Subchapter 5 Bankruptcy – An Alternative for Small Businesses
Updated: Mar 10
Closure of Non-Essential Businesses Will Have a Long Term Impact on Small Businesses
The Coronavirus COVID-19 Pandemic is going to have long term and long-reaching repercussions on a lot of big and small businesses. Even easing social distancing rules, and companies can start to reopen, a lot of companies will not see the traffic or the income that they saw before the pandemic. Retail stores and restaurants are going to have some tough decisions to make in the coming weeks and months.
Many restaurants are offering delivery and take-out services that they usually would not have provided previously just to allow for some cash-flow. One issue is that companies have laid off or furloughed a large number of people. Others have taken pay cuts. Many of these people who would be eating out more often, are now trying to conserve money where possible and are not calling for delivery or pick-up services.
Even if most people do not know what a Chapter 11 bankruptcy is, it is a well-known phrase. Over the last few years, there have been some large companies that have filed for protection under Chapter 11. There are some famous examples of companies that filed for Chapter 11 protection and never came back, such as Enron and Lehman Brothers.
There are many cases where companies did emerge from chapter 11, whether it was a result of getting their debts under control, changing their business model, or being purchased by other companies. In 2008, both General Motors and Chrysler filed for chapter 11. They were both famously bailed out by the Federal Government.
Sears, the 125-year old retail chain, filed for chapter 11 protection. It was one of the most significant cases in retail history. Even before the pandemic, retail chains were hard hit due to the increase in online shopping. Major brands such as Gymboree, Things Remembered, Payless ShoeSource, Forever 21, and Barneys New York all filed for chapter 11 protection in 2019. Some of these brands have curtailed operations or implemented new models, such as focusing on online sales. Some, such as Gymboree are going to be completely shuttered.
What is Chapter 11?
Chapter 11 is a form of bankruptcy that involves a reorganization of business affairs, debts, and assets. Chapter 11 is a very long, drawn-out, and expensive process. In many cases, such as General Motors and Chrysler, businesses will remain open and operating. They will work with the courts to enact a plan to change business processes, control debt, come up with a way to pay off creditors, and even sell off or close portions of the business to control costs and be able to pay down what is owed.
Not all businesses can remain open. The bankruptcy plan must be in the best interest of the creditors. The creditors may even suggest a program for the company in chapter 11.
Small Businesses may benefit from the new Subchapter 5 Bankruptcy
The Small Business Reorganization Act was signed into law in 2019 and introduced subchapter 5. When many small businesses need protection under Chapter 11, they find out, quite ironically, how expensive it is, and that they are not able to afford to go through the process.
There are some limitations within subchapter 5 that might make its use problematic for some. As written, there is a debt limit of $2,725,625 to be able to use subchapter 5. This limit has been significantly and temporarily increased as a part of the CARES Act passed on March 27, 2020, in response to the COVID-19 pandemic. The temporary limit is $7,500,000.
Other differences between subchapter 5 and a straight chapter 11 include:
Administrative costs which need to be paid as the time of the plan confirmation under chapter 11 can be paid over the life of the plan in subchapter 5
Subchapter 5 allows for debts to be paid over three to five years, much like a chapter 13 bankruptcy. Debtors must dedicate all of their disposable income to paying off their debt. This is beneficial to debtors as it allows for more time to pay off debt, and it will enable creditors to collect more of what is owed to them. If the company shuts down entirely, they might very well receive nothing
Subchapter 5 is designed to control costs and keep the process moving quickly. A plan is required to be in place within 90 days. The courts can extend this timeline under certain circumstances. Under these current pandemic conditions, it is expected that these extensions will be allowed at a higher rate than usual
Under chapter 11, a trustee is only named for cause. This means that if the bankruptcy was the result of fraud or gross mismanagement, the courts would appoint a trustee to take control of the debtor’s operations. In subchapter 5, a trustee is automatically appointed. Conversely, in chapter 11, there will be a creditor’s committee, which consists of the owners of the largest unsecured claims against the company. They oversee the plan to safeguard the proper management of the business while under chapter 11 protection. In subchapter 5, this committee is only appointed for cause.
Subchapter 5 protects small business owners from personal repercussions. In many cases, owners of small businesses use their own money or even leverage their assets, such as their home, to finance the business. They will then repay this loan over time. In chapter 11, owners are required to provide a new value of the investment, essentially agreeing to take a smaller amount of repayment to put those funds to pay off creditors. A subchapter 5 bankruptcy does not require this, protecting small business owners from extending the debt problems from their business to their personal lives.
Contact the Law Office of Kamini Fox for a Free Consultation regarding Chapter 11, Subchapter 5
We are living through unprecedented times. COVID-19 and the need for social distancing and shutting down businesses to protect the population and not overwhelm the hospitals are causing inconvenience for some and life-altering changes to others. Small businesses, which often work on small margins with minimal cushion for a “rainy day,” are suffering a great deal. We expect that chapter 11 bankruptcies are going to grow over the next several months. We also expect that the number of subchapter 5 bankruptcies will also increase.
Subchapter 5 might not be the right move for all small businesses. Still, thankfully the law had been put in place when it was as we expect this form of protection will help more small businesses survive where they might not have been able to when a full chapter 11 bankruptcy was their only option.