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 the 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, the two key goals for which it strove were: 

  1. To reduce the costs associated with Chapter 11 bankruptcy for small businesses. The cost of the bankruptcy process was identified as a key failure 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. 
  2. 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 did not participate in their Chapter 11 bankruptcies, making it nearly impossible to complete the reorganization process. 

By and in large, Chapter 11, Subchapter 5 of the US Bankruptcy Code met these two goals as most of the changes to Chapter 11 either reduced creditor involvement or minimized the overall fees and costs associated with a Chapter 11 reorganization bankruptcy. 

What are the Main Differences Between a Traditional Chapter 11 Bankruptcy and the New Subchapter 5 Bankruptcy?

As mentioned, many of the changes that Subchapter 5 introduced worked to limit creditor involvement or reduce process-associated costs. Some of these 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 is often 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 is required to file a very detailed Disclosure Statement, which includes owner/shareholder information, along with the business's plan for reorganization. The Subchapter 5 process does not require this document, helping to reduce creditor involvement and interest as well as providing protection for a business owner regarding other investments or personal information. Further, it helps minimize overall costs for the small business debtor, since it reduces the attorney fees associated with such documents. 

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 business 
  • A liquidation analysis
  • Projections regarding the business's ability to make future 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 usually paid in full, if the equity holders want to retain their equity and rights to future profits.

Subchapter 5 eliminates this rule, which means that the small business owner retains 100% of their equity even when the 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

In Chapter 11, a trustee is not automatically appointed over the business, like in Chapter 7 cases. Moreover, 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, but the business still retains control over all assets and operations. 

More specifically, 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 a company's model or financial condition, or report 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 can be a powerful option that many 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:

  1. Under $7,500,000 in non-contingent debt; until June 21, 2024, at which time it's scheduled to return to $2,725,625. 
  2. The business must be open and be pursuing business activities and
  3. 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.

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