales—or just going out of business—because bankruptcy was too expensive, too slow, and not accommodating to small business owners. Subchapter V bankruptcy was an effort to get around those problems."

When the Subchapter V debt limit increased from $2.5 million to $7.5 million, it made it possible for many more middle market companies to use this tool to reorganize, said Deborah Thorne, judge at U.S. Bankruptcy Court Northern District of Illinois (Chicago, IL). "The cases are much cheaper and faster than a traditional Chapter 11 bankruptcy," she said. "But the biggest factor is the input of the Subchapter V trustee. In Chicago, we have excellent advisors or lawyers who help the debtors and their goal is to facilitate a consensual plan."

Some of the major differences between a traditional Chapter 11 and a Subchapter V bankruptcy are that, in a Subchapter V bankruptcy, there is no absolute priority rule, the timeline is statutorily expedited, and there is no Official Committee of Unsecured Creditors appointed (a group of typically 3–9 of the debtors' largest unsecured creditors, who act as a fiduciary on behalf of all unsecured creditors in a traditional Chapter 11 proceeding). "The owner can retain equity, even if not all classes of claims are paid in full," said Michael Papandrea, attorney at Lowenstein Sandler LLP (Roseland, NJ). "In addition, administrative claims that arise in connection with the bankruptcy case do not need to be paid in full on the effective date of a plan because they can be paid out over a period of time under a Subchapter V plan."

"In many ways, those pros for debtors can be cons for trade creditors," Papandrea opined, particularly in light of the economics of many Subchapter V cases and the lack of a creditors' committee. "Administrative claims being drawn out; the speed at which the case occurs; no fiduciary acting on behalf of all [unsecured] creditors," are among the potential cons Papandrea identified. But, he added, "despite that being the case, the debtor still has the ability to wield substantially all of the benefits of a traditional Chapter 11 case."

Instead, a trustee is appointed in a Subchapter V bankruptcy case, Thorne said. "In a Subchapter V, where there's a trustee in place, the creditor's committee itself would not add much value. That doesn't mean to say that individual creditors can't look to the trustee to get information but these plans are oftentimes consensual as the creditors have agreed to this."

The American Bankruptcy Institute recently launched its Subchapter V Task Force. The Task Force intends to spend the next year studying how Subchapter V is working. According to the Task Force's mission statement, the Task Force is studying how Subchapter V is working, whether it is achieving its purposes and what changes are needed. The Task Force intends to issue a report in 2024.

The Task Force is seeking input from trade creditors on how Subchapter V is working. NACM is working with the Task Force to schedule a roundtable of trade creditors to discuss their experiences with Subchapter V with Task force members.

Interested in learning more about Subchapter V bankruptcy? Be sure to register for NACM's upcoming webinar on Approaching IV Years of Subchapter V: A Small Business Bankruptcy Retrospective.

*Audience discussion will follow the formal presentation and participation is strongly encouraged. NACM is looking for trade creditors with experience with small business debtors to participate in a roundtable that NACM will be scheduling with the ABI Subchapter V Task Force to solicit trade creditor input on the Subchapter V small business provisions.*

-Jamilex Gotay, editorial associate