Subchapter 5 in Chapter 11 Bankruptcy
Chapter 11 bankruptcy gives businesses the chance to restructure and reorganize their debt over three and five years while continuing to operate. However, a Chapter 11 filing is often too complex and expensive for many small business owners.
Subchapter 5 was added to Chapter 11 of the U.S. Bankruptcy Code in 2019 to make reorganization bankruptcies more accessible to small businesses. The subchapter went into effect in 2020. It gives small businesses that are earning a profit, but having trouble paying their obligations, a simplified process for paying down their debt.
Businesses that file under Subchapter 5 can force creditors to accept court-approved repayment plans of three to five years. They can also use the plan to shed some of their unsecured debt. Unsecured debt is debt for which you have offered no collateral, like most credit card debt. A mortgage or a car loan are secured debts because the creditor can seize your house or car if you don't pay.
What Are the Types of Business Bankruptcy?
Business owners considering filing for bankruptcy can file under one of two chapters. Each chapter offers different benefits to business owners.
- Chapter 7: This is a “liquidation" bankruptcy for businesses that are no longer viable. You will be required to sell all of your business assets to pay creditors and close the business. In return, you will be debt free.
- Chapter 11: This is a “reorganization" bankruptcy where you can force creditors to negotiate payment plans while the business stays open. This lets you repay most of your secured debts while continuing to run the business. Some of your unsecured debt may be discharged.
Both types of bankruptcy offer an automatic stay to protect you from creditors. This is often the biggest benefit of filing for bankruptcy. The automatic stay keeps creditors from collecting and will stop most court actions against you.
What Are the Benefits of Subchapter 5 Bankruptcy?
Filing a small business bankruptcy under Subchapter 5 offers you the following benefits:
- Continued business operations: You will continue to own and run your business so long as you stick to the payment plan. You will also need to pay your unsecured creditors all of your disposable income while the plan is in place.
- No creditor approval: The bankruptcy court can confirm your reorganization plan without the approval of your creditors if it finds it to be fair. A traditional Chapter 11 plan must be approved by creditors.
- Only your business can file a plan: In other Chapter 11 cases, your creditors can submit a plan on your behalf. But in Subchapter 5 only your business can submit one.
- No disclosure needed: In Chapter 11 cases, you must normally file a detailed disclosure statement with the court. The statement provides a breakdown of your business and if you can repay your creditors. In a Subchapter 5 case, no statement needs to be filed.
- Special trustee: You will continue operating your business in bankruptcy, but a trustee will be named to monitor its operations. The trustee will also make recommendations to the court regarding confirmation of the reorganization plan.
- Expenses paid in installments: In a traditional Chapter 11 case, you must pay all of the administrative expenses on the day the plan becomes effective. Subchapter 5 allows you to pay the expenses over the length of the plan.
Who Can Claim Subchapter 5 Bankruptcy?
Businesses that qualify for Subchapter 5 bankruptcy must be pursuing business activities and have debt that does not exceed $2.75 million. The debt cannot include those owed to company insiders. Also, at least 50% of the business debt must come from business activities. Businesses whose primary activity is owning and running a single property are not eligible.
COVID-19 Bill Temporarily Expanded Eligibility
The Coronavirus Aid, Relief, and Economic Security (CARES) Act enacted in March 2020 expanded Subchapter 5 eligibility to businesses with debts of up to $7.5 million for one year. The change was made to help with the expected increase in business bankruptcies as a result of the pandemic.
Creditors Still Enjoy Some Protections
Subchapter 5 made it easier for small businesses to file for a reorganization bankruptcy, but creditors still have the following Chapter 11 benefits:
- The reorganization must offer creditors at least what they would have received had you filed under Chapter 7.
- Secured creditors may still retain their rights to the property you put up as collateral.
- Secured creditors can protect their collateral and seek relief from the automatic stay.
Creditors may use these rights to force you to give them better treatment under your reorganization plan.
A Bankruptcy Attorney Can Help
Subchapter 5 simplified Chapter 11 filing for small businesses, but it is still a complex process. A skilled attorney can walk you through each step in filing for bankruptcy to ensure the best possible result. Working with an experienced bankruptcy attorney near you can offer you guidance and work to protect your assets.