CARES Act: Amendments to Subchapter V of Bankruptcy Code.
Last week, Congress passed the Coronavirus Aid Relief and Economic Security Act ("CARES"). An important part of CARES amends a very recently enacted provision of the United States Bankruptcy Code concerning small businesses known as "Subchapter V." Subchapter V took effect just prior to the Coronavirus crisis and covered businesses with secured and unsecured debts up to $2,725,625. It combines features of the existing Chapter 11 for businesses and Chapter 13 for individuals, providing a new fast-track path for small businesses to reorganize and discharge their debts. Its primary purpose is to eliminate certain expensive and time-consuming features of Chapter 11 that have made Chapter 11 unworkable for many small businesses.
Responding to the crisis, CARES increased the debt threshold by almost $5 million to $7.5 million for the next year. This increase, combined with some debtor-friendly features of Subchapter V and the limited time frame, will likely lead to many Subchapter V filings between now and March 2021. Below we outline the main provisions of Subchapter V and ways in which creditors can oppose plans and gain leverage over Subchapter V debtors in restructuring debt.
Within 90 days of a bankruptcy filing, Subchapter V debtors must file a plan providing for payments to creditors over a three to five-year period. The payments must equal the debtor’s "disposable income," defined as all income not necessary for (a) support of the debtor and dependents; and (b) expenses of business. Subchapter V eases or eliminates some of the critical hurdles faced by Chapter 11 debtors in confirming a plan. For example, under Subchapter V, normally no disclosure statement is required, no official creditors’ committee is formed, administrative expenses may be paid after a plan is confirmed, the debtor has an unlimited exclusive right to file a plan, and creditors do not get to vote on the plan. As opposed to under Chapter 11 and Chapter 13, the debtor can modify the terms of a mortgage on a principal residence, provided the funds given for the mortgage were not used primarily to purchase the residence and were used primarily in connection with the debtor’s business -- e.g., when the proceeds of a HELOC loan are used for business purposes or a loan to a business entity is secured by a mortgage on its principal’s residence. Also, unlike under Chapter 11, debtors may retain equity in their business without the consent (vote) of creditors even if creditors are not paid in full.
Virtually all other requirements of Chapter 11 are incorporated in Subchapter V, including the provisions for adequate protection of a secured creditor and the prohibition against a debtor’s use of cash collateral without either the secured creditor’s consent or a court order, the plan’s treatment of creditors may not be discriminatory and must be fair and equitable, the debtor must establish that the plan is feasible, the debtor can cram-down against a secured creditor and a secured creditor can make an election under Section 1111(b). Although creditors do not get to vote on the plan, they can challenge a debtor’s qualification to file a plan under Subchapter V and can object to the a debtor’s plan on the grounds that the debtor is not using all its disposable income or that the plan fails to meet one or more of the requirements for plan confirmation. Finally, unlike Chapter 11, Subchapter V provides for appointment of a trustee upon filing, whose duties are normally ministerial, including collection and disbursement of funds. However, a creditor can ask the Court to have a trustee assume greater power or control of operations in the event of a debtor’s fraud, dishonesty, incompetence, or gross mismanagement.
Although Subchapter streamlines the bankruptcy process for small businesses and provides a debtor with rights not available under Chapter 11, it leaves intact virtually all rights, remedies and protections of debtors and creditors provided for under Chapter 11.