Four Things to Know About the CARES Act and the New Small Business Bankruptcy Reorganization Act

On Behalf of Odin, Feldman & Pittleman, P.C. | Jun 16, 2020 | Bankruptcy, COVID-19

In an attempt to make chapter 11 more streamlined and less expensive for debtors, Congress amended the bankruptcy code to add a brand new reorganization chapter: Subchapter V. Subchapter V is available exclusively to small-business debtors and provides a new option that is intended to be quicker and cheaper; it also offers less oversight and fewer reporting requirements than a traditional chapter 11 case. Congress originally made the new Subchapter V option available to all businesses with $2.7 million or less in aggregate secured and unsecured non-contingent and liquidated debt. That amount was increased to $7.5 million for the rest of 2020 under the CARES Act. Here are four things you need to know about Subchapter V and the CARES Act:

A Subchapter V Debtor No Longer Needs to Convince Any of Its Creditors to Vote for the Plan
In most traditional chapter 11 bankruptcies, a debtor has to convince at least one impaired class of creditors to vote for the plan. This was a major barrier to many debtors succeeding in chapter 11. Unsurprisingly, it can be a challenge to convince creditors to support the plan, particularly where creditors are only being paid a fraction of the amount they are owed.

However, under the new Subchapter V, a small-business debtor no longer has to convince any creditors to vote in favor of the plan. Now, a debtor only needs to show the bankruptcy court that it is going to devote all of its disposable income to the plan over the next three to five years. This change makes small-business reorganizations in bankruptcy cases that were otherwise non-viable, now possible.

For creditors, this change significantly decreases the leverage a large unsecured creditor can have in a Subchapter V bankruptcy. In a traditional chapter 11, a creditor with a large judgment claim, for example, could force the debtor to the negotiating table because otherwise, a plan could not be confirmed. With the changes brought by Subchapter V, creditors will need to use different tools to exert leverage on the debtor and extract concessions.

A Debtor Now Has to Deal with a Trustee
In a traditional chapter 11, debtor’s management continues to operate and manage the affairs of its business, absent rare circumstances where a chapter 11 trustee is appointed. However, in all Subchapter V cases, a trustee will be appointed to monitor the debtor’s affairs, make recommendations regarding confirmation of the debtor’s plan, and facilitate the development of a consensual plan. The debtor will bear the cost of paying for the trustee.

The support of the trustee will likely be valuable for both debtors and creditors. Courts will likely defer to the trustee’s views on the prospects of a Subchapter V case. For debtors, the appointment of a trustee in every case adds another party the debtor is going to have to negotiate with and persuade regarding the merits of the plan. For creditors, the appointment of a trustee provides another party who may be able to raise concerns about the debtor’s case and can address issues about the debtor’s finances if the case starts to go awry. Both debtors and creditors in Subchapter V will greatly benefit by having experienced counsel who can assist in gaining the support of the appointed trustee.

A Debtor Needs to be Prepared to Propose a Plan within 60 Days
Traditional chapter 11s can often take at least a year, and sometimes take many years, to be completed. Subchapter V is designed to get debtors in and out of bankruptcy extraordinarily fast. The debtor must file a plan within 90 days after the bankruptcy is filed, a status conference is held 60 days after filing, and the debtor must provide a written report regarding the efforts it made to achieve a consensual plan at least 14 days before that conference. However, in exchange for this compressed timeframe, a debtor can avoid some of the filing requirements of a traditional chapter 11.

For Subchapter V debtors, this compressed time frame will require more planning before the bankruptcy is filed to ensure the debtor is able to understand its debts and cash flow and provide a report to the court within the required timeframe. For creditors, the early status conference provides an opportunity to educate the court about the creditor’s views on the case. However, a creditor who wishes to be heard needs to be prepared as soon as possible once the case is filed. Chapter 11 plans, whether traditional or under Subchapter V, are a major restructuring of the creditors rights vis-à-vis the debtor. Creditors who fail to make sure that their claims are properly addressed in any proposed chapter 11 plan can easily be barred from recovering their claims at all. As a result, getting representation as soon as possible after a case is filed is particularly critical in the Subchapter V context.

Subchapter V May Provide Debtors with Significant Leverage Over Landlord Creditors
Because Subchapter V became effective in February of this year, the law is still developing regarding how it will interact with other provisions of the bankruptcy code. One important conflict that has not been addressed by the bankruptcy courts yet deals with how landlords will be treated under Subchapter V.

In a traditional chapter 11 case, debtors who are remaining in leased space after filing bankruptcy generally are required to pay and keep current their post-bankruptcy rent. This is because the bankruptcy code requires debtors to “timely perform all the[ir] obligations” under any unexpired lease of nonresidential real property, and landlords are given an “administrative claim” for unpaid rent, which in a traditional chapter 11 must be paid in full at the time a bankruptcy plan is confirmed. This is an important protection for landlords whose tenants file bankruptcy.

But in Subchapter V, debtors are permitted to pay administrative creditors through the plan, which means creditors may have to wait up to five years to be paid in full for the expenses accrued during the course of the bankruptcy case. So far, no bankruptcy court has considered the interaction between the provision of the bankruptcy code that requires debtors to “timely perform” their lease obligations and the provision that allows Subchapter V debtors to pay administrative claims over five years.

Recently, in response to the COVID-19 pandemic, there has been a trend to weaken landlord protections. For example, in May, the bankruptcy court for the Eastern District of Virginia in the Pier 1 case, allowed the debtor, over the objection of their landlords, to accrue unpaid rent as an administrative claim, notwithstanding the obligation in the bankruptcy code to “timely perform” the obligations under the lease. Similar orders were entered in the Modell’s Sporting Goods, Inc. case (pending in the District of New Jersey) and the CraftWorks Parent, LLC case (pending in Delaware). Both cases were cited by the Court in Pier 1, which recognized that chapter 11 debtors “throughout the nation” were seeking “to find a way to ‘shelter in place’” during the COVID-19 pandemic. In each case this “sheltering” took the form of avoiding or delaying payments to their landlords.

It remains unclear whether bankruptcy judges’ tolerance of delayed landlord payments in exchange in large cases will also be reflected in smaller chapter 11 cases. But the relief granted in these highly scrutinized cases makes it likely that more and more debtors will seek similar relief, asking courts to delay their obligation to pay landlords in exchange for those landlords receiving an administrative claim.

If a Subchapter V debtor can force landlords to accept post-petition rent payments over five years, small-business debtors may have significant leverage against landlords compared to a traditional chapter 11 plan. Landlords could potentially be forced to accept the risk that the debtor is unable to perform the plan. As a result, landlord creditors in particular will need to be on guard in Subchapter V cases and may need to take steps early in the case to ensure their interests are adequately protected.

Whether exploring potential restructuring options or seeking to protect rights as creditors, the bankruptcy attorneys of Odin Feldman Pittleman are ready to assist with your specific circumstances. For more information, contact OFP attorney Bradley D. Jones at 703-218-2100 or another member of the Bankruptcy Law Group.

This correspondence should not be construed as legal advice. The contents are intended for general informational purposes only, and you are urged to consult a lawyer concerning your own situation and legal questions.

Disclaimer: The information contained herein is provided for informational purposes only and should not be construed as legal advice on any subject matter. This information contained herein is not provided in the course of an attorney-client relationship and is not intended to constitute legal advice. Any information contained in this article is not intended to be a substitute for legal counsel. No one should act or refrain from acting on the basis of any content included in this article but should instead seek the appropriate legal advice on the particular facts and circumstances at issue from a properly licensed attorney. The author expressly disclaims all liability in respect to actions taken or not taken based on any of the contents of this article. This article contains general information and may not reflect current legal developments.