What Is Subchapter 5 Bankruptcy?

Subchapter 5 Bankruptcy

Filing for bankruptcy can be a difficult decision. It can be even harder if your business is failing. Unfortunately, the bankruptcy process can also be challenging. Some small businesses get a second chance. They can get current with their debts by filing for Chapter 11 bankruptcy.

However, a Chapter 11 filing can be too expensive and complex for many small business owners. That’s why Congress enacted the Small Business Reorganization Act of 2019 (SBRA). It is also known as Subchapter 5 and, as such, was added to the US Bankruptcy Code. It went into effect the following year. 

Subchapter 5 was intended to be the easier, cheaper, and faster version of Chapter 11 bankruptcy. The goal was to allow small businesses earning a profit to restructure and reorganize their debt. By going through a simplified process, they can pay their debt. 

Although there are benefits, critics claim that Subchapter 5 can be manipulated. They believe larger companies are using it to capitalize on the many benefits.

Bankruptcy for Small Business Owners

Filing a small business bankruptcy under Subchapter 5 offers a fresh start. Businesses that file can force creditors to accept court-approved repayment plans. They can also get some of their unsecured debt discharged. When debts are “discharged,” they are wiped out, and the creditor cannot collect them.

Sometimes, creditors can prevent a debt from being discharged. For example, suppose the debtor obtained money through fraudulent means. Then, creditors can object to its discharge. If the debt survives the bankruptcy, the creditor can start collecting.

Businesses that qualify for Subchapter 5 have to actively pursue business activities. But, their debt can not exceed the debt limit. Also, at least half of the business debt has to come from business activities. Businesses whose primary activity is running or owning a property are not eligible.

Small businesses that consider filing can benefit from hiring a small business attorney. Although the procedure is simpler, a knowledgeable attorney can make sure everything is in order.

What Are the Types of Business Bankruptcy?

Business owners considering filing for business bankruptcies can file under the:

• Chapter 7
• Chapter 11

Each one of them offers different benefits.

For example, Chapter 7 is known as liquidation bankruptcy. It’s suitable for businesses that are no longer viable. The business owner will have to sell all of their business assets. That way, they can pay creditors and close the business. In return, they will be debt free.

Chapter 11 is a reorganization bankruptcy. It allows business owners to force creditors to negotiate payment plans. Also, the business stays open. They continue running while paying back a portion of their debts to creditors over a set period. Essentially, they get to reorganize the business’ debt obligations. 

At the same time, the filing party gets to keep property and business assets. Debts can be reorganized in a way that will allow for timely and consistent payments. Most of the secured debts can be repaid. But, some unsecured debt may be discharged.

In both types of bankruptcy, debtors are protected from creditors by an automatic stay. This is often considered the biggest advantage of bankruptcy.

How Does Automatic Stay Work?

When a debtor files for bankruptcy, the automatic stay goes into effect. It keeps creditors from collecting and stops most court actions against the debtor.

That means creditors have to be extremely careful. For example, with the automatic stay in effect, the creditors:

• Must stop any eviction or foreclosure;
• Can’t contact the debtor;
• Halt all litigation and collection efforts.

Violating the automatic stay can result in steep penalties. Creditors who violate it may have to pay thousands of dollars.

In some cases, the court may be asked to lift the automatic stay. Suppose the debtor filed for bankruptcy to defraud the creditor. That may qualify the creditor to ask for the order to be lifted.

Also, if creditors’ debt was excluded from discharge, they may be able to continue collection efforts. Creditors can also pursue their efforts if the debtor’s bankruptcy case is dismissed. If that occurs, the automatic stay will be lifted.

Benefits of Subchapter 5 of the Bankruptcy Code

Small business debtors can enjoy several benefits when filing bankruptcy under Subchapter 5. These benefits include the following:

• The debtor’s business stays open: The business operations continue to run, though the owner has to stick to the payment plan.
• Creditor consent is not required: The bankruptcy court can confirm the reorganization plan without the creditors’ approval. However, the plan can’ unfairly discriminate. It also has to be fair and equitable. A traditional Chapter 11 plan has to be approved by creditors.
• Only a small business can file a plan of reorganization: In other Chapter 11 cases, creditors can propose a competing plan. That can occur if the debtor doesn’t propose a plan within 120 days of the bankruptcy filing. In Subchapter 5, that is not the case.
• No disclosure is needed: In Chapter 11 cases, the debtor files a detailed disclosure statement. The statement provides important information on whether creditors can be repaid. In a Subchapter 5 case, that statement is not needed.
• Administrative expenses differ: In a traditional Chapter 11 case, the debtor has to pay all of the administrative expenses. The last day for payment is the plan’s effective day. Subchapter 5 allows the debtor to pay them over the life of the plan.
• A special trustee will be named: A trustee will be named to monitor continued business operations. The trustee can recommend changes regarding the plan to the bankruptcy court.

The court and the Office of the US Trustee can supervise a trustee. Note that the trustee doesn’t represent creditors or the debtor. Both debtors and creditors have rights in bankruptcy. But you can’t expect the trustee or the bankruptcy judge to stand up for you. A bankruptcy attorney may be able to help. They can also stop you from making common mistakes made before filing for bankruptcy.

Other Differences Between Chapter 11 and Chapter 11 Subchapter V

There are other differences between these bankruptcy types. For example, in Subchapter 5, there is no appointment of an unsecured creditors committee. Typically, the US Trustee appoints an official committee of unsecured creditors. The committee usually consists of unsecured creditors. They represent the interests of all unsecured creditors. These creditors can prevent or delay plan confirmation if they don’t like it.

In Subchapter 5, a committee is not appointed unless a court orders otherwise. The appointment of an official committee will be the exception. This substantially reduces costs small business debtors have to pay. It also provides a somewhat unobstructed path to plan confirmation.

Traditional Chapter 11 also has the Absolute Priority Rule. It requires that the unsecured creditors of a higher priority class have to be paid first. With Subchapter 5, a lower-priority class of creditors can be paid first. That can occur even if higher-priority creditors haven’t been paid in full.

What Is the Debt Limit for Subchapter 5 Bankruptcy?

To qualify for Subchapter 5, the business must first qualify as a small business and it must be below the there is a debt limit. When the SBRA was first enacted, the debt limit was $2,725,625. That means a business qualified as a “small business” if it owed that amount or less.

However, the debt cap was temporarily raised to $7.5 million. It occurred when the Coronavirus Aid, Relief, and Economic Security (CARES) Act was passed in 2020. That limit was extended until March 27, 2022. Routine adjustments by the Judicial Conference of the US increased the debt cap to $3,024,725 on April 1, 2022. 

Whether the limit will be raised to $7.5 million again remains to be seen.

How Does Subchapter 5 Bankruptcy Affect Creditors and Their Claims?

Subchapter 5 bankruptcy offers a streamlined process for business debtors, impacting creditors and their claims. Under this option, creditors face reduced administrative costs and a quicker resolution. Debtors retain control over assets and continue normal operations.

While the debtor completes the plan payments, they can potentially retain equity interests without the contribution of any ‘new value’ even if the other creditors aren’t paid in full.

Provisions related to the Paycheck Protection Program and the Small Business Administration can influence how claims are addressed, making it essential for creditors to stay updated.

How Can a Bankruptcy Attorney Help?

Small businesses that can’t handle their secured and unsecured debts may have to consider filing for bankruptcy. Although Subchapter 5 seems straightforward, that’s not always the case. Even this efficient and relatively inexpensive method can carry certain complications.

When dealing with bankruptcy for a small business, an ounce of prevention is worth a pound of cure. Our attorneys can help you mitigate the risks of not complying with the bankruptcy code. We can negotiate the complexities of the bankruptcy system to resolve these issues.

Our firm has significant experience and knowledge of the bankruptcy process. Don’t go through it alone. Contact the Law Offices of Scott J. Goldstein for assistance.