THE NEW CHAPTER V: A CHANCE FOR SMALL BUSINESSES TO SURVIVE

By Deborah I. Hollander, Esq.

The Small Business Reorganization Act of 2019 (“SBRA”) is the most extensive reform to the Bankruptcy Code since 2005.   It added a new Subchapter V to the Bankruptcy Code, to allow small businesses to reorganize without completely going out of business.

Reorganization under the protection of the bankruptcy gives the debtor a “financial breathing spell” from most creditor collection efforts. This protection allows a business to continue its operations while formulating a plan of reorganization to repay its creditors. Up until February of this year, a business could only reorganize under Chapter 11, a complex process which most small businesses could not afford, which small businesses rarely successfully completed and which provided little protection for the entrepreneur who founded and continues to run the business.

Chapter 11 now has a newly created Subchapter V which makes it possible for business owners to keep their ownership interests without having to pay senior creditors in full or provide new value.   Within 60 days of filing, the court will schedule a substantive status conference to help chart the course for the debtor.  The debtor’s plan is due within 90 days of the date of filing.

What size and type of businesses qualify?

To qualify as a small business debtor, the debtor must be a person or entity engaged in commercial or business activity with aggregate secured and unsecured debts of $2,725,625.00.   Businesses which make public offerings and corporations which are part of larger corporate entities regulated by the Securities and Exchange Commission are not eligible. Nor is “single asset real estate,” owners, business whose income comes from operating a single piece of real estate eligible.

Reduced Costs under Subchapter V

There are cost savings built into the new Subchapter V, as opposed to a regular Chapter 11.  The debtor is not requirement to pay United States Trustee (“UST”) quarterly fees. There are no appointments of a committee of unsecured creditors. There is no requirement for a disclosure statement to accompany the debtor’s plan of reorganization.  The period of Reorganization is limited to a five year period.

How the New Chapter V bankruptcy will work

Only the business itself can file for bankruptcy under this chapter.  Creditors cannot join together to force the business into this form of bankruptcy.  The business begins by filing for bankruptcy and electing Subchapter V.  Upon “electing” that Subchapter, shall apply to the debtor’s case, the debtor must file a copy of the business’s most-recent balance sheet, statement of operations, cash-flow statement, and federal income tax return or a sworn statement that such documents do not exist.

 The Subchapter V Trustee

A trustee will be appointed in every Subchapter V case. Within 14 days after filing. The trustee will serve as a fiduciary for creditors and is accountable for all property of the debtor as well as for ensuring the debtor makes the payments as required by debtor’s reorganization plan. The trustee must participate in certain bankruptcy court conferences and hearings concerning matters to the value of any property subject to a lien, the confirmation of a reorganization plan and any modification post-confirmation, and the sale of property of the estate. The trustee’s service terminates upon substantial consummation of the plan

A subchapter V trustee ordinarily will not operate the business of the small business debtor.  The presumption is that the principal of the corporation will continue to operate the business as a debtor in possession. A subchapter V debtor may lose its status as a debtor in possession only if the court finds, after notice and a hearing, that the debtor engaged in fraudulent, dishonest, or incompetent behavior or grossly mismanaged its financial affairs.

The Status Conference

Within sixty days after the business files its petition, the bankruptcy court will hold a status conference to further the expeditious and economical resolution of a case.  The Court can court postpone this conference only if   such extension is needed as a result of circumstances for which the debtor should not justly be held accountable.  At least later 14 days before the date of the status conference, the debtor must file with the court and serve on the trustee and all parties in interest a report that details the efforts the debtor has undertaken and will undertake to attain a consensual plan of reorganization.

The Submission of the Plan: 

The next important step is the debtor’s submission of its actual plan to reorganize.  This must happen no later than 90 days after the case is filed, unless the court extends this period because of circumstances for which the debtor should not justly be held accountable.

The plan must include the following: a brief history of the business operations of the debtor; a liquidation analysis; and projections with respect to the ability of the debtor to make payments under the proposed plan of reorganization. In addition, the plan must provide for the submission of all or such portion of the future earnings or other future income of the debtor to the supervision and control of the trustee as is necessary for the execution of the plan.

If the business owner borrowed against his home to fund the business, he may be able to reduce or modify that mortgage. The debtor may modify the rights of a mortgage or lien holder secured only by a security interest in his principal residence of the debtor if the new value received in connection with the granting of the security interest was used primarily in connection with the small business of the debtor, but not the mortgage used to buy the home.

Confirmation or Rejection of the Plan

In order for the plant to be confirmed, the Bankruptcy court must find that: (1) the debtor will be able to make all payments under the plan; or (2) there is a reasonable likelihood that the debtor will be able to make all payments under the plan; and the plan provides appropriate remedies, which may include the liquidation of nonexempt assets, to protect the holders of claims or interests in the event that the payments are not made.

The plan must provide that all of the projected “disposable income” of the debtor to be received will be applied to payments under the plan for three-year to five year period, beginning on the date that the first payment is due. The plan may also include of the distribution of property to creditors within that same three-year to five year period as long as the property so distributed is not less than the projected disposable income of the debtor.

            DISPOSABLE INCOME

Obviously, a key feature of a Plan is the identification of “Disposable Income” since that is the money which must be paid to the Trustee to fund the plan. There is a new and specific definition of “Disposable income” for Subchapter V small businesses. “Disposable income” means “the income which is received by the small business enterprise debtor and which is not reasonably necessary to be expended — (1) for the maintenance or support of the debtor or a dependent of the debtor or for a domestic support obligation that first becomes payable after the date of the filing of the petition; or (2) for the payment of expenditures necessary for the continuation, preservation, or operation of the business of the debtor.” § 1193(d). This is different than the definition of “disposable income” in other parts of the code. Overtime, case law, will flesh out this definition.

FLEXIBILITY IN TREATING GROUPS OF DEBTORS

The plan must be fair and equitable with respect to each class of interests.  It is not necessary that the group of creditors agree to their treatment. The bankruptcy court may confirm a plan even if a class of claims or interests has rejected the plan providing that such plan does not discriminate unfairly, and is fair and equitable with respect to each class of claims or interests that is impaired.

The plan must satisfy one of three alternatives to pay secured creditors. (1) The holders retain their liens and receive on account of their claims deferred cash payments totaling at least the amount of their claims, as valued on the plan’s effective date. (2) If the plan contemplates selling secured property then the plan must provide that the secured creditors receive the indubitable equivalent of their claims.

If a Plan Is Not Confirmed

If a plan is not confirmed, it is probable that the debtor will end up in a Chapter 7 bankruptcy. Technically, the debtor may obtain any money provided to the trustee but actual receipt of refunds is unlikely, Under the statute, the trustee shall return any payments received from the debtor, but only after deducting– (1) any unpaid claim allowed under section 503(b) of this title; (2) any payment made for the purpose of providing adequate protection of an interest in property due to the holder of a secured claim; and (3) any fee owing to the trustee.

Operating Under the plan

If a plan is confirmed, the debtor has three to five years to complete it, i.e., pay off all the debts and successfully sell all the secured property as outlined in the plan.  During that period there will be a “bankruptcy estate” which includes all property acquired by the debtor after the date of commencement of the case, but before the case is closed, dismissed, or converted to a case under chapter 7,  12, or 13 of title 11, whichever occurs first. It also includes all earnings from services performed by the debtor during such period.

During this period, the debtor remains in possession, although “disposable income” must be provided to the trustee to distribute according to the plan. The debtor may employ pre-filing creditors, as long as their claim was less than $10,000 at the time of filing. This is a crucial element because small businesses may try to keep themselves afloat by borrowing or suspending pay to the business’s founders or other key employees.  It also allows the debtor to use the same accountants and attorneys it had prior to the filing, even if it owes them outstanding bills.

 

 Modification After Confirmation.

Of course, business is not always predictable.  Therefore, it is possible to modify a plan once confirmed.  The debtor may modify the plan at any time after confirmation of the plan and before substantial consummation of the plan, but may not modify the plan so that the plan as modified fails to meet the requirements required for original confirmation. The proposed modification must be approved by the Court, after a notice is given to creditors and a hearing is held before the Bankruptcy Court.

Discharge After Completion Of The Payments

 If all goes well, during three to five years of the plan, the debtor generate sufficient disposable income to make all payments due under the plan within that period. If so, the bankruptcy court must grant the debtor a discharge as soon as. Such discharge will cut off all debts as provided under the plan. Of course, if a debt itself lasts longer than the plan (such as a ten year mortgage, which was kept current but not fully paid off during the plan), or if a debt is inherently non-dischargeable under bankruptcy law, (such as federal taxes), those will remain.

Otherwise the debtor now has a fresh start, having satisfied or discharged  the pre-filing debts, and regains control of all, including its disposable income.

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