Ohio Bankruptcy: Chapter 11, Subchapter V
By SUSAN CRESS BROWNING | AUGUST 25, 2020
In Part One of our Bankruptcy Basics series, we discussed Ohio Chapter 7 Bankruptcy, which can be read at this link. In Part Two of our series, we discussed Ohio Chapter 13 Bankruptcy which can be read at this link. In Part Three of our series, we discussed Ohio Chapter 11 Bankruptcy which can be read at this link.
In our final blog in the series, we explore a new Bankruptcy solution now available to small businesses called the Small Business Reorganization Act – or Subchapter V to a Chapter 11 Bankruptcy.
Finally, More Favorable Relief for Small Businesses
There have always been economic fluctuations in operating a small business that have necessitated relief under the Bankruptcy Code. However, this has historically proven to be a lengthy and expensive process. Legislators recognized these deterrents to small business debtors getting a fresh start and drafted a new Subchapter to the Bankruptcy Code to improve the process and allow more small business debtors to take advantage of its provisions.
The enactment of these provisions, which pre-date COVID-19, are timelier and more appropriate than the drafters could have ever thought possible. With shutdowns, social distancing, and mask orders, now more than ever, we are seeing small businesses struggle, especially in the restaurant and food service industry.
Small Business Reorganization Act- Subchapter V
The Small Business Reorganization Act became effective February 19, 2020. The purpose of the Act was to streamline the process making it less expensive, and easier and quicker for small businesses to file for Chapter 11 Bankruptcy.
To take advantage of Subchapter V, the debtor must qualify as a small business debtor and must be engaged in commercial or business activities. It is likely that this definition would include the winding up of a business as well as the continuation of business in Chapter 11. This requires that at least 50% of the debtor’s debts come from commercial or business activity.
In addition, there is a debt limit that a debtor must not exceed in Subchapter V which is set at $2,725,625 million. However, the Coronavirus, Aid, Relief, and Economic Security Act (“Cares Act”), effective March 27, 2020, changed this to $7.5 million for one year following the effective date. This amendment will allow even more debtors to take advantage of the new Subchapter V provisions.
The filing procedure of a Subchapter V case is different from a standard Chapter 11 case. The debtor must make an election upon bankruptcy filing to take advantage of the provisions. Parties in interest may object to the debtor’s election of Subchapter V status.
Once a debtor becomes a Debtor in Possession, controlling the assets and operations of the business, it has powers of a trustee. A Debtor in Possession must provide its most recent balance sheet, statement of operations, cash-flow statement, and federal tax return.
A Debtor in Possession, or senior management, must file a monthly operating report, procure insurance, attend meetings and hearings, and file statements of financial affairs including required schedules.
A disinterested Subchapter V Trustee is appointed to facilitate, provide oversight, and monitor the case. Some of the Trustee’s duties include: Facilitating in the development of a consensual plan; Appearance at status conferences, confirmation, modification hearings, hearings on valuation of secured property and sale of estate property; reviewing and objecting to Proofs of Claim; accounting for property received by the estate; opposing discharge in proper cases; and, filing final reports.
These duties are expanded in a case where the Debtor in Possession is removed due to fraud or misconduct.
Some procedural benefits to Subchapter V are that no creditor committees are formed and no disclosure statements and hearings on disclosure statements are required unless ordered by the court.
The United States Trustee is not paid by the debtor in Subchapter V; rather, the Subchapter V Trustee is paid for services by the debtor as an administrative expense.
Initial Status Conference
The court will hold an initial status conference within 60 days after filing. The debtor, debtor counsel and Subchapter V Trustee must attend, and creditors may elect to attend. The purpose of this conference is to further the expeditious and economical resolution of a case under Subchapter V.
A debtor is required to file a report 14 days ahead of the first status conference, detailing what efforts have been made to procure a consensual plan agreeable to the creditors.
Debtor and Trustee may hire a professional to assist in the case. However, Trustee, debtor attorney and any other professionals must be disinterested.
A distinct change for debtor attorney is that they may be owed up to $10,000 in pre-petition fees without being considered a conflict of interest. However, these fees may only be paid as a general unsecured creditor. If debtor paid the attorney an avoidable preference the attorney is disqualified from representation.
The court will set the confirmation hearing, deadlines for acceptance or rejection of the proposed plan, objections to confirmation and filing Proofs of Claim.
A plan of reorganization must be filed by the debtor within 90 days of filing.
Only the debtor may propose a plan. This differs from Chapter 11 where creditors may propose a competing plan after the exclusivity period ends.
There is no disclosure statement or hearing required unless ordered by the court. However, a statement of the history of operations of the business is required in the plan when submitted. In addition, a liquidation analysis, and projections of disposable income available to pay the plan are required to determine its feasibility.
A proposed plan may be a consensual plan if all classes of creditors consent to the plan. This requires that more than 50% of the creditors in each class approve the plan and those creditors represent at least 2/3 of the total dollar amount in the class. A consensual plan must pay administrative and priority claims on the effective date of the plan. If a creditor fails to file a timely ballot it, is deemed to have accepted the plan.
If a consensual plan is not accepted, then the debtor may propose a cramdown plan without approval of any creditors.
The cramdown plan will propose to pay debts to be discharged over a three to five-year period. Long- term debts may be paid over a longer time but will not be discharged. Priority debts and administrative claims may be paid over the three to five-year plan period. Unsecured creditors may receive a percentage of their claim or they may receive nothing.
Secured creditors’ claims can be crammed down to the value of the collateral. The remainder of the claim will become an unsecured claim. However, secured creditors can elect treatment that requires that their claim be paid in full, but they receive no interest.
One of the biggest changes in bankruptcy law is the ability of a debtor to modify a mortgage on their principal residence if the loan was not used to purchase the property and was primarily used for business purposes. In this situation, the loan would be secured only to the extent that the value of the residence supports it. The balance will be deemed a general unsecured claim. This may be particularly relevant in SBA loans that require a lien on personal residence.
The debtor may modify the plan at any time prior to confirmation.
For the court to confirm a plan it must be fair and equitable and must not unfairly discriminate.
A consensual plan requires that all classes must vote in favor of the plan. For a class to accept the plan, more than 50% of creditors in the class and at least 2/3 of the monetary claims in that class must vote to accept.
If any or all classes fail to approve the plan, the debtor may propose a cramdown plan. This plan is funded with projected disposable income despite whether the debtor is an individual or business entity. Projected disposable income is the income a debtor has that is not reasonably necessary for the maintenance and support of debtor and dependents, including payment of domestic support obligations, and that which is necessary for the continued operation of the business. In the case of a business filing, projected disposable income is the income of the business beyond what is necessary for the continuation, preservation, or operation of the business. There is more room for discretion in this analysis based on individual circumstances and businesses than in other bankruptcy chapters.
The projected disposable income is paid for a three-year period or such longer time as the court may determine, not to exceed five years.
Feasibility is determined by the ability of the debtor to make the payments. The debtor must be reasonably certain to make the payments. In addition, there must be set remedies in the event debtor fails to make the required payments.
Creditors can object to confirmation of the plan.
In a consensual case, the Subchapter V Trustee is terminated when the plan is substantially consummated. This is generally when property has been transferred and distributions have begun. The debtor will make payments to the creditors.
In a nonconsensual plan, the Trustee will make payments to the creditors, unless the plan provides for the debtor to do so, and the trustee will continue as the trustee in the case.
A consensual plan may be modified at any time prior to substantial consummation if creditors do not reject the modified plan and it meets all other confirmation requirements.
A cramdown plan may be modified at any time prior to the last payment made by the debtor if it meets all other confirmation requirements.
Only the debtor may modify the plan.
Discharge in a Subchapter V case depends on whether the confirmed plan was consensual or a cramdown plan.
In a consensual plan, discharge will be issued upon confirmation of the plan for both an individual and a business entity. However, if the plan is a liquidation of most or all the debtor’s assets, the business would no longer operate, and the debtor would not be eligible for discharge in a Chapter 7, then a discharge will not be entered.
Discharge will be granted despite whether any creditor filed a Proof of Claim or accepted or rejected the plan. Debts owed to governmental units and certain taxes will not be discharged by an individual or business entity.
Discharge will not be granted to an individual when the debt is for certain taxes, fraud, larceny, breach of fiduciary duty, domestic support obligations, and/or unscheduled claim, just to name a few.
In a cramdown plan, the discharge will be entered as soon as practicable after the three to five-year period. Only the debts scheduled to be paid in the three to five-year commitment period will be discharged. Long term debts will not be discharged.
In a cramdown plan an individual may not discharge claims based on fraud, domestic support obligations, larceny, breach of fiduciary duty, unscheduled claims, certain taxes etc. Due to the language of the statute it is unclear whether a business entity may discharge debts of this type.
Remedies for default will be spelled out in the confirmed plan. In a consensual plan, the creditors have agreed and possibly negotiated for default terms. In a cramdown plan, the court and Subchapter V Trustee determine whether the default language is acceptable.
Default provisions could include sale of non-exempt property, conversion to Chapter 7 if assets are available for liquidation, dismissal if conversion would add no value to the estate, and debtor may be removed as Debtor in Possession, and/or relief from stay may be granted for pursuit against secured property.
When plan is consensual, dismissal results in the confirmed plan replacing old obligations and creditors must pursue their rights under those new terms.
In a cramdown plan where dismissal occurs, creditors and debtors return to their pre-bankruptcy status including costs and fees accumulated during the pendency of the bankruptcy.
With these distinctions made between the new Small Business Reorganization Act Subchapter V and other bankruptcy options it is hopeful that this Act will be a new tool in the small business debtor’s arsenal to navigate the bankruptcy process and alleviate debt concerns.
In reading the above, you will note that this process can be quite complex. This article is written to outline those complexities and to give contrast to the other types of bankruptcy relief in the other three parts of the blog.
If you are struggling financially, please contact me so I can explain solutions available to you in a FREE Consultation. Susan Browning, Finney Law Firm, (513) 943-6650, or email at [email protected]