THE SUBCHAPTER 5 ELECTION. Chapter 11 now contains a “Subchapter 5”
which applies only to “small business debtors” that make a so-called
“Subchapter 5” election. See 11
U.S.C. §§ 1181-1195. Absent such an
election, the small business case will be administered under the existing small
business provisions of Chapter 11. Although
the 2005 BAPCPA amendments to the Bankruptcy Code streamlined the Chapter 11
process for small business debtors
(i.e., a plan has to be confirmed within 300 days), the process was still viewed as too onerous and expensive
for those that qualified. Subchapter 5 provides small business debtors the
option of using a new law designed to make the chapter 11 process faster and
cheaper, including the process for selling a distressed business under a
plan. It brings to Small Business Cases
under Chapter 11 features previously available only in Chapter 12 or 13
cases. SBRA also reshuffles the leverage
between debtors and creditors and tries to promote consensual outcomes.
THE INTERIM BANKRUPTCY RULES. Interim amendments to the Federal Rules
of Bankruptcy Procedure also have been promulgated to guide cases where the
debtor has made the Subchapter 5 election.
The interim bankruptcy rules, including Interim Bankruptcy Rule 1020,
implement the SBRA. New forms also may
MAKING THE ELECTION. The Subchapter 5 election must be made on
the petition for relief for voluntary cases or within 14 days after the order
for relief in involuntary cases.
Although the Subchapter 5 election is made when the bankruptcy petition
is filed, Rule 1020(b) suggests the petition can be amended to make the
Subchapter 5 designation after the filing.
Doing so may not be advisable, however, because a delayed election may
cause key deadlines to be missed. Another potential issue involves the
retroactive application of the SBRA to cases pending before its effective date.
ELIGIBILITY CRITERIA. Subchapter 5 cases are available to any
entity or individual engaged in commercial or business activity with aggregate
and liquidated debts of not more than $2,725,625, of which more than 50% is
commercial or business debt. The new
law helps clarify eligibility. More than 50% of the debt has to be commercial
or business. In view of SBRA’s changes to the absolute priority rule, inter
alia, individual chapter 11 debtors with primarily business debts should
consider whether they can make the Subchapter 5 election. The eligibility requirements to be a small
business debtor have been modified insofar as more than 50% of the debt now
must be from the commercial or business activities of the debtor and the
exclusion for single asset real estate debtors has been clarified.
VS. CONSENSUAL PLANS: SBRA differentiates between confirmation under
§1191(a) and 1191(b). Section 1191(a)
deals with a plan that is accepted by all classes of claims – i.e., a
consensual plan. Section 1191(b)
addresses a “cramdown plan.” As
discussed herein, certain SBRA provisions apply, or do not apply, depending
upon whether the plan is consensual or not.
Existing law differentiates between a consensual plan and a cramdown.
However, the requirements to confirm a cramdown plan are essentially the same
as the requirements for a consensual plan, other than the absolute priority
rule. The SBRA eases the burdens for confirming
a cramdown plan and thus provides debtors with more leverage to negotiate
concessions from creditors. Conversely,
debtors fare better under SBRA if they are able to negotiate a consensual plan. As discussed herein, the SBRA tries to foster
ABSOLUTE PRIORITY RULE. Like in
Chapter 13, the absolute priority rule does not apply with respect to classes
of unsecured creditors when the debtor makes the Subchapter 5 election. Thus, the owners of the business can retain
their ownership interest even if unsecured claims are not paid in full. Similarly, an individual debtor can retain
property even if they do not pay unsecured creditors in full. Secured creditors, on the other hand, still
must be paid in accordance with §1129, but like before, their claim can be
bifurcated into a secured and unsecured portion. Also, secured creditors can still make the
§1111(b) election. Prior to SBRA, the
owners of a…
In an earlier post FactorLaw discussed Merchant Cash Advances, which is a form of financing that appears to be marketed to certain types of small businesses, according to an article dated November 20, 2018 published in Businessweek (the “BW Article”). The BW Article offers what we believe is an in depth treatment of how Merchant Cash Advances work and how they can be abused to the detriment of small businesses.
The major premise of the BW Article is best summarized by the following lead-in: “How an obscure legal document turned New York’s court system into a debt-collection machine that’s chewing up small businesses across America?” That “obscure legal document” is, of course, the confession of judgment that often accompanies the documentation for a Merchant Cash Advance. According to the BW Article, “some lenders have abused this power.” The BW Article also indicates the authors conducted “dozens of interviews” and reviewed “court pleadings” and based upon those sources the BW Article reports that “borrowers describe lenders who’ve forged documents, lied about how much they were owed, or fabricated defaults out of thin air.” The BW Article further reports that: “Cash-advance companies have secured more than 25,000 judgments in New York since 2012, mostly in the past two years, according to data on more than 350 lenders compiled by Bloomberg Businessweek.” The authors of the BW Article opine that “New York’s courts are especially friendly to confessions and will accept them from anywhere, so lenders require customers to sign documents allowing them to file there. That’s turned the state into the industry’s collections department.”
FactorLaw continues to handle cases for companies or individuals that are dealing with Merchant Cash Advances and continues to believe that a bankruptcy filing sometimes is a viable option for dealing with a Merchant Cash Advance. The automatic stay generally stops all collection actions, and in a chapter 11 case individuals and businesses sometimes are able to restructure debt obligations, including secured debt or debt arising from a confession of judgment. Chapter 13 also is available to individuals and, like chapter 11, generally allows individuals to retain property while they are working to repay debt over time.
If you would like more information regarding bankruptcy filings and would like to speak to one of our experienced attorneys, please call (312) 878-6976 or fill out a contact form here.
I. Explanation of absolute priority rule
Consumer debtors that do not qualify for protection under Chapter 7 or Chapter 13 of the Bankruptcy Code, are left with filing under Chapter 11, where they will come face-to-face with the absolute priority rule (the “APR”). The APR is a cornerstone of bankruptcy law. It was first developed by the Supreme Court in the late nineteenth-century to deal with widespread collusion in railroad reorganizations. To prevent unfair deals between senior creditors and equity holders, the Court held that “stockholders are not entitled to any share of the capital stock nor to any dividend of the profits until all the debts of the corporation are paid.”
Simply stated, the APR establishes a hierarchy of rights in bankruptcy proceedings, commencing with secured creditors at the top of the heap and ending with equity holders (or the debtor when the case involves an individual) at the bottom. This rule recognizes that equity holders, or debtors, have less rights and entitlement to recovery of a bankrupt enterprise’s assets because they stood to reap the most if the entity succeeded. It also recognizes that equity-holders generally control the allocation of value and absent limitations, they would unfairly allocate a disproportionate share to themselves. “This rule assured those who did business with the corporation that if the business were dissolved the creditors would be paid before the insiders would recover their investments. In case of collapse, the creditors could count on payment in full before equity collected anything from the business assets.”
Individuals debtors may find problematic their efforts to satisfy the APR because a Chapter 11 plan cannot be confirmed over the objection of a dissenting class of creditors if value is being allocated to the debtor, unless secured creditors and unsecured creditors are paid in full (see below discussion on the requirements for full payment), or the Plan meets the stringent “new value” test. On a practical level, an individual debtor cannot retain any property in a Chapter 11, unless all senior creditors are paid in full, including over an extended time period; all impaired classes accept the plan; or the debtor contributes what is known as “new value” in exchange for retaining its equity interests. 
II. How the rule applies in chapter 11
The APR evolved beyond a judicially created doctrine when Congress codified it as part of the Bankruptcy Code in 1978. To confirm a Chapter 11 plan, all impaired classes must accept the plan. However, a court may still confirm the plan (i.e., through a “cramdown”) if an impaired class rejects it, but only if the plan is otherwise “fair and equitable” within the meaning of the Bankruptcy Code, or, in some cases, the debtor contributes “new value” in accordance with that exception to the APR, and satisfies certain other criteria enumerated in §§1129(a)(1) through (a)(14).
To be fair and equitable, a plan must provide property of a value, as of the effective date of the plan, equal to the allowed amount of a creditor’s claim or it must satisfy the APR. A plan can satisfy the APR if value is allocated in accordance with the APR – e.g., if unsecured creditors are not paid in full, the debtor receives no property.
Full payment to senior classes does not necessarily require a single payment of the full amount owed and does not have to be immediate or in accordance with existing debt instruments (except for loans on an individual’s principal residence, which cannot be modified), so long as the payment stream is accompanied with an appropriate interest rate and is otherwise “fair and equitable.” Thus, the deferred cash payments can be structured in many ways, so long as the restructured terms are “fair and equitable” in the view of the Court.
This makes the cramdown of a Chapter 11 plan difficult for individual debtors that have a lot of debt and limited means to repay that debt.
III. After BAPCPA a minority of lower courts have held that the APR no longer applies in individual chapter 11 cases.
In 1988, the Supreme Court unanimously held the APR applied in individual Chapter 11 cases. However, the Bankruptcy Abuse Prevention and Consumer Protection Act (“BAPCPA”) that was enacted in 2005, led some courts to question whether the APR was still applicable in individual Chapter 11 cases.
BAPCPA modified §1129(b)(2)(B)(ii) and added §1115. The interaction between these two provisions has generated some decisions holding that the APR no longer applies when the debtor is an individual, although the majority view, which is followed by five Circuit Courts, holds otherwise – i.e., the APR still applies and was not abrogated by BAPCPA.
Section 1129(b)(2)(B)(ii) provides that, “in a case in which the debtor is an individual, the debtor may retain property inclu…