The Benefits of Subchapter V — But Are You Guaranteed to Stay?

The key modifications to Chapter 11 and characteristics of Subchapter V include:

• Requirement to file a plan quickly. As part of the give-and-take of Subchapter V, debtors generally are required to file a plan within 90 days after entering bankruptcy, absent a showing of circumstances "for which the debtor should not justly be held accountable." This expedited plan timeline may not be ideal for some debtors, but for many debtors it functions as a minor inconvenience given the more relaxed economic standards and factors discussed below. The circumstances for which the 90-day period may be extended also can be somewhat flexible.
• Modification of the absolute priority rule. The "absolute priority rule" provides that existing owners of a debtor may not retain their equity interest in the debtor over the objection of a class of unsecured creditors, unless the unsecured class is paid in full or the owners contribute material new value into the debtor. In what is perhaps the single most important modification of the traditional Chapter 11 requirements to a non-publicly held company, that rule simply does not apply in a Subchapter V case — as long the plan provides that unsecured creditors will be paid the debtor's "disposable income" for a period of three years (or up to five years if extended by the bankruptcy court). In that event, equity holders of a Subchapter V debtor may continue to own and manage their business, even when unsecured creditors are paid a de minimis sum and vote against the plan or object to confirmation.
• No requirement to file a disclosure statement. A Subchapter V debtor is not required to file an accompanying Chapter 11 disclosure statement, unless ordered by the bankruptcy court for cause. The elimination of the disclosure statement requirement significantly reduces cost of preparing a plan and expedites the confirmation process.
• No competing plans. Only a debtor may file a Chapter 11 plan in a Subchapter V case. This limitation allows Subchapter V debtors to focus on their plan without having to worry about exclusivity or the distraction posed by a competing plan proposed by creditors.
• Modification of plan payments for administrative expense claims. A Subchapter V debtor may pay administrative expense claims over the term of the plan. In contrast, in traditional Chapter 11 cases, the debtor must pay administrative expense claims on the effective date of the plan or in the ordinary course of business. This allows a Subchapter V debtor to amortize some of the costs of filing bankruptcy.
• Reduced administrative expenses and creditor interference. Subchapter V provides that an official committee of unsecured creditors will not be appointed unless ordered by the bankruptcy court for cause. The elimination of a creditors' committee significantly reduces administrative expenses and overbearing oversight that may sometimes scuttle traditional Chapter 11 cases. Relatedly, Subchapter V debtors are also excused from paying United States Trustee quarterly fees.
• The concept of the debtor in possession survives with some oversight. A Subchapter V debtor's management team may continue to manage the debtor's affairs as debtor in possession. However, a Subchapter V trustee is appointed to monitor the debtor's affairs, evaluate the debtor's assets, assess the debtor's prospects for success, and make recommendations regarding confirmation of the debtor's plan. In practice, a Subchapter V trustee generally is more helpful to the debtor than not, especially when dealing with creditors who may be adverse to the debtor.

Eligibility for Subchapter V: Debt Amount and Recent Adjustments

To be eligible for Subchapter V, a debtor must: 1) meet the definition of a "small business debtor"; and 2) elect to be treated as a debtor under Subchapter V. Prior to the COVID-19 pandemic, the Bankruptcy Code defined a small business debtor as a business "engaged in commercial or business activities … that has aggregate noncontingent liquidated secured and unsecured debts … in an amount not more than $2,725,625 (excluding debts owed to 1 or more affiliates or insiders) not less than 50 percent of which arose from the commercial or business activities of the debtor."

As part of the Coronavirus Aid, Relief, and Economic Security Act of 2020, Congress temporarily increased the debt limit under this Bankruptcy Code section from $2,725,625 to $7.5 million until March 27, 2021. This increase made it possible for more substantial companies, with significant contingent and unliquidated debts that might otherwise be compelled to reorganize under the traditional Chapter 11 provisions, to qualify for Subchapter V's more relaxed standards. On March 27, 2021, Congress passed the COVID-19 Bankruptcy Relief Extension Act (https://bit.ly/3Uxuha3), which extended the increased debt cap provision through March 27, 2022. Although Congress did not act immediately, on June 7, 2022, Congress subsequently passed the Bankruptcy Threshold Adjustment and Technical Corrections Act (https://bit.ly/3UFL0bg), which retroactively reinstated the $7.5 million debt threshold for an additional two years. Accordingly, until at least June 2024, Subchapter V will remain a viable option for a much larger pool of small and mid-sized businesses to reorganize.