Subchapter 5 vs. Traditional Ch 11 Bankruptcy
E.J. Simonsen | Sep 8, 2022
Also known as the Small Business Reorganization Act of 2019, Chapter 11, Subchapter 5 bankruptcy is a new process that was developed to help small businesses more successfully navigate through reorganization. While there's a lot to know about this new process, one of the questions our attorneys hear most often is, "What's the difference between Chapter 11 bankruptcy and this new Subchapter 5 option?"
In this article, we're going to break down:
- Why Congress prioritized and passed Subchapter 5 bankruptcy.
- How the new Subchapter 5 process differs from the traditional Chapter 11 bankruptcy process.
- Who is qualified for a Subchapter 5 bankruptcy.
The Goal of the New Subchapter 5 — Why Congress Passed the Small Business Reorganization Act of 2019
Chapter 11 bankruptcy is often known as the "reorganization bankruptcy." It is structured to afford businesses the opportunity to reorganize, reduce, or eliminate debts in the hopes that by doing so they will once again become profitable.
Unfortunately, many of the businesses filing for Chapter 11 bankruptcy were small businesses, and the complexity and high costs resulted in few of them reorganizing successfully. While some attempts had been made to adjust the Bankruptcy Code, before the Small Business Reorganization Act of 2019, the "small business debtor" continued to struggle to reorganize under Chapter 11.
The Goals Behind Subchapter 5
When Congress passed Subchapter 5, it did so with two key goals in mind:
- To reduce the costs associated with Chapter 11 bankruptcy for small businesses. The cost of the bankruptcy process was identified as a key fail point for many small businesses. Because the process was so complex and drawn out, many small businesses didn't have the capital to make it through the bankruptcy process, let alone implement their reorganization plan.
- To minimize the involvement of creditors in the bankruptcy process. In many small business bankruptcies, the debts owed to creditors are not significant enough for the creditor to dedicate time and money to the process. For this reason, many creditors were not participating at all in Chapter 11 bankruptcies for smaller businesses, which made it nearly impossible for the business to complete the reorganization process.
Chapter 11, Subchapter 5 of the US Bankruptcy Code was developed with these two goals at its core. Most of the changes Subchapter 5 implements are included to either reduce creditor involvement or minimize the overall fees and costs associated with the reorganization bankruptcy.
What are the Differences Between a Traditional Chapter 11 Bankruptcy and the New Subchapter 5 Process?
As mentioned, most changes that Subchapter 5 introduces work to limit creditor involvement or reduce process-associated costs. Key differences between a traditional Chapter 11 bankruptcy and a Chapter 11, Subchapter 5 bankruptcy include:
Elimination of the Committee of Creditors
Subchapter 5 eliminates the Committee of Creditors that would be required in a Chapter 11 bankruptcy. This not only works to eliminate superfluous creditor involvement, but it also helps reduce the cost of Chapter 11 bankruptcy for small businesses. The Committee of Creditors incurs significant professional fees that a small business would be responsible for paying. Without the Committee, the process moves along more quickly and at a significantly reduced cost to the business.
Elimination of Need for Filed Disclosure Statement
In a traditional Chapter 11 bankruptcy, the business would be required to file a very detailed Disclosure Statement along with the business's plan for reorganization. The Subchapter 5 process does not require this document, helping again to reduce creditor involvement. More importantly, this also minimizes the cost for the small business, as it reduces the fees associated with drafting and approval.
It's important to note that while a Disclosure Statement isn't required under Subchapter 5, the small business is still required to provide certain information that might usually be in the Disclosure Statement like:
- A brief history of the operations of the debtor
- A liquidation analysis
- Projections regarding the plan and the debtor's ability to make plan payments
Subchapter 5 Reorganization Plans May Only Be Filed by the Debtor
Under Subchapter 5, creditors cannot file competing reorganization plans, which helps move the reorganization process along. And, given that in most small business cases, creditors have little interest in providing unique reorganization plans, or if they do, they would propose a plan the business owners would never accept. This essentially removes an unnecessary step in an already long process.
Subchapter 5 Eliminates the Absolute Priority Rule
The traditional Chapter 11 bankruptcy process includes an "Absolute Priority Rule."
This rule essentially requires that all senior class creditors must be paid in full before other classes of creditors and equity holders can receive any money or property. This rule establishes a line of priority where nonconsenting creditors are always paid in full.
Subchapter 5 eliminates this rule, which means that the small business owner can retain 100% of their equity even when a reorganization plan does not pay creditors in full.
Subchapter 5 Reorganization Plan Confirmation and Voting
Traditional Chapter 11 bankruptcies require that creditors confirm the proposed reorganization plan. Under Subchapter 5, a reorganization plan can be confirmed without a consenting creditor. What's more, Subchapter 5 eliminates the need for creditors to vote on the confirmation of the plan. Whether creditors agree or disagree, the court may approve the reorganization plan. Again, this moves the bankruptcy timeline along swiftly and reduces the involvement of the creditor in the reorganization process.
Small Businesses May Modify Loans Secured by Real Property
This is another protection that was delivered specifically to protect small business owners. In a traditional Chapter 11 bankruptcy, the business may not modify secured loans, even if the claim is secured by the principal residence of the business owner.
Under Subchapter 5, if a business owner used a house (principal residence) as security for a loan that funded the small business, the business's reorganization plan may modify the loan.
Appointment of a Standing Trustee
The final significant difference between these two types of Chapter 11 bankruptcy — traditional and Subchapter 5 — involves the appointment of a standing trustee.
In a traditional Chapter 11 bankruptcy, a trustee is only appointed if there is cause — usually in the event of gross misconduct or fraud. Under Subchapter 5, a standing trustee is automatically appointed, though the business still retains control of all assets and operations.
Under Subchapter 5, the trustee does not control or override the owner but instead works to assist the court or the business’s attorney with items that help the small business bankruptcy stay on track. They may do things like account for property, review the company's business operations and financial condition, or report any misconduct. In general, the trustee is there to facilitate a smooth process. Again, this is done in an attempt to make reorganization more feasible for small businesses.
Who is Qualified for a Chapter 11, Subchapter 5 Bankruptcy?
If your business is considering bankruptcy, or if you're an accountant looking into options for a client, Subchapter 5 bankruptcy is a useful option that many still don't know enough about. It can provide the same benefits of a traditional Chapter 11 bankruptcy — the chance for a business to reorganize its finances and become profitable again — at a significantly reduced cost and shortened timeline. Wondering if the business you have in mind qualifies?
Here are the requirements for a Subchapter 5 bankruptcy:
- Under $2,725,625 in non-contingent debt. NOTE: Congress increased this debt limit in June 2022 to $7.5 million through June 21, 2024.
- The business must also be pursuing business activities and
- 50% of business debt comes from business activities.
Most clients that The Lane Law Firm has worked with in a bankruptcy capacity lately have fallen well within these requirements, making it a useful option for many American businesses still working to get back on their feet after the global pandemic.
If you're new to the idea of a Chapter 11, Subchapter 5 bankruptcy, or if you're still not sure which bankruptcy option is best for your business, it's always best to talk to an experienced attorney. The business bankruptcy and business debt relief attorneys at The Lane Law Firm are here to help.