Small Business Subchapter V Is Doing Exactly What Congress Intended

For some time now, Congress has been mainly known for gridlock and uncivil debate. But there have been many moments when Congress has come together in a bipartisan fashion to find solutions to long-standing problems. One of those moments occurred three years ago when members of both parties in both the House and Senate got together to pass the Small Business Reorganization Act (SBRA). Then a funny thing happened after the expansive new law was enacted – it worked exactly as intended.

The SBRA was designed to address widely perceived problems that small businesses encountered when trying to reorganize under chapter 11 of the Bankruptcy Code. There was a developing consensus that chapter 11 was too costly and slow for businesses with modest assets which could not afford the financial drain and distraction of drawn-out bankruptcy processes. As a result, businesses that might be saved were dismantled and jobs unnecessarily lost.

The new law added a new voluntary subchapter V within chapter 11 for businesses holding less than $2.7 million in debt (adjusted annually for inflation). As an alternative to navigating the complex chapter 11 process, subchapter V provided streamlined procedures and tighter deadlines for debtors to develop a plan to rehabilitate the ailing business. The key substantive change under SBRA was the elimination of the "absolute priority rule” whereby the owners of the debtor-business had to pay creditors in full or lose their equity and control. This was a major downside for closely held and family businesses that lacked bankruptcy sophistication and did not want to unduly risk losing the enterprise they had worked a lifetime to build.

Among many other important changes, the new law also required the United States Trustee to appoint private trustees with a mandate to help ensure the filing of accurate financial information and to facilitate the filing of a consensual plan of reorganization. The trustee also is expected to identify businesses that cannot successfully reorganize and help move them to liquidation sooner before all the assets are dissipated.

There were major challenges in implementing the law. Not the least amongst those challenges was the USTP finding about 200 new trustees with business acumen. Although many existing trustees appointed under other chapters also were appointed under subchapter V, it was important to select businesspeople who would focus on finances, rather than lawyers who might focus on litigation. In addition, there was a lot of initial concern that debtors’ counsel would be reluctant to give up partial control of the case to an independent trustee whose mandate was to assist both debtors and creditors in finding a swift business solution.

The SBRA became effective in February 2020, just a month before much of the country shut down due to COVID. In an effort to assist more businesses facing economic hardships caused by the pandemic, Congress quickly expanded SBRA to cover businesses with up to $7.5 million in debt. That change increased the number of SBRA debtors by one-third. The higher debt limits were temporary for one year and later extended until June 2024.

The early results of SBRA were favorable and those trends have continued. Here are some of the key metrics of success:

Three out of every four small business bankruptcy debtors choose to proceed under the expedited subchapter V process. This shows the popularity of the alternative among both small businesses and their bankruptcy counsel. To date about one-third of all chapter 11 cases are small businesses.
Subchapter V small businesses confirm a reorganization plan at almost twice the historical rate for small businesses (56 percent vs. 31 percent.) In addition, more than 70 percent of the confirmations are consensual plans without creditor opposition. (There are no compilations of historical data on consensual plans in non-SBRA cases.)
Subchapter V cases are dismissed at less than one-half the historical rate for small businesses (25 percent vs. 53 percent.) This suggests that subchapter V trustees are successfully helping smaller companies stay in business.
Subchapter V cases are resolved more quickly and spend less time in bankruptcy. Subchapter V debtors confirm plans about 40 percent faster than the historical speed for small businesses (6.4 months vs. 10.8 months). Similarly, cases are dismissed more than 20 percent faster than the historical average (4.7 months vs. 6 months).

A few caveats are in order. The law is still fairly new so trends may not hold. Creditors also may want to crunch their internal numbers to compare their rate of recovery on debts under SBRA and the old system. Importantly, ultimate outcomes – such as whether companies that reorganize under SBRA complete their plan payments and remain viable over the long-term -- will require the passage of more time before they can be measured.

Government often-times seems broken, but sometimes it still works. All available objective data point to success so far for SBRA achieving the objectives Congress set when it passed the new law. Creditors may want to study their own internal results. Congress will need to evaluate longer-term experience before deciding whether to extend the higher debt limits when the current SBRA expansion expires in two years.

Commentary provided by Clifford J. White, Senior Advisor - Bankruptcy Compliance for AIS.