Article contributed by Paul H. Aloe
With the pandemic impacting small businesses, especially those in the food industry who have seen supply lines disrupted and have faced difficulty in retaining staff. Many of these businesses have yet to recover from the economic shutdowns from the pandemic. While many businesses have been fortunate to have creditors such as landlords, banks and vendors work with them and provide necessary relief from debtors, many businesses were not so fortunate. These businesses may be left with crushing debt that simply cannot be repaid in any meaningful way. For these businesses, bankruptcy may be a viable option.
Traditionally there were two options for businesses in the bankruptcy code. Under Chapter 7, the debtor business liquidates all of their assets, which are then distributed among its creditors, and goes out of business. Chapter 7 involves the end of the business and the appointment of a trustee, who among other responsibilities is tasked with recovering monies for creditors. Armed with so-called “strong arm” powers, the trustee can sue owners and others to recover preferential payments and “fraudulent conveyances” under either state or federal law. These aspects often make Chapter 7 an unattractive option for many small business owners, who may choose to liquidate without the benefit of bankruptcy petition.
Under Chapter 11, the debtor business retains control over their business while working out payment arrangements with creditors, allowing them to stay in business. Chapter 11 allows the business to restructure and remain in business. It allows the debtor to jettison unprofitable leases and executory contracts. Many large businesses have successfully reorganized under Chapter 11.
Bankruptcy under Chapter 11 has been the typical option for large businesses. But the downside is that it is very expensive. The debtor typically must pay not only for its own counsel and other professionals, but counsel and professionals retained by a creditors committee. There are expensive and time-consuming reporting requirements. And in most cases, the business must obtain the affirmative vote of various classes of creditors – for each class two thirds in amount, and majority in number. In many cases, the owners, to retain equity in the business, must contribute fresh capital, or “new value” in bankruptcy parlance. As a practical matter, Chapter 11 is often too expensive, too time consuming for the typical small business. It is typically used for large businesses, often with shares traded on public markets.
This changed with the passage of the Federal Small Business Reorganization Act (SBRA) of 2019 and the introduction of Subchapter V. Subchapter V creates a presumption that there should be no creditors committee appointed. It streamlines other costs and eliminates the trustee fee. The provisions take on some aspects of a Chapter 13 (reserved for individuals), but can be used to restructure the business, or in the appropriate case, sell it to a new buyer without the burden of the existing debts. While Subchapter V still has a trustee, the role of the trustee is different – basically assisting the debtor to restructure. Most significantly, Subchapter V eliminates a provision that prohibits owners from retaining equity interest in the re-organized debtor. Thus, many closely held smaller businesses can successfully reorganize, have its owners retain its equity, and not be crushed by the costs of the proceedings. In the experience of this author, many businesses that could never survive a full-blown Chapter 11 can successfully reorganize under Subchapter V.
As originally enacted when it went into effect in February of 2020, a company could file for bankruptcy protection under Subchapter V if they had debts totaling less than $2,725,625. This is a relatively low limit. The Coronavirus Aid, Relief and Economic Security Act (CARES) raised the ceiling to $7,500,000 until March 27, 2021. Subsequent legislation this year extended the $7,500,000 ceiling until March 27, 2022.
For a business in food services, Subchapter V could be a lifeline. If you have a strong, underlying business that was doing well until last year and are having troubles due to supply problems or staffing issues, reorganization under Subchapter V is a good option.
Whatever business struggles the business is going through now, it’s important to know there are options and a means to reorganize the business debt while maintaining control of the business. Subchapter V gives small businesses a process like Chapter 11, but at a fraction of the cost. There are situations where the underlying business and its future are sound, but its debt load is crushing its prospects. With the debt restructured, a previously failing business can grow and prosper. In addition, a business often faces one or two creditors who are not willing to be reasonable with the business. Bankruptcy can help create a plan that can overcome the unreasonable position of a handful of creditors, especially where other creditors are supportive.
It is important to keep in mind, however, that bankruptcy is harsh medicine, and not always the right medicine. Experienced counsel will explore various options to reorganizing a business. Often, when creditors are few, a restructuring can be achieved with the consent of the creditors without the need for a bankruptcy filing. But it is important that a business experiencing financial distress seek out professional help early. Many companies wait too long, until their accounts are completely dried up and they have nothing left. Unfortunately, many businesses that might have been saved are forced to liquidate because they wait until things are too late.
In addition, for those businesses with debts less than $7.5 million, but greater than $2,725,625, the higher limit is now scheduled to sunset on March 27, 2022. Struggling businesses whose debts fall within those two numbers need to consider filing for Subchapter V before the deadline.
Often with small businesses it’s not just the business that is in trouble, but the owners as well. Unfortunately, business owners are forced to give guarantees to banks, landlords and even vendors. While filing the business alone does not create a stay for owners, a plan can often provide relief for owners as well. And where there are guarantees, if the business liquidates or goes into Chapter 7, the owners remain on the hook with respect to the guarantees.
Finally, bankruptcy is not a solution for a business that does not have the prospect of being profitable. Bankruptcy can help fix past mistakes and misfortunes, including the impact of the pandemic. Whatever route a business owner chooses, most businesses have more options than they realize.
Paul H. Aloe is a partner at Kudman Trachten Aloe Posner LLP. He concentrates his practice in the following areas: litigation, bankruptcy, zoning and land use, commercial real estate, business reorganizations, business law and employment litigation. He graduated from Maurice A. Deane School of Law at Hofstra University in 1983. He received his BA from The George Washington University in 1980. You can reach Paul at email@example.com.