Subchapter 5 Bankruptcy: Understanding the Benefits for Small Businesses

The federal Small Business Reorganization Act (SMRA) established streamlined procedures for eligible small businesses seeking protection under Chapter 11 of the U.S. Bankruptcy Code. These procedures exist under the new Subchapter 5, and filing for bankruptcy under Subchapter 5 offers several benefits to small businesses that qualify. Here, a Miami Chapter 11 bankruptcy lawyer at Edelboim Lieberman explains what small business owners need to know about the Subchapter 5 bankruptcy process.  

What Qualifies as a “Small Business” for Purposes of Subchapter 5?

Subchapter 5 is intended to help “small businesses” reorganize under Chapter 11. While reorganizing under Chapter 11 allows companies to remain in business after filing for bankruptcy (unlike pursuing a liquidation bankruptcy under Chapter 7), the cost of pursuing a traditional Chapter 11 filing can be prohibitive for many small businesses. With the creation of Subchapter 5 under the SMRA, Congress sought specifically to expand Chapter 11’s accessibility to small businesses that might not otherwise have a practical choice between reorganization and liquidation.

For purposes of Subchapter 5, a “small business” is defined in 11 U.S.C. Section 1182(1). Under this section of Subchapter 5, an eligible small business (or “debtor”) is one which is:

“[E]ngaged in commercial or business activities . . . [and] has aggregate noncontingent liquidated secured and unsecured debts as of the date of the filing of the petition or the date of the order for relief in an amount not more than $7,500,000 (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.”

Many small (and not-so-small) businesses qualify to file for reorganization under this definition. While there are a few exceptions, these exceptions only apply to a fairly small subset of businesses.

What Are the Benefits of Filing for Bankruptcy Under Subchapter 5?

For businesses that qualify, filing for bankruptcy under subchapter 5 can afford several benefits. Again, one of the main benefits is that Subchapter 5 opens up the prospect of reorganization to businesses that might otherwise be limited to pursuing liquidation or other reorganization alternatives. Within the context of the bankruptcy process itself, some of the main benefits of filing under Subchapter 5 include:

No Obligation to File a Disclosure Statement

When filing for bankruptcy under Chapter 11 outside of subchapter 5, debtors must file a disclosure statement to which their creditors then have access during the bankruptcy process. Under Subchapter 5, a disclosure statement is not required. Instead, debtors only need to file a reorganization plan for the bankruptcy court’s approval.

No Opportunity for Creditors to File Competing Plans

In a traditional Chapter 11 reorganization bankruptcy, the debtor’s creditors have the opportunity to file their own proposed reorganization plans in certain circumstances. They do not have this opportunity under Subchapter 5. Without any competing plans to contend with, Subchapter 5 debtors typically have a much smoother and more streamlined path to plan confirmation.

No Unsecured Creditors’ Committee

In a traditional Chapter 11 reorganization bankruptcy, the debtor’s unsecured creditors are represented by a committee that advocates for their collective interests during the bankruptcy process. However, in a Subchapter 5 bankruptcy, this isn’t the case (unless the bankruptcy judge rules otherwise). Unsecured creditors’ committees can wield substantial power, and they can play a significant role in crafting the debtor’s reorganization plan or preventing plan confirmation. With no unsecured creditors’ committee involved, Subchapter 5 bankruptcies are typically much quicker and much less expensive than traditional Chapter 11 filings.

Avoidance of the Absolute Priority Rule

Filing under Subchapter 5 also avoids the application of Chapter 11’s “Absolute Priority Rule.” Under this rule, all unsecured creditors in a higher priority class have the right to be paid in full before creditors in a lower priority class receive any distributions from the debtor’s bankruptcy estate. Among other things, this means that equity holders can retain their interests in the debtor without satisfying higher-priority creditors’ claims in full.

Creditor Consent Not Required

Outside of a small business bankruptcy filed under Subchapter 5, Chapter 11 requires that at least one impaired class of creditors consent to the debtor’s reorganization plan. Obtaining this consent often requires substantial negotiation, and this in turn results in a less-than-optimal plan for the debtor.

However, in a Subchapter 5 small business bankruptcy, no creditor consent is required. Subchapter 5 allows for confirmation of a debtor’s proposed reorganization plan as long as the plan is “fair and equitable.” Under 11 U.S.C. Section 1191(c), a plan is considered “fair and equitable” if:

• The plan meets the requirements of Section 1129(b)(2)(A) with respect to secured claims;
• The plan provides that the debtor’s projected disposable income over the next three to five years (as approved by the court) will be used to make payments under the plan; and,
• Either (i) the debtor will be able to make all payments under the plan, or (ii) there is a “reasonable likelihood” that the debtor will be able to make all of the payments required under the plan and the plan provides for appropriate remedies in the event of nonpayment.

What Are the First Steps for Pursuing a Small Business Bankruptcy Under Subchapter 5?

If you own or run a small business and are interested in learning more about the Subchapter 5 bankruptcy process, your next step is to speak with a Miami Chapter 11 bankruptcy lawyer who has experience handling cases under Subchapter 5. In addition to confirming your company’s eligibility under Subchapter 5, an experienced Chapter 11 bankruptcy lawyer will also be able to evaluate any other options that your company may have available.

Schedule an Appointment with a Miami Chapter 11 Bankruptcy Lawyer

If you have questions about the Subchapter 5 bankruptcy process, we encourage you to contact us for more information. We have extensive experience representing companies in these and other business bankruptcy proceedings. To schedule an appointment with a Miami Chapter 11 bankruptcy lawyer at Edelboim Lieberman, please call 305-768-9909 or tell us how we can reach you online today.