Editors’ Note: This article is a preview of a chapter that will be included in the forthcoming 2022-2023 edition of STRATEGIC ALTERNATIVES FOR AND AGAINST DISTRESSED BUSINESSES (“Alternatives”) and it is copyrighted by Thomson Reuters. It is published here by DailyDAC with the permission of Thomson Reuters.Download a PDF of this Article
President Reagan famously joked that “I’m from the Government and I’m here to help” are nine of the most terrifying words in the English language. Politics aside, few laws are as universally acclaimed as subchapter V of chapter 11 of the Bankruptcy Code.
The reason is elegantly simple: it works. It saves businesses. It helps the people that own those businesses. And it is cheap and fast – at least compared to “regular” chapter 11.
Regular chapter 11 (by which we mean any chapter 11 other than a pre-pack or a subchapter V) is far more expensive with a far less certain outcome than a subchapter V chapter 11 case.
Don’t read too much into this. Traditional chapter 11 is powerful medicine, and for the right patient, it is the very best medicine. The problem is that while it was created to help businesses of all sizes, the way chapter 11 evolved has been influenced disproportionately by bankruptcy courts’ decisions in massive cases. What makes sense and works well for the bankruptcy case of United Airlines, Lehman Brothers, Pacific Gas and Electric, WorldCom, or Sears doesn’t necessarily make sense for Joe’s Pizza Shop or Mary’s Motor Coach, Inc.1 The result: regular chapter 11 is often too expensive, time-consuming, and uncertain for the typical small business.2
This reality pushed smaller distressed companies (and their creditors) to look for alternatives to chapter 11 cases, with that trend growing since the late 1990s. These alternatives include chapter 7 bankruptcy, receiverships, assignments for the benefit of creditors (ABCs), and Article 9 sales.
Like most things in life, traditional chapter 11 and its alternatives have pros and cons. The fairly new option of subchapter V will not always be the best solution, but it has already proven itself excellent in many cases, at least from the perspective of the company and its owner(s). Why? Because in the hands of a skilled attorney, it can achieve all the benefits and more of regular chapter 11 at a fraction of the cost, time, and uncertainty.
We have organized this chapter with reference to the following questions:
Subchapter V was created by the Small Business Reorganization Act of 2019 (the “SBRA”). The SBRA, which had bipartisan support in Congress, was drafted in consultation with the National Bankruptcy Conference (“NBC”) and the American Bankruptcy Institute (“ABI”), with significant input from the National Conference of Bankruptcy Judges (“NCBJ”) and the American College of Bankruptcy (“ACB”). The SBRA was designed to help small businesses and their owners by providing a new, simpler path through chapter 11 than that offered by a traditional chapter 11 filing.3
Subchapter V went into effect on February 19, 2020. Given its recent enactment, there is little case law interpreting subchapter V’s provisions. As a result, and because subchapter V is such a departure from prior law, some of what we write here is speculation. But, hell, we’ve been known to run with scissors, so away we go…4
Subchapter V’s provenance traces from the ABI’s 2014 publication of its Final Report and Recommendations of the Commission to Study the Reform of Chapter 11 and numerous other reports, articles, and letters from various constituent parties and groups tendered in support of the subchapter V legislation. Collectively, these sources identified elements of conventional chapter 11 requirements, policy, and practice that rendered chapter 11 impractical to impossible for most smaller businesses to navigate, even after the 2005 amendments to the Bankruptcy Code (BAPCPA) that aimed to help small businesses.5 The House Committee Report published in support of the legislation noted the following:
a) So-called “small businesses” – privately-held businesses (e.g., “family businesses”) ranging from 50 to 5,000 employees – collectively employ more workers than businesses that employ more than 5,000.
b) As a group, only 50% of small businesses survive five years, and 33% survive ten years.
c) Traditional chapter 11 requires a substantial investment in time and money for both the debtor and its creditors, who must engage in the process for it to succeed. The cost and timeline of a traditional chapter 11 were prohibitive for most small businesses, particularly given their typical time horizon. The vast majority of creditors in small business bankruptcies have claims that are too small to warrant active participation.
In devising subchapter V, the drafters looked primarily to chapter 12 (and to a lesser degree, to chapter 13) for models. For example, the subchapter V trustee fulfills a similar role to the panel trustees assigned to monitor chapter 12 family farm bankruptcies.6
In chapters 12 and 13, the trustee has no operational or possessory role in the case, but serves as a fiduciary to creditors, a resource for the debtor as it pursues reorganization, and an advisor to the court. As in chapter 12, the subchapter V trustee may also serve as the disbursing agent for creditor payments. But subchapter V differs from chapter 12 in significant ways – in particular, the confirmation requirements for chapter 12 closely resemble those of chapter 13, while subchapter V incorporates most (but not all) of the requirements of §1129(a). As case law interpreting elements of subchapter V emerges, we see judges looking for guidance on the similarities and differences between subchapter V, chapter 12, and chapter 13 as they address the issues coming before them.7
We start with a simple hypothetical: meet BobCo. BobCo owes its bank $1 million and its trade vendors $2 million. BobCo’s business as a going concern could be sold, at the most, for $500,000, and if sold piecemeal, the total sale proceeds would be far less. BobCo can elect to file chapter 11 under subchapter V. We don’t need to know anything more. 8 The only real eligibility requirement for a business is a debt limit. As of the time of the publication of this chapter, to elect subchapter V, a debtor must have no more than $7.5 million of qualifying debt. 9
But what about Bob? 10 We forgot to mention that he guaranteed BobCo’s bank debt. Can he file chapter 11 and elect it to proceed under subchapter V? To answer that, we need to know a little more about Bob: in addition to the BobCo debt he guaranteed, Bob also owes $200,000 on the mortgage to his house, has a $20,000 car loan, and $50,000 in credit card debt.
So, even if we have to count BobCo’s $1 million bank debt, Bob is well under that qualifying $7.5 million debt cap even assuming all the debt we’ve mentioned is indeed qualified debt).
Notice that our hypothetical assumes that BobCo’s debt + Bob’s debt taken together is less than $7.5 million. Why did we write it that way? To keep it simple.
You see, the Bankruptcy Code tells us that if a debtor files for chapter 11, that debtor’s qualifying debt on the petition date + the qualifying debt of its affiliates who are also debtors in bankruptcy, taken together,11 cannot be more than $7.5 million.
There’s one other eligibility requirement that Bob has to meet because, unlike BobCo, he is a human being: at least 50% of his qualifying debt had to arise from his own “commercial or business activities.”12
Again, a debtor cannot elect to proceed under subchapter V unless the debtor’s qualifying debts are no greater than $7.5 million. We’ve been begging the question long enough; a debt is qualifying if it: (a) is not owed to an insider or an affiliate, (b) is not contingent, and (c) is liquidated. Let’s illustrate each:
While the SBRA made changes to the Bankruptcy Code’s definition of a “small business debtor” under §101(51D), it retained the requirement that a small business debtor must be engaged in “commercial or business activities.” This exact requirement applies to the definition of a subchapter V “debtor,” under Bankruptcy Code § 1182(1)(A).
Courts have split on what types of activity are required to qualify as sufficient “commercial or business activities.” A majority of courts that have considered the issue have held that a debtor must be currently engaged in commercial or business activities to meet the definition of a debtor under § 1182(1)(A).The debtor, however, need not necessarily be operating when it elects subchapter V treatment.15 By contrast, a minority of courts have held that subchapter V debtors do not need to be currently engaged in commercial or business activities to qualify for subchapter V and can use the subchapter V process to address matters like “residual” business debts.16
The eligibility of nonprofit entities to proceed under subchapter V has also been tested under the “commercial or business activities” standard. At least one court has concluded that there is no requirement that a subchapter V debtor be engaged in for-profit business to qualify for subchapter V.17
As we say in our introduction, because traditional chapter 11 is usually not a panacea for smaller businesses, many have come to avail themselves of chapter 11 alternatives. Principally these include “friendly” Article 9 foreclosures, assignments for the benefit of creditors, and out of court workouts.
A detailed discussion of such alternatives is beyond the scope of this chapter, but here is a concise summary of the three most likely options:18
The limitations and other negatives of these alternatives, as compared to subchapter V, may make subchapter V the best option, but maybe not. It may be that the debtor’s goals (or the goals of a prospective buyer of the business with whom the debtor wants to do a deal, or the goals of a secured creditor who is calling the shots19) are limited in a way that makes the advantages of subchapter V irrelevant.
This can be a confusing question, even to most bankruptcy attorneys, because the plain language of the Bankruptcy Code is not as straightforward as it could be on the subject. It’s not that complicated, however:
With all of that as background, the punch line is that a small business case is not all that different than a traditional chapter 11 case. Both, however, are pretty different than a subchapter V case – or else this chapter would have been a waste of time for us to write and a waste of your time to read.
We juxtapose for you some of the key differences between all three:
|Traditional Chapter 11 Case||Small Business Case||Subchapter V Case|
|Debt Limit||No limit||Not more than $2,725,625||Not more than $7,500,000|
|Categorization / Identification||Applies to a chapter 11 debtor that does not proceed as a small business debtor in a small business case.||Debtor indicates it is a “small business debtor” by checking a box on the Petition. Proceeding as a small business case may be mandatory for a “small business debtor” as defined in §101(51D) even if it does not indicate that status on the Petition and also doesn’t elect to proceed under subchapter V. See Note 21, supra.||Requires election to proceed under subchapter V and the Debtor must meet the requirement.|
|Business / Property Type||Limited restrictions22||Must not have its primary business be ownership of single asset real estate. See §101(51D).
Must not be a corporation or its affiliate of a corporation that is subject to reporting requirements under §13 or 15(d) of the Securities and Exchange Act of 1934. See 15 USC §§ 78m &o(d).
|Same as small business case.|
|Creditors Committee||Mandatory (subject to eligible creditors willing to serve). See §1102||Not appointed unless the court appoints one for cause. See §1102(a)(3).||Same as small business case.|
|Trustee||Chapter 11 trustee can be appointed for cause. See §1104.||Chapter 11 trustee can be appointed for cause (§1104)||subchapter V trustee is automatically appointed. See §1183. Duties expand pursuant to §1183(b)(4) if debtor is removed as debtor in possession under §1185(a).|
|Reporting requirements||Monthly reports of cash receipts
and disbursements (operating
|§ 308(b) provides that a debtor in a
small business case shall file “periodic financial and other reports” detailing:
|Must comply with the requirements of §1116(1)(A) and (B) as well as the requirements for small business case under §308 (see § 1187(1) and (2)). See also Fed.R.Bankr.P. 2015(a)(6).|
|Initial Debtor Interview||None||U.S. Trustee must conduct initial interviews with small business debtors prior to the first meeting of creditors (28 USC § 586(7)).||Same as small business case.|
|Meeting of Creditors (§341)||Shall be convened by the US Trustee within a reasonable time after the Petition Date.||Same||Same|
|Automatic Stay||Applies with very limited exceptions. See §362.||Small business debtor is not entitled to the protection of the automatic stay if it had been a debtor in a case dismissed within one year prior, or if it had been a debtor in a case for which a plan was confirmed within two years prior, or if the debtor had acquired substantially all the assets of a small business debtor within two years prior. See §362((n).||Same as small business case.|
|Absolute Priority Rule||Applies||Applies||Does not apply.|
|Equity||Wiped out unless creditors paid in full or new value contributed.||Wiped out unless creditors paid in full or new value contributed.||Equity can be retained without paying creditors in full|
|Plan Filing and Confirmation Deadline||No absolute time limit.||Plan must be filed within 300 days of the filing date (§ 1121(e)) and confirmation must occur
within 45 days of the filing of the plan (§1129(e)) unless the court extends the deadline for cause.
|Plan must be filed with 90 days of the Petition Date, unless extended for cause §1189(b). The Bankruptcy Code does not state what happens if this deadline is not met.|
|Plan Exclusivity23||120 days after the Petition Date (extendable for cause). See §1121(b).||180 days after the Petition Date (extendable for cause) but not later than 300 days unless period is further extended upon proof that it is more likely than not the court can confirm a plan within a reasonable period. See §1121(e)(1) and (2).||Only the debtor may file a plan See §1189(a).|
|Disclosure Statement||Disclosure statement must be filed unless court excuses upon motion. See §1125.||Must file a disclosure statement, except that court may allow plan to proceed without separate disclosure statement if plan itself contains “adequate information” for creditors. See §1125(f).||No disclosure statement is required, as §1125 does not apply in subchapter V unless the court orders otherwise for cause. See §1181(b).|
|US Trustee Quarterly Fees||Payable per statute. See 28 U.S.C. § 1930(a)(6).||Payable per statute. See 28 U.S.C. § 1930(a)(6).||No UST fees|
A debtor must affirmatively elect24 for its case to proceed under subchapter V at the time it files its chapter 11 petition. Parties in interest have 30 days after the conclusion of the § 341 meeting of creditors (or 30 days after the debtor amends its petition electing such treatment, if later) to object to a debtor’s subchapter V election.25
Funny but true answer #1: it’s not. Not if you are an unsecured creditor.
Funny but true answer #2: how much time do you have?
There are four main advantages, as compared to a traditional chapter 11:
Don’t think, however, that subchapter V is a cakewalk.30
There remain stringent substantive and procedural protections for parties in interest. In the confirmation context, for example, if a subchapter V debtor crams down its plan under §1191(b), then there are two consequences:
Unlike traditional chapter 11, where parties other than the debtor are allowed to file a plan, §1189(a) allows only the debtor to file a plan. The debtor, however, must file a plan within 90 days of the bankruptcy filing (unless the court extends the deadline).31
This chapter is intended primarily for the businessperson contemplating strategic options for their distressed business and for attorneys and other professionals not expert in business bankruptcy. If you happen to be a bankruptcy attorney, however, you likely already know that this is the real game-changer as compared to traditional chapter 11.
i.Confirmation in Traditional Chapter 11
Stop the train! And back it up a bit. That is, if you do not happen to be a business bankruptcy attorney, then we need to give you at least a basic understanding of what it takes to confirm a plan in a traditional chapter 11. Only then can we contrast it to the requirements in subchapter V.
The Bankruptcy Code is well organized and easy to navigate (at least compared to many other statutes). In traditional chapter 11, a plan must meet the requirements set out in §1129 in to be confirmed. Think of §1129(a) as a checklist of all the things a plan has to include or provide to be confirmed. Then think of §1129(b) as a second pathway to confirmation if the plan cannot satisfy each and every element of §1129(a).
There are 15 separate requirements in §1129(a), numbered (a)(1) through (a)(15).32 Some are usually harder to satisfy than others. One in particular—(a)(8)—is excused by §1129(b)(1) if the plan “does not discriminate unfairly” and is “fair and equitable as to each class of claims or interests that is impaired under, and has not accepted, the plan.”33
The italicized words cannot be understood simply by using one’s common sense and comprehension of the English language. Each is a legal term of art defined elsewhere in the Bankruptcy Code, by case law, and in some cases both. The term “fair and equitable,” for example, is defined by §1129(b)(2).
(Don’t allow your eyes to start glossing over now; we’re just about to get to the critical part.)
We need to back up just a little more before we move on.
What does §1129(a)(8) require? It requires every class under the plan to either accept the plan or to not be impaired by the plan. So, if that is not the case, the plan can’t be confirmed under §1129(a). And that is where §1129(b)(1) comes in.
Section 1129(b)(1), again, essentially says, “if your plan meets every requirement of §1129(a) except §1129(a)(8), you can still confirm your plan under §1129(b).” This manner of confirmation is what is popularly called “cramdown.” When one crams down a plan, it does so on a class (or more than one class) that is impaired under the plan, but which has not accepted the plan.
Now we can go back to §1129(b)(2). Again, it defines “fair and equitable,” and it does so differently depending on whether the class at issue is comprised of a secured claim, one comprised of unsecured claims, or one comprised of equity interests.
(Stay with us, we’re almost there.)
A plan is fair and equitable as to a class of unsecured claims if the plan provides that either (a) each holder of a claim in that class “will receive or retain on account of such claim property of a value, as of the effective date of the plan, equal to the allowed amount of such claim; or (b) no junior class will receive or retain anything under the plan on account of its claim.”34
Now we’ll say it in plain English: a plan in a traditional chapter 11 or non-subchapter V small business chapter 11 satisfies the test as to a class of unsecured claims if either: (a) members of the class will be paid in full on their allowed claims, either in full on the effective date or over time and with a market rate of interest; or (b) no junior class gets anything under the plan. This, which we mention in Section 8 above, is the “Absolute Priority Rule”35 and, again, its existence (and nonexistence in subchapter V) is the critical reason, more than any other, why subchapter V is so good.
Assume you (or your fund, family office, etc.) owns XYZ, Inc. You are considering a chapter 11 filing for XYZ, Inc. because the debt on its balance sheet is killing the company. You can use traditional chapter 11 to restructure the balance sheet and right-size the company, no problem. But unless you can pay all unsecured classes 100% of what they are owed, or you know they will voluntarily agree to less, your equity will be wiped clean. Stated another way, the company can emerge from traditional chapter 11 with a beautifully clean balance sheet, but the only problem is that the equity will be owned by someone else.
This is the most challenging problem a debtor faces in traditional chapter 11 that subchapter V solves.
ii. No Absolute Priority Rule in Subchapter V in a Cramdown of Unsecured Creditors
The Absolute Priority Rule simply doesn’t exist in subchapter V. To be more precise, to cramdown a subchapter V plan on a class of unsecured claims or interests, the plan still cannot discriminate unfairly, and must still be fair and equitable. The difference is that the definition of “fair and equitable” is different in subchapter V. No longer is it satisfied by members of the class being paid in full or, in the alternative, by classes junior to it getting nothing.
Instead, Bankruptcy Code §1191(c)(2) now provides that a plan is fair and equitable as to a class of unsecured creditors or to a class of interests if at least one of two things is true: either the plan applies all of its “projected disposable income” over three to five years to payments under the plan;36 or the value of the property to be distributed under the plan in that same timeframe is not less than the debtor’s projected disposable income.37
The latter standard is modeled on §1225(b)(1)(C), which was added to chapter 12 in the 2005 BAPCPA amendments to provide family farmers with more flexibility in the timing of their plan payments to account for the cyclical nature of farming. As one court has noted, “§1191(c)(2)(B) allows subchapter V debtors to pay more than, but not less than, their projected disposable income in a particular period and to control the timing of payments.”38
iii. Cramdown Excuses More than Just §1129(a)(8)
We wrote above that in a traditional chapter 11 case:
“§1129(b)(1) . . . essentially says, ‘if your plan meets every requirement of §1129(a) except §1129(a)(8), you can still confirm your plan under §1129(b). This manner of confirmation is what is popularly called ‘cramdown.’”
Another key difference between traditional chapter 11 and subchapter V is that in subchapter V, if the debtor can satisfy the cramdown requirements, it can confirm a plan that, in addition to failing to satisfy §1129(a)(8), may also fail to satisfy §1129(a)(10) and (a)(15).
Bankruptcy Code §1129(a)(10) requires that, in a traditional chapter 11 case, if a class of claims is impaired under a plan, at least one class of impaired claims must accept the plan, determined without including any acceptance of the plan by any insider. By doing away with this requirement, a subchapter V debtor can cramdown a plan even if no impaired class of claims accepts the plan.
Bankruptcy Code §1129(a)(15) pertains to individual chapter 11 debtors and requires that:
In a case in which the debtor is an individual and in which the holder of an allowed unsecured claim objects to the confirmation of the plan—
(A) the value, as of the effective date of the plan, of the property to be distributed under the plan on account of such claim is not less than the amount of such claim; or
(B) the value of the property to be distributed under the plan is not less than the projected disposable income of the debtor (as defined in §1325(b)(2)) to be received during the 5-year period beginning on the date that the first payment is due under the plan, or during the period for which the plan provides payments, whichever is longer.39
Subchapter V cramdown does not, therefore, require that an individual debtor’s plan meet the projected disposable income requirement of §1129(a)(15) if the subchapter V debtor is cramming its plan down under §1191(b). But as we discuss in below, every subchapter V debtor (not just an individual) seeking to cramdown a subchapter V plan must meet a different projected disposable income standard.
In the case of an individual debtor, as Judge Bonapfel notes in A Guide to the Small Business Reorganization Act of 2019, it is significant that the projected disposable income rule in subchapter V comes into play only if one or more classes do not accept the plan, because in a non-subchapter V case, a single creditor can hold up confirmation by invoking § 1129(a)(15).40
iv. Administrative Claims May be Paid Over Time Under a Cramdown Plan
In traditional chapter 11, a plan must pay administrative and gap claims in full on the plan’s effective date unless the particular claim holder agrees otherwise.41 Bankruptcy Code §1191(e), however, provides that a plan crammed down in subchapter V may provide for payments of these claims over time.42
v. Projected Disposable Income
Bankruptcy Code §1191(c)(2)(a) requires that, for a subchapter V debtor to confirm a plan without consent (i.e., cramdown), the plan must provide that all of the debtor’s “projected disposable income” during the life of the plan be committed to paying claims. As observed by the court in In re Moore Properties of Pers. Cty.,43 this projected income requirement is, in essence, the subchapter V substitute for the Absolute Priority Rule applicable in non-subchapter V chapter 11 cases.
This “projected disposable income,” or “best efforts,” test is not a new concept in bankruptcy, but its incorporation into subchapter V (and specifically its application to non-individual chapter 11 debtors) is. In chapters 12 and 13 of the Bankruptcy Code, the term “disposable income” is a defined term.44
And in individual chapter 11 cases, §1129(a)(15) incorporates the definition from chapter 13.
Section 1191(d) tells us that in subchapter V, a debtor’s “disposable income” is “the income that is received by the debtor and that is not reasonably necessary to be expended” for the following specific purposes:
This definition is nearly identical to the chapter 12 and 13 definitions,45 with the most notable difference being that the chapter 13 definition permits debtors to deduct charitable contributions from their disposable income.
Few cases have addressed whether a debtor’s plan met the projected disposable income test in subchapter V. In In re Sizzler USA Acquisition, Inc., et al.,46 the subchapter V trustee objected to confirmation, arguing the plan did not commit the debtor’s “actual” disposable income, if higher than the debtor’s projections, to pay claims over the life of its plan. The court rejected this argument and confirmed the plan over the subchapter V Trustee’s objection.47
Looking outside of subchapter V, as Judge Bonapfel did in A Guide to the Small Business Reorganization Act of 2019, may prove useful in the near term. In discussing how “projected disposable income” may be interpreted in the context of subchapter V business reorganizations, Judge Bonapfel anticipates that chapter 12 precedent can provide guidance to business debtors who may wish to include plan provisions for establishing cash reserves over time to use for things like anticipated capital expenditures or reinvesting in and growing a business.48
vi. Two Words About Secured Creditors & Subchapter V: “So What?”
The requirements to cramdown a secured creditor is the same in subchapter V as in traditional chapter 11, and the right of a secured creditor to make a §1111(b) election also persists unaltered in subchapter V.49 This is not to suggest (despite our snarky header) that secured creditors are immune from harm in subchapter V but, the degradation of their position in subchapter V is far less as compared to that of unsecured creditors.
vii. Protecting Creditors from Plan Default
As discussed in Section 9(b)(i), even if all classes reject a subchapter V debtor’s plan, it can still be crammed down on creditors if the plan does not discriminate unfairly and is “fair and equitable,” with respect to each class of claims or interests. Bankruptcy Code § 1191(c) defines what constitutes “fair and equitable,” in a subchapter V case, replacing the “fair and equitable” requirements set forth in Bankruptcy Code § 1129(b) for traditional chapter 11 cases. Section 1191(c) institutes a “rule of construction” for determining whether a plan is fair and equitable sufficient to cramdown a subchapter V plan.
With respect to secured claims in subchapter V, §1191(c) did not change the requirement that a plan meet § 1129(b)(2)(A)’s requirements for cramming down secured claims under a plan. But partially secured creditors with unsecured deficiency claims are limited in their ability to block confirmation of a subchapter V plan.50
Section 1191(c) does, however defines “fair and equitable” with respect to other claims and interests to mean that the subchapter V plan, as of its effective date, either: (a) provides that all of the debtor’s “projected disposable income,” be received during the 3-5 year term of the subchapter V plan, or that (b) the value of property to be distributed under the plan is not less than the debtor’s projected disposable income over the term of the subchapter V plan. 11 U.S.C. § 1191(c)(2)(A), (B). We discuss the “projected disposable income,” requirement in greater detail in Section 9(b)(ii) above.
Finally, §1191(c) requires that, for a subchapter V plan to be fair and equitable, the debtor must also show that it will (or a reasonable likelihood that it will) be able to make all payments called for under the plan and that “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.”51
Other than providing for the permissive liquidation of nonexempt assets, the final requirement that a subchapter V plan provide “appropriate remedies,” to creditors and interest holders in the event of nonpayment is not specific as to what may otherwise constitute “appropriate remedies.” Concerning secured creditors, however, this standard can be met very simply, by allowing the secured creditor to retain its lien under the terms of the subchapter V plan.52
But with respect to unsecured creditors and interest holders, alternatives to liquidating estate assets may take many different forms and will likely be the product of negotiated resolutions with creditors active in the subchapter V case, or may otherwise be proposed by the subchapter V Trustee.53 Thus, “appropriate remedies,” are likely to vary from case to case where a debtor’s plan does not propose liquidating assets to satisfy creditor claims in the event of a subchapter V plan default. One commentator suggested these possible alternatives: (a) prohibited from selling certain assets post-confirmation; (b) granting security interests to unsecured creditors in estate assets; (c) offering third-party guaranties to creditors, providing them with an alternate (presumably healthy) party capable of curing plan defaults; and (d) procuring a payment bond as insurance against plan defaults.54
A fundamental issue for smaller (and even larger non-public) debtors is that lenders, landlords, and others who extend significant credit to them often require personal guarantees from their owners. In that very common scenario, chapter 11 for the business alone cannot achieve the goal of really curing the owners’ problems because the bankruptcy of a debtor offers no relief for a guarantor.
A potential solution? An individual subchapter V case. There are significant advantages to a private business owner who qualifies to pursue a personal subchapter V case, particularly prior to a subchapter V for the company. Timing and planning are key, and there are traps for the unwary.55
In every subchapter V case, a trustee is appointed under Bankruptcy Code § 1183. The subchapter V trustee has specific statutory duties that, generally speaking, charge her with monitoring and oversight functions, the right to appear and be heard on specific matters, facilitate a consensual plan, and act as disbursing agent under a plan confirmed through cramdown. As we note in Section 1, this role is similar to a chapter 12 or 13 trustee.
Subchapter V trustees are selected and appointed by the office of the U.S. Trustee. At its outset, the U.S. Trustee’s office “recruited, vetted and trained approximately 250 selectees from more than 3,000 applicants. . . [with] strong business acumen, and include lawyers, CPAs, MBAs, restructuring consultants and financial advisors with diverse backgrounds in such areas as business, law, accounting, turnaround management and mediation.”56
Thus, the trustee’s role (at least through plan confirmation) can be thought of as akin to a mediator,57 a disinterested person who (where necessary) can understand the debtor’s business and financial matters to work with all parties in the case to reach agreement regarding the terms of the debtor’s plan.58 Once a consensual plan is confirmed, the trustee’s role is terminated upon substantial confirmation of the plan.59
Although the subchapter V trustee’s role is not, in the first instance, adversarial, a subchapter V trustee may be ordered to investigate the “acts, conduct, assets, liabilities, and financial condition of the debtor, the operation of the debtor’s business and the desirability of the continuance of such business, and any other matter relevant to the case or to the formulation of the plan.”60 There is no standard scope or rule for such an investigation as each case is unique.61
If the trustee conducts an investigation, she is required to file and serve a statement of investigation setting forth the salient facts of the investigation and her conclusions.62 If that report details mismanagement, fraud, dishonesty in reports or schedules, or failure to comply with court orders and rules, the court may remove the debtor (or its principals) for cause and order the trustee to take on management of a subchapter V debtor’s estate.63
And in the case of a subchapter V plan confirmed through cramdown, the trustee takes on the role of disbursing agent under the plan, charged with collecting plan payments for distribution to creditors, unless the plan or confirmation order provides otherwise.64
About 16 years ago one of your humble co-authors had the pleasure of co-writing a very long article titled, “Chapter 11: Not Perfect, But Better Than the Alternatives.”65 It argued that traditional chapter 11 works very well, and we believe it still does. Yet, just three years ago, that same co-author wrote as article titled, “Rise of the Alternatives –The Increasing Use of Strategic Alternatives to Chapter 11,”66 that argued alternative legal paths like assignments for the benefit of creditors and friendly Article 9 sales gained in popularity in recent years because of chapter 11’s deficiencies regarding smaller companies. We believe that is also true.
Subchapter V bridges the gap. Certainly, it will not be the right solution for all problems. But subchapter V is certain to give other alternatives a real run for their money.
Within a bankruptcy case, senior secured creditors often continue to indirectly maintain substantial control over the debtor’s business. A debtor’s major pre-petition lenders commonly provide or participate in a debtor-in-possession (“DIP”) loan to the debtor. As a DIP lender, a pre-petition creditor can use the terms of the DIP financing agreement to direct or constrain the debtor’s management, by, for example, requiring the debtor to meet certain cash-flow milestones or requiring it to confirm a plan of reorganization within a specific amount of time (possibly effectively requiring, if such milestones are not met, the debtor to sell its assets under section 363 of the Bankruptcy Code, in which sale the secured creditor may purchase the assets of the debtor by credit bidding). Sometimes, a secured creditor may try to use the DIP financing to make a play for ownership of the reorganized entity post-emergence.
Upon entering chapter 11, such a debtor may seek to finance its operations using encumbered cash over which the secured creditor has control. The debtor, typically, files a “cash collateral motion,” which frequently contains terms similar to those found in motions for DIP financing, asking the court to permit the debtor to use senior creditor’s cash collateral. The debtor’s ability to strike a deal with its secured creditor on cash collateral and DIP financing, at minimum, affects the timing of a bankruptcy filing. For an in-depth discussion of the often-intertwined processes of DIP financing and authorizations of use of a secured creditor’s cash collateral, see Friedland, et al., Commercial Bankruptcy Litigation, §§ 5.1 et seq. (2021 ed.).
The more control the creditor asserts, however, the greater risk it runs of incurring personal liability for financial losses that are directly or indirectly caused by the secured creditor’s wrongful conduct. For an in-depth discussion about lender liability, see Friedland, et. al., Strategic Alternatives For And Against Distressed Businesses, §§ 15:1 et seq. (2021 ed.).
Jonathan Friedland is a senior partner in Sugar Felsenthal Grais & Helsinger LLP’s Chicago office. He is ranked AV® Preeminent™ by Martindale.com, has been repeatedly recognized as a “SuperLawyer”, by Leading Lawyers Magazine, is rated 10/10 by AVVO, and has received numerous other accolades. He has been profiled, interviewed, and/or quoted in publications such as Buyouts…
Mr. Cahill is partner at Sugar Felsenthal Grais & Helsinger LLP, in Chicago, Illinois. He guides secured lenders, creditors, debtors, creditors’ committees, potential purchasers and others through bankruptcy cases, out-of-court workouts, assignments for the benefit of creditors, and receiverships. Mr. Cahill has substantial mega-case experience at national law firms representing very large debtors, and has…
Mark S. Melickian is a partner at Sugar Felsenthal Grais & Helsinger LLP in Chicago, and is head of the firm’s Restructuring, Insolvency, and Special Situations group.
Jack is a corporate and restructuring partner in the Chicago office of Sugar Felsenthal Grais & Helsinger LLP. Jack’s practice covers a range of healthy and distressed business engagements. He is widely recognized for his excellent work as a restructuring attorney including recognition by various organizations for his strategic thinking and tactical expertise, including SuperLawyers…
Hajar is an associate with Sugar Felsenthal Grais & Helsinger LLP in both its Business Transactions Group and its Restructuring & Insolvency Group.
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