The coronavirus is expected to permanently close down millions of small businesses in this country. Even businesses that were doing well before the virus are hard-hit.
Good news—there is hope.
For those struggling with whether to reopen the business, it is fortunate that Congress passed an amendment to the bankruptcy code, which went into effect in February 2020. Called “Subchapter 5,” and it gives small business owners hope. Subchapter 5 has some very strong remedies to get a business back on its feet.
Unlike the traditional Chapter 11, and the long and expensive procedures that go with it, Subchapter 5 has two big and unique features: a bankruptcy judge can force creditors to accept a plan of reorganization if even if they don’t like it, and the owner can continue running the business as usual.
Subchapter 5 can get a business time to get current with back lease or mortgage payments, pay pennies on the dollar to the unsecured trade vendors, and pay the value of collateral (i.e., equipment, tools of trade) instead of the outstanding debt, all spread out over several years.
Still, any guaranteed loans will pose problems for the guarantor (usually the owner of the business). Sometimes a personal bankruptcy may go hand-in-hand with the Subchapter 5.
The important thing to remember is, Subchapter 5 does not generate revenue. A business owner needs to figure out how to make ends meet after the case is filed. If there is no money coming in, there’s nothing that’ll save the business.
However, if the business is sound, and can begin resuming operations, future cash flow will help the small business owner climb out of the hole, with much less debt than before the filing.
HOW COVID-19 IMPACTS CHAPTER 7, CHAPTER 13 AND THE SUBCHAPTER 5
On March 27, 2020, President Trump signed into law the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act” or “Act”), a $2.2 trillion stimulus package designed to lessen the widespread economic effects of the coronavirus, also known as COVID-19. The Act includes several temporary modifications to chapter 7 and chapter 13 of the U.S. Bankruptcy Code. Below is a summary.
SMALL BUSINESSES AND SUBCHAPTER 5
Congress passed a significant amendment to the Bankruptcy Code into law in August 2019. That law went into effect in February 2020. Buried in Chapter 11 of the Code, the new subchapter 5 is like a “Chapter 11-Lite.” And good timing– no one could have foreseen that by March 2020, thanks to a bat virus in Wuhan China, the U.S. economy would grind to a halt.
For small businesses, COVID-19 has been devasting. Businesses that were on sound financial footing now find their doors shuttered, with little or no business coming in. As restaurants, coffee shops, and “mom and pop” businesses that serve the walk-in market have been closed, the bills (rents, vendor payments, utilities) are march on. Subchapter V may provide a lifeline to small businesses as they start to reopen.
While this attorney ahs never been a fan of Chapter 11—much because of the high costs—Subchapter 5 may be the solution. It is less expensive to file and operate a business than in Chapter 11. For starters, it lacks the crushing reporting requirements of Chapter 11.
Other highlights include:
- The debt limit in the August 2019 bill is $2,725,625. With President Trump’s signing of the CARES Act, the debt limit has been temporarily raised to $7,500,000.
- Similar to a Chapter 13, Subchapter V allows a debtor to pay the value of equipment (referred to as a “cram down,” over up to five years.
- Get up to five years to get current with past due rents and other long-term debt, while resuming to pay those on-going debts the month following the filing of the case.
- While a debt must pay the “projected disposable income” over the life of the plan, the goal in Subchapter V will be to pay “pennies on the dollar” to unsecured creditors.
- A Subchapter V debtor must normally file its plan of reorganization within 90 days after filing the bankruptcy. However, the Bankruptcy Court may extend this deadline “if the need for the extension is attributable to circumstances for which the debtor should not justly be held accountable.” Obviously, in the COVID-19 environment, courts are likely to grant extensions liberally.
- More good news with Subchapter V. Usually, a Chapter 11 trustee is appointed only for cause, such as fraud or gross mismanagement. Under Subchapter V, a trustee is automatically appointed, but the debtor retains control of its assets and operations. And there is no provision for appointing a “Creditors’ committee.”
- Subchapter V does not adopt the dreaded “Absolute Priority Rule” found in Chapter 11. That rule requires a plan to propose “new value,” which translates to new equity infused into the case.
CERTAIN FEDERAL PAYMENTS EXCLUDED FROM DEFINITION OF “INCOME”
Within Chapter 7, almost any money held by the debtor on the date of filing is part of the bankruptcy “estate.” The goal of all trustees is to get as much of that money as possible. In Colorado, a debtor’s wages are protected up to 75 percent. A recent Colorado Bill may protect wages up to 80 percent.
Under the CARES Act, for cases under chapter 7 and 13, it modifies the definition of “current monthly income” in 11 U.S.C. § 101(10A)(B)(ii) to expressly exclude payments made under federal law relating to the national emergency declared by the President under the National Emergencies Act with respect to COVID-19. Similarly, the Act provides that any payments made to individuals under federal law relating to the COVID-19 pandemic do not constitute “disposable income” required to be committed to a chapter 13 debtor’s plan pursuant to 11 U.S.C. § 1325(b)(2). The amended definition of “disposable income” will benefit both current chapter 13 debtors who did not have confirmed plans as of the date of enactment of the CARES Act, as well as future chapter 13 debtors.
Its not clear as I write this whether Congress goofed up and left that part of the amendment out of the final Bill. Still, the two Chapter 13 trustees in Colorado have indicated no intention to grab the money. Chapter 7—different deal.
MODIFICATIONS AND PLAN PERIOD EXTENSIONS FOR CHAPTER 13 DEBTORS WITH CONFIRMED PLANS
The CARES Act permits chapter 13 debtors with plans that were confirmed as of the date of enactment of the CARES Act to seek modifications of their plan due to COVID-19-related hardships. The Act adds a subsection to 11 U.S.C. § 1329 to permit a debtor to modify a confirmed plan, after notice and a hearing, if such debtor is experiencing a “material financial hardship” due, “directly or indirectly,” to the COVID-19 pandemic. Under the Act, a plan also may be modified to extend the plan period up to seven years after the first payment under the original confirmed plan became due. A bankruptcy court may approve such a modification upon request of a debtor. Until the amendment sunsets one year from March 27, 2020, chapter 13 debtors with plans confirmed prior to the enactment date will be able to seek to modify their plans consistent with this provision.