Small Business Reorganization Act and Subchapter V

A 60-day mandatory conference and the filing a pre-conference report by the debtor 14 days before the conference describing the efforts taken and to be taken to reach a consensual plan of reorganization is required. Presumably this will provide the bankruptcy court with information about whether the debtor is on track to timely file its plan. This deadline can be extended pursuant to §1189(a) only upon a finding that such extension is "attributable to circumstances for which the debtor should not justly be held accountable."

The rules relating to retention of professionals have been modified to allow attorneys and accountants that are owed less than $10,000 pre-petition not to be disqualified for lack of disinterestedness under §327 of the Bankruptcy Code. These amounts can be paid off under a plan and do not need to be written off.

The provisions in the Bankruptcy Code for the appointment of a creditors' committee do not apply in a Subchapter V case "unless the court for cause orders otherwise "under §1181(b).

In addition, in a Subchapter V case a standing trustee is automatically appointed to supervise the case. The standing trustee acts as an advisor and should generally focus on non-legal matters in order to "facilitate the development of a consensual plan of reorganization."

The standing trustee has certain duties including being accountable for all property received, examining proofs of claim and objecting as required, opposing discharge if advisable, furnishing information about the estate and its administration and preparing and filing a final report. The standing trustee is also obligated to appear and be heard at the 60-day conference and any hearings concerning: 1) the value of property subject to a lien; 2) confirmation of a plan; 3) modification of a plan post-confirmation; or 4) the sale of property of the estate.

One very important role for the standing trustee is to collect and retain plan payments until confirmation of a plan and to make sure that the debtor makes timely payments as required under a confirmed plan. The standing trustee then distributes payments pursuant to the plan, or if the plan is confirmed without the consent of an impaired class, for the term of the plan.

Plan, Disclosure Statement, Property of the Estate and Confirmation

There are two ways in which a Subchapter V plan can be confirmed: consensually or through cramdown. A consensual plan is one that is accepted by all classes of claims. A cramdown plan does not have an impaired accepting class of claims, but can be confirmed if the plan does not discriminate unfairly and is fair and equitable. The term fair and equitable has a different meaning in a Subchapter V case. For example, as to each class of secured creditors the plan must satisfy the requirements of §11229(b)((2)(A) and as to other classes of creditors the plan as of the effective date must provide that: i) all of the projected disposable income of the debtor to be received in the three-year period beginning on the date the first payment is due under the plan (or such longer period fixed by the court not to exceed five years) will be applied to make payments under the plan; or (ii) the value of property to be distribute under the plan in the three or five-year plan term is no less that the projected disposable income of the debtor.

Disposable income has also been redefined to mean income received by the debtor and that is not reasonably necessary to be expended for: 1) maintenance or support of the debtor or a dependent or a domestic support obligation; or 2) payment of expenditures necessary for the continuation preservation or operation of the debtor's business.

Further, the concept of property of the estate depends on several factors. First, in a cramdown plan estate property includes earnings and property acquired post-petition and post-confirmation until the case is either closed, dismissed or converted. On the other hand, under a consensual plan property of the estate is limited to that which existed at confirmation.

While more favorable to a debtor, a cramdown plan under Subchapter V must also satisfy other obligations under sections 1181(c), 1186(a), 1192, 1193(c) and 1194(b). The goal of the Subchapter V plan process is to foster consensual plans where creditors would do better than they would under a cramdown plan. Noteworthy is the fact that the absolute priority rule does not apply in a Subchapter V case and therefore equity owners can retain their interests in the debtor without paying holders of a non-consenting impaired classers.

The SBRA eliminates the requirement of a disclosure statement unless the court orders otherwise. That said, the plan must contain a brief history of the debtor's business, operations during the case, feasibility projections and a liquidation analysis. However, in the event that a disclosure statements is ordered by the court, the SBRA provides for expedited procedures under §1187(c).

Finally, no competing plans are allowed. The debtor can modify a plan before confirmation or after confirmation either before or after substantial consummation if, after notice and a hearing, circumstances warrant such modification.

Treatment of Claims

In a non-consensual plan, a debtor can pay administrative claims over the three to five-year life of the plan but this option is not authorized under a consensual plan and such claims must be paid at confirmation. This flexibility to pay such claims over a period of time allows a debtor to avoid having a plan blocked by an administrative expense clamant.

Modification of a claim secured by the debtor's principal residence is permitted under Subchapter V so long as the mortgage was not used to purchase the residence and the new value received in connection with granting the security interest was used primarily in connection with the debtor's business. Under Chapter 11 and 13, a debtor cannot modify a claim secured solely by his principle residence. This change is the law favors small business debtors and creates incentives for parties to reach a consensual plan. By way of example, the recent case of In re Ventura , 2020 WL 1867898 (E.D. N.Y. April 10, 2020), presents a number of novel issues such as amending prior petition to elect Subchapter V treatment and seeking to strip down mortgage on debtor's principal residence.

Discharge

A discharge of debt under a non-consensual plan occurs at the end of the plan period which can be up to five years. On the other hand, under a consensual plan the discharge is entered upon plan confirmation. Normally, an individual debtor would not receive a discharge until all plan payments have been made. Finally, the standing trustee is relieved of its duties upon substantial consummation of the plan.

Excluded Provisions

A number of provisions in the Bankruptcy Code are inapplicable in subchapter V cases including §§105(d), 1101(1) 1104, 1105, 1106, 1107, 1108, 1115, 1116, 1121, 1123(a)(8), 1123(c), 1127, 1129(a)(15), 1129(b), 1129(c), 1129 (e) and 1141(d)(5). And other provisions do not apply "unless the court for cause shown orders otherwise'" such as §§1102(a)(1)(2) and (4), 1102(b), 1103 and 1125. That said, care should be taken to carefully understand how some provisions like §1116(1) that appear to be inapplicable are merely modified under SBRA.

Change in Preference Laws

Finally, the SBRA changed the threshold for filing preference claims by raising it to $25,000 so that claims of less than that amount must be filed in the district where the defendant resides. In addition, the debtor must exercise reasonable due diligence and must "take into account a party's known or reasonably knowable affirmative defenses" … before filing the adversary proceeding. In theory, raining this threshold and requiring analysis f defenses should reduce the number of preference actions.

Conclusion

The SBRA represents a long-awaited change in the Bankruptcy Code that recognizes that small businesses were not financially able to restructure debt and reorganize their business under the traditional Chapter 11 process because of the cost of that process. This is a welcomed statutory development that finally provides a small business with an opportunity to reorganize itself, to restructure its debt, to save jobs and to meaningfully benefit from the fresh start spirit and intent of our bankruptcy laws.

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Robert W. Dremluk is a partner in the New York office of Culhane Meadows PLLC, and a member of The Bankruptcy Strategist's Board of Editors. His work focuses on diverse interests in federal and bankruptcy court litigation, and advice and risk assessment regarding transactional matters, including asset purchases and structured finance transactions. He may be reached at [email protected].