April 3, 2020
Barely a month after Bankruptcy Code amendments providing a cheaper, more efficient path to chapter 11 relief for small businesses took effect under the Small Business Reorganization Act of 2019 (“SBRA”), Congress has nearly tripled the debt-eligibility threshold from roughly $2.7 to $7.5 million in response to economic fallout from the COVID-19 shutdown. This expanded access under the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act expires after one year, temporarily benefiting not only additional independent small businesses but also larger players such as private equity funds by providing a new tool for restructuring struggling portfolio companies and distressed financing relationships.
Simpler Problems Need Simpler Solutions
On February 19, 2020, the SBRA added a new subchapter V to chapter 11 of the Bankruptcy Code for companies with up to $2,725,625 million in debt. Although chapter 11 already provided some protections for certain businesses with up to $2 million in debt, the time and expense of achieving a confirmable plan still created a heightened risk of administrative insolvency for many or rendered chapter 11 relief impractical. But the optional subchapter V, now available to companies with up to $7.5 million in debt under the CARES Act, does away with many burdensome requirements and allows equity owners to retain control.
First, the process is substantially accelerated. A disclosure statement is not required for cases commenced under subchapter V, and the debtor must file a plan within ninety days after the petition date. No other party may file a competing plan, and no committee of unsecured creditors is appointed unless ordered by the court, reducing expenses and minimizing the potential for litigation. Second, a trustee is appointed to help achieve a consensual plan by mediating between the debtor and creditors. Unlike a traditional chapter 7 or 11 trustee, a subchapter V trustee does not take possession of the debtor’s assets and has no ability to sell them, instead operating as a facilitator for the parties outside the courtroom. Third, a plan can be confirmed without the support of any impaired class as long as all projected disposable income will be applied to plan payments. Administrative claims may also be paid over time rather than as a condition to confirmation, making payment to professionals and other costs of running the bankruptcy case more manageable for the debtor. Finally, and perhaps most significantly, the absolute-priority rule is lifted so equity owners may retain their interests without providing new value.
Implications of Expanded Eligibility
Though very small businesses were positioned to benefit from the recently enacted subchapter V, the temporary increase to its debt threshold under the CARES Act is a real game changer for many more businesses previously too large to qualify for subchapter V relief but too small to absorb the cost and complications of a regular chapter 11 filing. Notably, a $7.5 million debt cap also creates interesting new options for private equity investors seeking to restructure certain of their portfolio companies as they face new economic realities. With its emphasis on cost cutting, equity control, and consensus building, subchapter V offers both creditors and investors an additional tool to drive negotiations and pursue solutions as they navigate both sudden market turbulence and the long-term economic impact of a global pandemic. It is not a panacea for all their investment holdings, but expanded subchapter V eligibility presents meaningful opportunities for private equity sponsors to restructure some of their cash-strapped portfolio companies quickly and efficiently in the wake of COVID-19 while retaining equity and control. At a minimum, it is an experimental remedy worthy of further examination.
McGuireWoods has published additional thought leadership related to how companies across various industries can address crucial COVID-19-related business and legal issues.