The 2021 Consolidated Credit Act (LCA), promulgated in December 2020, broadens the advantageous reorganization conditions already available for companies in difficulty under sub-chapter V of Chapter 13 bankruptcy of the Bankruptcy Code. Now reorganizing businesses have more time to decide whether to keep or reject real estate leases and can extend rental obligations as part of a reorganization plan. These advantages build on the important advantages already available in subchapter V:
- Small business owners can keep their equity stakes while getting rid of their unsecured debt in many cases.
- Only the submitting company can propose a reorganization plan.
- The submitting company can extend the payment of its reorganization costs over time.
- There is no formal committee of unsecured creditors, just a “permanent trustee” with limited authority in the matter.
However, many small businesses that would benefit from a reorganization under Subchapter V will no longer be eligible to file under Subchapter V as of March 27, 2021. As of March 2020, Subchapter V has generally allowed companies with unconditional liquidated debts (excluding obligations to insiders and affiliates) totaling $ 7.5 million or less to reorganize using its favorable terms. But that increased debt limit is expected to drop back to the previous level of $ 2,725,625 by the end of March. Firms in financial difficulty – and their owners – should therefore consider requesting a reorganization of subchapter V well before mid-March in order to avoid the risk that the lowered debt limit could exclude them from the advantageous reorganization conditions of the subchapter V.
Additional services of subchapter V for eligible debtors
CAA has extended the benefits of using subchapter V for reorganization. These benefits remain in place for bankruptcy cases filed before December 27, 2022.
Debtors reorganized under Subchapter V may be granted additional time after filing for bankruptcy before having to pay rent in many cases. Beyond the 60 days granted to a debtor to delay payment of rent under current law, the CAA now allows a subchapter V debtor to request an additional 60 days rent leave (for a full extension 120-day rent payment) if the business is in financial difficulty. as a result of COVID-19. The debtor can also repay the rent deferred over many years as part of a subchapter V reorganization plan, an added benefit for businesses with cash flow problems.
CAA gives debtor tenants additional time to decide whether to keep or relinquish certain commercial real estate leases. Previously, under the Bankruptcy Code, these debtors had only 120 days to “assume or reject” a commercial real estate lease and could only apply for authorization for a 90-day extension of that period from the bankruptcy court. Under the CAA changes to the Bankruptcy Code, all Chapter 11 debtor-tenants will have 210 days to assume or reject commercial real estate leases, a period that can be increased by an additional 90 days with court leave. This additional decision period gives bankrupt debtors who occupy leased business premises greater flexibility in formulating a reorganization plan. Debtors can also use the extra time to try to renegotiate the terms of their existing leases, especially in light of changes in consumer buying habits resulting from the COVID-19 pandemic.
CAA amends Section 364 of the Bankruptcy Code (which governs financing obtained in bankruptcy), allowing subchapter V debtors to apply for and obtain Paycheck Protection Program (PPP) loans . However, the Small Business Administration (SBA) has yet to act for this amendment to take effect for small business debtors. Only if the SBA acts, will subchapter V bankrupt companies have clear legal authority to obtain troubled financing under the PPP program. At this time, the SBA has given no indication that it plans to take any action to make this amendment effective for Sub-Chapter V borrowers.
Even if the SBA ultimately allows subchapter V debtors to obtain PPP loans, bankruptcy court approval for this financing would still be required. Under the CAA, the court must hear the debtor’s request for approval of a PPP loan within seven days. Later, if the loan is not canceled under the PPP program, the CAA assigns this debt the status of “super priority” administrative costs in the event of bankruptcy. This means that the PPP loan is paid in priority over any other administrative expenditure, although the debtor may repay the PPP loan in installments over time as part of a sub-chapter V reorganization plan (just as a debtor can also extend other administrative claims). The CAA also overrides any provision in other loan documents that prohibits the debtor from obtaining a PPP loan.
In addition, the CAA favors certain creditors who grant concessions to companies in financial difficulty which subsequently go bankrupt. Under the CAA, some owners and suppliers accepting deferred payments from debtors before bankruptcy will not have preferential liability once the business goes bankrupt, even where previous law would have provided otherwise. Normally, deferred debt repayments within 90 days of bankruptcy may expose the beneficiary to preferential recovery. Under the CAA, these payments will not trigger liability preferably as long as (1) they were under an enforceable contract or lease entered into before filing for bankruptcy; (2) the lease or the enforceable contract was amended after March 13, 2020 to provide for deferred payments; and (3) the amendment did not allow for late fees, penalties or interest in excess of what would have been due in the absence of the amendment.
Even companies with debts greater than $ 7.5 million can qualify for subchapter V
Many eligible businesses have already chosen to meet the increased debt limit of $ 7.5 million, including those with actual claims against them well in excess of $ 7.5 million. For example, a number of retail and restaurant debtors, as well as their affiliates, have successfully elected to proceed under subchapter V with outstanding trade and guarantees receivables below the $ 7.5 million cap. dollars, but with contingent debt (including for the rejection of heavy leases and enforceable contracts) this ultimately brings the total actual claims above the ceiling of $ 7.5 million.
Certain companies remain ineligible for the treatment of sub-chapter V, whatever the amount of their debt. These ineligible entities include companies required to file reports with the Securities and Exchange Commission (SEC) and their affiliates, companies primarily engaged in holding single-asset real estate, and companies owned by Affiliated debtor groups with debt over $ 7.5 million. Thus, although subchapter V is a powerful tool for qualifying debtors, limits to its use remain.
Benefits of subchapter V for eligible debtors
As we noted in our April 2020 alert, the use of Subchapter V to reorganize instead of a typical reorganization under Chapter 11 provides benefits to qualifying businesses and their owners. Indeed, since the entry into force of sub-chapter V in February 2020, hundreds of companies have chosen to take advantage of the advantages it offers.
Unlike a typical Chapter 11 bankruptcy, in a Subchap V case:
- Only the debtor can propose a reorganization plan. While the plan must be filed within 90 days of the onset of bankruptcy, the debtor can request an extension if the reason is “attributable to circumstances for which the debtor should not rightly be held responsible”.
- The debtor does not need to file a disclosure statement with the scheme.
- Owners of the debtor can retain their equity even if the opposing creditors are not fully paid, provided that the proposed plan otherwise meets the confirmation requirements.
- No category of impaired debt needs to vote in favor of confirming a plan, even if the plan pays creditors less than in full.
- Administrative costs incurred by the debtor after filing for bankruptcy can be paid over time, even if the creditors object.
- No official committee of unsecured creditors is appointed. Instead, a disinterested permanent trustee facilitates confirmation of a plan and seeks to ensure debtor compliance.
- The debtor does not need to pay certain government fees required in other bankruptcy cases.
- A private debtor can amend a debt secured by a principal residence if the debt has been used primarily in connection with the debtor’s business and not to acquire the residence.
Because of these advantages, debtors have much more leverage to reorganize under subchapter V despite opposition from creditors. The process is also less costly and more streamlined than a typical Chapter 11 case. And the CAA has further enhanced the potential benefits of a Sub-Chapter V filing.
Companies facing financial difficulties should now assess reorganization options to take advantage of subchapter V
Subchapter V is a powerful tool for many companies in financial difficulty. The CAA has made Subchapter V even more useful – and flexible – for qualifying debtors. However, given that the increased limit of $ 7.5 million of unconditional liquidated debt is due to expire on March 27, 2021 and revert to the old debt limit of $ 2,725,625, financially troubled businesses should carefully consider their financial statements. options before the end of March. Timely review will help ensure that companies in need of a reorganization can take advantage of Subchapter V at the highest debt limit, if they are otherwise eligible.