Congress Recontours the Landscape for Small Business Chapter 11 Cases With new Subchapter V

The ILC is pleased to present the following analysis of the Small Business Reorganization Act (H.R. 3311; S. 1091) (the "SBRA").

On August 23, 2019, the SBRA was signed into law. It becomes effective on February 19, 2020. A reader-friendly (html) version of the bill can be found at here. Here is what you need to know:

Subchapter V is for Both Individuals and Entities. "Persons," i.e. both individuals and business entities, may be Small Business Debtors under new Subchapter V. See §§ 101(42) and 101(51D)(A). Cf. § 109(e) (limiting eligibility for Chapter 13 to individuals only).

Eligibility Has Been Modified in Two Ways. Subchapter V relief remains available to Small Business Debtors engaged in commercial and business activities having aggregate noncontingent liquidated secured and unsecured debt, excluding debts owed to affiliates or insiders, of not more than $2,725,625 (as of April 4, 2019). The SBRA adds the requirement that not less than 50% of that debt has arisen from commercial or business activities. The SBRA also modifies the real estate exclusion. Persons whose primary activity is the business of owning real estate remain ineligible, but the language "or operating real property or activities incidental thereto" has been stricken and replaced with "single asset real estate."[i] Thus, a debtor whose primary activity is to own or operate more than one property will now be eligible for Subchapter V.

Debtors Must Opt-In to Subchapter V. Small Business Debtors who wish to proceed under Subchapter V must opt in by checking the appropriate box in Item 13 of their voluntary petitions. See § 1182(1) and (2); amended § 101(51D)(A); and § 103(i) ("Subchapter V of chapter 11 of this title applies only in a case under chapter 11 in which a Small Business Debtor elects that subchapter V shall apply.") Petitions now give qualifying individual filers two options at Item 13 regarding their election: "Yes. I am filing under Chapter 11, I am a small business according to the definition in the Bankruptcy Code, and I do not choose to proceed under Subchapter V of Chapter 11," or "Yes. I am filing under Chapter 11, I am a small business debtor according to the definition in the Bankruptcy Code, and I choose to proceed under Subchapter V of Chapter 11." Non-individual filers have only one box to check: "The debtor is a small business debtor as defined in 11 U.S.C. § 101(51D), and it chooses to proceed under Subchapter V of Chapter 11." By not checking that box such a debtor could still proceed with a "small business case" (defined below). Amended Bankruptcy Rule 1020 will still provide the U.S. Trustee and other parties-in-interest 30 days after the conclusion of the § 341(a) meeting, or 30 days after any amendment to the Small Business Debtor's self-designation an opportunity to object.

Small Business Cases Continue Without the Subchapter V Opt-In. The Committee on Rules of Practice and Procedure of the Judicial Conference of the United States, in its October 3, 2019 Memorandum on the Report of the Advisory Committee on Bankruptcy Rules, reinforces that Small Business Cases can go down two possible tracks: "SBRA does not repeal existing chapter 11 provisions regarding small business debtors, but instead it creates an alternative procedure that small business debtors may elect to use. Proceedings using the current chapter 11 provisions will continue to be called 'small business cases,' while cases for which the new procedure is elected will be called "cases under subchapter V of chapter 11." For Small Business Debtors who do not opt-in, the 300-day deadline for filing a plan and disclosure statement (see § 1121(e)(2)) and the requirement of confirmation within 45 days of any such filing (see § 1129(e)), along with all the other provisions of the Bankruptcy Code currently required of Small Business Debtors, will therefore apply.

Debtor in Possession Status, Duties and Powers. The Small Business Debtor is a debtor in possession under the Bankruptcy Code and has all the rights, other than the right to compensation under section 330, and powers, and shall perform all functions and duties of the Standing Trustee (discussed below), except the duties specified in section 1106(a)(2) (if debtor hasn't done so, file schedules, statements, and other documents required by sections 521(a)(1)), (a)(3) (except to the extent that the court orders otherwise, investigate the acts, conduct, assets, liabilities, and financial condition of the debtor, the operation of the debtor's business and the desirability of the continuance of such business, and any other matter relevant to the case or to the formulation of a plan) and (a)(4) (as soon as practicable, file a statement of the investigation of debtor's financial condition and transmit a summary or copy to any creditors' or equity committee, any indenture trustee, or as ordered). See § 1184.

The DIP Can be Removed - and Then Reinstated. Section 1104 is inapplicable under Subchapter V. Instead, on request of a party in interest, and after notice and a hearing, the court shall order that the debtor shall not be a debtor in possession for cause, including fraud, dishonesty, incompetence, or gross mismanagement of the affairs of the debtor, either before or after the date of commencement of the case, or for failure to perform the obligations of the debtor under a confirmed plan. See § 1185(a). On request of a party in interest, and after notice and a hearing, the court may also reinstate the debtor in possession. See § 1185(b).

There Is a 60-Day Mandatory Conference. Not later than 60 days after entry of the order for relief (unless extended on a finding that an extension is merited "attributable to circumstances for which the debtor should not justly be held accountable") the court shall conduct a status conference "to further the expeditious and economical resolution of the Subchapter V case." The Small Business Debtor is required to file a pre-status conference report 14 days before the status conference. The report must detail the "efforts the debtor has undertaken and will undertake to attain a consensual plan of reorganization." See § 1188(c).

The Debtor Has 90 Days to File a Plan. The Small Business Debtor must file a plan within 90 days of the order for relief unless the court extends that period upon a finding that such an extension is "attributable to circumstances for which the debtor should not justly be held accountable." See § 1189(b). Per section 1181(a), section 1121 is inapplicable in cases under Subchapter V, so neither the 300-day outside deadline to file a plan and disclosure statement (see § 1121(e)(2)) nor the requirement to obtain confirmation within 45 days of filing a plan will apply in a Subchapter V case.

There Can Be No Competing Plans. Only the Small Business Debtor may file a plan in a case under Subchapter V. See § 1189(a). Again, section 1121 has been made inapplicable to cases administered under Subchapter V. See § 1181(a).

Committees Are Possible but Unlikely. Sections 1102(a)(1), (a)(2), (a)(4), 1102(b) and 1103, regarding the appointment, selection and powers of official committees of creditors, do not apply in a Subchapter V case "unless the court for cause orders otherwise." See § 1181(b). Section 1102(a)(3) provides that "[u]nless the court for cause orders otherwise, a committee of creditors may not be appointed in a small business case . . . ."

The SBRA Has a Separate Disclosure Exemption. Unless the court for cause orders otherwise, section 1125 does not apply to a case under Subchapter V. See § 1181(b). The SBRA simply requires that "[a] plan filed under this subchapter-(1) shall include-(A) a brief history of the business operations of the debtor; (B) a liquidation analysis; and (C) projections with respect to the ability of the debtor to make payments under the proposed plan of reorganization." See § 1190. The Committee Note to Official Form 425, the Plan of Reorganization for Small Business Under Chapter 11, states that "there will generally not be a disclosure statement in subchapter V cases . . . ."

Mandatory Application of § 1125(f) Streamlines Any Disclosure Ordered and Solicitation. If the court nevertheless orders a Small Business Debtor to comply with section 1125, the expedited procedures of "section 1125(f) shall apply." See § 1187(c). Section 1125(f) permits: (1) determination by the court that the plan itself provides adequate information and that a separate disclosure statement is not necessary; (2) approval of a disclosure statement on standard forms approved by the court or adopted under 28 U.S.C. § 2075; (3) conditional approval of a disclosure statement subject to final approval after notice and a hearing; (4) solicitation of acceptances and rejections based on a conditionally approved disclosure statement; or (5) a single, combined hearing on the adequacy of the disclosure statement and confirmation of a plan. The Northern and Southern Districts of California have their own combined form plans and disclosure statements[ii] and a procedure for utilizing section 1125(f).

The Absolute Priority Rule Is Inapplicable. The prohibition on equity owners retaining their interests in the debtor without paying holders of non-consenting impaired classes (see § 1129(b)), does not apply in cases under Subchapter V. See § 1181(a).

Confirmation Can Occur Without the Vote of Any Impaired Consenting Class. If all of the requirements of section 1129(a), other than paragraphs (8), (10), and (15), are met with respect to a plan, on request of the debtor, the court shall confirm the plan notwithstanding the absence of an impaired accepting class of claims so long as the plan does not discriminate unfairly and is "fair and equitable." See § 1191(b). The SBRA imposes a number of additional obligations on Small Business Debtors if confirmation takes place under section 1191(b) as set forth in sections 1181(c), 1186(a), 1192, 1193(c), and 1194(b).

The Term Fair and Equitable Has Been Modified. Under section 1191(c), fair and equitable in a Subchapter V Small Business Case means (as to each class of secured claims) the plan meets the requirements of section 1129(b)(2)(A).[iii]

Section 1191(c) states that, for a plan to be fair and equitable, as of effective date:

(A)All of the projected disposable income of the debtor to be received in the 3-year period beginning on the date the first payment is due under the plan (or such longer period fixed by the court not to exceed 5 years) will be applied to make payments under the plan (see also § 1190(2)); or

(B)There is a reasonable likelihood that the debtor will be able to make all payments under the plan ; and, the plan provides appropriate remedies, which may include the liquidation of non-exempts assets, to protect the holders of claims or interests in the event that the payments are not made.

Disposable Income Has Been Redefined. Section 1129(a)(15) is inapplicable in Subchapter V. Disposable income for a Small Business Debtor has been redefined and means the income that is received by the debtor and that is not reasonably necessary to be expended for: (1)(A) the maintenance or support of the debtor or a dependent of the debtor; or (B) a domestic support obligation that first becomes payable after the date of the filing of the petition; and (2) the payment of expenditures necessary for the continuation, preservation, or operation of the business of the debtor. See § 1191(d). This new definition of disposable income does not reference section 1325(b)(2), as does section 1129(a)(15). The import is that Small Business Debtors who elect into Subchapter V will not be subject to the expense limitations imposed on above-median income Chapter 13 debtors.

Property of the Estate and Post-Petition Earnings Are Included in Individual Case. Section 1115, defining the scope of property of the estate in an individual case, has been made inapplicable in Subchapter V cases. Under the SBRA, "[i]f a plan is confirmed under § 1191(b) [without the consent if all impaired classes] . . . property of the estate includes all post-petition property acquired and earnings from services performed before the case is closed, dismissed, or converted to a case under chapter 7, 12, or 13. See § 1186(a)(1), (a)(2).

Modification of Trust Deeds on Residences Now Permitted. The SBRA modifies the Code's prohibition of the rights of holders of certain secured claims against the principal residences of debtors in Chapter 11. See § 1123(b)(5). Under section 1190(3), a Small Business Debtor may now modify the rights of the holder of a claim secured only by a security interest in real property that is the principal residence of the debtor "if the new value received in connection with the granting of the security interest was-(A) not used primarily to acquire the real property; and (B) used primarily in connection with the small business of the debtor." See § 1190(3).

Payment of Certain Priority Claims Now Permitted Though a Plan. Subchapter V plans may be confirmed under section 1191(b) (without the consent of all impaired classes) that provide for the payment through the plan of section 503(b) administrative expenses or, in an involuntary case, section 502(f) gap period expenses. See § 1191(e). Official Form 425, the Plan of Reorganization for Small Business Under Chapter 11, is contrary: it states at paragraph 3.02 that "Each holder of an administrative expense claim allowed under § 503 of the Code, [and a "gap" claim in an involuntary case allowed under § 502(f) of the Code,] will be paid in full on the effective date of this Plan, in cash, or upon such other terms as may be agreed upon by the holder of the claim and the Debtor."

The Debtor Can Modify a Plan Within the Plan's Term. Section 1127 is made inapplicable in a Subchapter V case. See § 1181(a). Under section 1193, the Small Business Debtor in a Subchapter V case may modify a plan before confirmation, unless it fails to meet the requirements of sections 1122 and 1123, with the exception of section 1123(a)(8) (regarding the commitment of income from personal services now found in section 1190(2)). Modification after confirmation, before or after substantial consummation, may be approved if, in addition, "circumstances warrant such modification and the court, after notice and a hearing, confirms such plan, as modified, under § 1191(b) of this title." See § 1193(c). The time within which the debtor may modify the plan is 3 years, or such longer time as may be fixed by the court (but not to exceed 5 years). The votes of holders of claims in impaired accepting classes are deemed to have accepted or rejected the modified plan unless they change their votes within such period as may be fixed by the court. See § 1193(d).

Discharge. If the plan is confirmed by consent under section 1191(a), then section 1141(d)(1) applies. See § 1181(c). However, section 1141(d)(5) is made inapplicable in a Subchapter V case, and the requirements for the discharge of Small Business Debtors in cases in which a plan has been confirmed under section 1191(b) have changed. Under section 1192, the court shall grant the debtor a discharge of all debts provided in sections 1141(d)(1)(A) and 503 as soon as practicable after completion by the debtor of all payments due within the first 3 years of the plan, or such longer period not to exceed 5 years as the court may fix, unless the court approves a written waiver of discharge executed by the debtor after the order for relief. The discharge is of all debts as provided under the plan except any debt (1) on which the last payment is due after the first three years of the plan, or such other time not to exceed five years fixed by the court; or (2) that is otherwise nondischargeable.

The Subchapter V Standing Trustee. The SBRA provides for the appointment of a standing trustee in every case (hereafter referred to as the "Standing Trustee.") See § 1183(a).

Standing Trustee Selection and Appointment. 28 U.S.C. 586(b) provides that "[i]f the number of cases under subchapter V of chapter 11 or chapter 12 or 13 of title 11 commenced in a particular region so warrants, the United States trustee for such region may, subject to the approval of the Attorney General, appoint one or more individuals to serve as Standing Trustee or designate one or more assistant United States trustees to serve in cases under such chapter." The SBRA gives the U.S. Trustee wide latitude in who it selects. "If the United States trustee has appointed an individual under section 586(b) of title 28 to serve as standing trustee in cases under this subchapter, and if such individual qualifies as a trustee under section 322 of this title, then that individual shall serve as trustee in any case under this subchapter. Otherwise, the United States trustee shall appoint one disinterested person to serve as trustee in the case or the Unites States trustee may serve as trustee in the case, as necessary." See § 1183 (emphasis added). The skills required of Standing Trustees, given their duties (see below) may be more similar to those of Chapter 11 or 12 trustees than those of Chapter 13 trustees. Applications are now being taken for a nationwide pool of trustees from which appointments can be made.

Reassignment of Certain Duties from Debtor to Standing Trustee. The SBRA obligates the Standing Trustee under section 704(a)(2) to be accountable for all property received; under section 704(a)(5) to examine proofs of claim and object to improper filings; under section 704(a)(6) to oppose the debtor's discharge, if advisable; under section 704(a)(7) to furnish information concerning the estate and the estate's administration if requested by a party-in-interest; and under section 704(a)(9) to make a final report and file a final account of the administration of the estate with the court and with the U.S. Trustee's Office. See § 1183(b)(1), (b)(2).

Role at Hearings. The SBRA obligates the Standing Trustee to appear and be heard at the 60-day status conference and any hearing that concerns: (a) the value of property subject to a lien; (b) confirmation of a plan filed under Subchapter V; (c) modification of the plan after confirmation; or (d) the sale of property of the estate. See § 1183(b)(3).

Plan and Adequate Protection Payments. The Standing Trustee is to collect and retain plan payments until confirmation or denial of confirmation of a plan. The Standing Trustee is obligated to ensure that the Small Business Debtor commences making timely payments required by a confirmed plan. See § 1183(b)(4). The Standing Trustee then distributes payments in accordance with the confirmed plan. Should a plan be confirmed under section 1191(b), without the consent of all impaired classes, the Standing Trustee makes all payments under the plan (see § 1194(b)) for the term of the plan, which may be up to 5 years.

If a plan is not confirmed, the Standing Trustee is to return to the Small Business Debtor payments made by the debtor after deducting unpaid administrative claims, adequate protection payments to secured claimants and the fees of the Standing Trustee. See § 1194(a).

The court, after notice and a hearing, may authorize the Standing Trustee to make payments to the holder of a secured claim for the purpose of providing adequate protection of an interest in property. See § 1194(c).

Duties Following Replacement of Debtor in Possession. If the debtor ceases to be a debtor in possession, the Standing Trustee is required to perform the duties specified in section 704(a)(8) (filing reporting if the business of the debtor is to be operated) and sections 1106(a)(1), (a)(2) and (a)(6), including operating the business of the debtor. See § 1183(b)(5). The SBRA amends section 363(c)(1) to authorize the Standing Trustee in Small Business Cases to enter into ordinary course transactions and use estate property in the ordinary course without notice or hearing. Section 364(a) has also been amended to authorize the Standing Trustee in a Small Business Case to obtain ordinary course unsecured credit or to incur ordinary course unsecured debt as an administrative expense.

Domestic Support Obligations. If there is a claim for a domestic support obligation, the Standing Trustee shall perform the duties specified in section 704(c) (provide notices to holders of domestic support obligations and state child support enforcement agency). See § 1183(b)(6).

Plan Facilitation. The Standing Trustee is obligated to "facilitate the development of a consensual plan of reorganization." See § 1183(b)(7). This phrase is not mentioned elsewhere in the SBRA or otherwise used in the Bankruptcy Code. Cf. § 1302(b)(4) (duty of Chapter 13 trustee to advise and assist the debtor in performing the plan).

Standing Trustee's Term. If the plan is confirmed by meeting all of the requirements of section 1129(a), including the consent of all impaired classes of claims, the service of the Standing Trustee terminates at substantial consummation.[iv] See § 1191(a). Should a plan be confirmed under section 1191(b), without the consent of all impaired classes, the length of the plan will be five years, as will be the term of the Standing Trustee given his or her obligation to make payments under such a plan, unless the plan or confirmation order provide otherwise. See § 1194(b). The United States trustee may reappoint the Standing Trustee as needed to appear and be heard at any hearing that concerns modification of the plan after confirmation or removal of a debtor for cause. See §§ 1183(b)(3)(C), 1185(a).

Fees in Subchapter V Cases. The Standing Trustee will receive compensation identical to that of Chapter 12 and Chapter 13 trustees consisting of a 5% fee from all payments received by such individual under plans in the cases under Subchapter V. See 28 U.S.C. § 586(e)(2)(A), (B). The words ''other than under subchapter V,'' have been added following ''chapter 11 of title 11'' in 28 U.S.C. § 1930(a)(6)(A), making quarterly U.S. Trustee fees inapplicable in Subchapter V cases. See also amendment to § 326(b).

The Disinterestedness Requirement Has Been Relaxed in All Cases Under Title 11. Section 1195 relaxes the definition of disinterestedness in all cases under title 11, providing that "[n]otwithstanding section 327(a) of this title, a person is not disqualified for employment under section 327 of this title, by a debtor solely because that person holds a claim of less than $10,000 that arose prior to commencement of the case." See § 1195.

Changes to Venue of Low Dollar Preference Proceedings and Due Diligence as to Affirmative Defenses Changes in All Cases. While virtually all of the revisions in the SBRA relate solely to small business cases, there are two notable exceptions related to all preference actions filed under section 547(b).

Section 547(b) has been amended to require "reasonable due diligence in the circumstances of the case" on the part of the plaintiff "taking into account a party's known or reasonably knowable affirmatives defenses under [§ 547](c)." See amended § 547(b). Actions to which 28 U.S.C. § 1409(b) applies and in which the amount in controversy is less than $25,000 (up from $10,000) must be commenced in the district in which the defendant resides. See amended 28 U.S.C. § 1409(b). It is critical to note that it is not clear whether 28 U.S.C. § 1409(b) applies to avoidance actions. See Webster v. Republic Nat'l Distrib. Co. LLC (In re Tadich Grill of Washington D.C. LLC), 598 B.R. 65, 67 (Bankr. D.D.C. 2019) (holding that 28 U.S.C. § 1409(b) does not apply to a proceeding "arising under title 11.") Cf. Creditors' Trust v. Crown Packaging Corp. (In re Nukote Int'l, Inc.), 457 B.R. 668, 684 (Bankr. M.D. Tenn. 2011) (Omission of proceedings "arising under" Title 11 was inadvertent, and that § 1409(b) should apply to such proceedings.) A bill with technical corrections to the change made to section 547(b) is anticipated to be introduced in the next Congress.

Bankruptcy Code Sections Not Applicable in Subchapter V Cases. Section 1181 of the SBRA, entitled "Inapplicability of other sections," identifies in subsection (a) the sections of the Bankruptcy Code not applicable in Subchapter V cases: sections 105(d), 1101(1), 1104, 1105, 1106, 1107, 1108, 1115, 1116, 1121, 1123(a)(8), 1123(c), 1127, 1129(a)(15), 1129(b), 1129(c), 1129(e), and 1141(d)(5). Sections 1102(a)(1), (a)(2), (a)(4), 1102(b), 1103, and 1125 only apply if the court so orders. See § 1181(b). Finally, if a plan is confirmed non-consensually under section 1191(b), section 1141(d) shall not apply, except as provided in section 1192. See § 1181(c).

Changes to the Interim Rules, New Official Forms. On October 16, 2019, the Committee on Rules of Practice and Procedure of the Judicial Conference of the United States issued its Memorandum on the Proposed Interim Rule and Official Form Amendments for Public Comments in Response to Small Business Reorganization Act of 2019 which, with the interim rules and forms, can be found at here. The Rules Committee issued the following caveat to its work to implement the SBRA: "When it became clear that the SBRA would likely become law, the Advisory Committee on Bankruptcy Rules began an intensive effort to review the SBRA's provisions and determine changes to the bankruptcy rules and official bankruptcy forms necessary to implement the Proposed Interim Rule and Official Form Amendments for Public Comment in Response to the Small Business Reorganization Act of 2019 legislation by its effective date. Although changes to the official forms can be approved in time for the SBRA effective date, changes to the bankruptcy rules take three years or more under the process established by the Rules Enabling Act, 28 U.S.C. §§ 2071-77, and will not be completed by that time. As a result, our committees will issue interim SBRA rules for adoption as local rules or by general order in each judicial district."

These materials were prepared by Robert G. Harris (rob@bindermalter.com), a partner in the Silicon Valley bankruptcy law firm Binder Malter Harris & Rome-Banks LLP with editorial contributions from John N. Tedford of Danning, Gill, Diamond & Kollitz LLP and Christopher D. Hughes of Nossaman LLP.

[i] 11 U.S.C. § 101(51B).

[ii] http://www.canb.uscourts.gov/sites/default/files/forms/plan_and_disclosure_7-30-12.wpd and https://www.casb.uscourts.gov/forms/chapter-11-individual-combined-plan-reorganization-and-disclosure-statement

[iii] Holders of secured claims must retain their liens and receive one of the three following alternative treatments: (i) retention of the claimant's lien and receipt, on account of the claim, of deferred cash payments totaling at least the allowed amount of the claim, valued as of the plan's effective date; or, (ii) if the plan provides for a sale of the collateral, for attachment of the secured claimant's lien to the proceeds of such sale; or, (iii) for realization of the indubitable equivalent of the claim.

[iv] The Small Business Debtor shall, not later than 14 days after substantial consummation, file and serve notice thereof. See § 1183(c)(2).