The Restructuring Report

In 2020, Congress enacted the Small Business Reorganization Act (SBA), which codified Subchapter V within Chapter 11 of the Bankruptcy Code. The newly added subchapter is remarkably powerful, and with the new additions from Congress, creates a streamlined process for small businesses to reorganize. After passing the SBA, Congress subsequently increased the applicable debt limits for businesses eligible for Subchapter V, from approximately $2.7 million to $7.5 million, which qualified many more businesses for Subchapter V relief. With reduced costs, powerful tools for the debtor, and an extremely fast pace, Subchapter V provides small businesses with new ways to reorganize. Despite over 4,500 Subchapter V filings since 2020, the process remains relatively new, and courts continue to grapple with the intricacies of each provision. This article seeks to address two recent issues addressed by the courts.

A Structured Dismissal in Subchapter V

One of the unique features of the Subchapter V process is that a trustee is appointed to assist the debtor in possession with the process, including negotiating a plan for reorganization and providing general advice to the debtor, creditors and the bankruptcy court. The Subchapter V trustee plays an important role, and courts have strictly upheld the trustees’ role as “honest brokers.” As noted in In re New York Hand & Physical Therapy PLLC, the success of reorganization under the subchapter is attributable to “the openness and transparency of the debtor with the . . . trustee . . . the U.S trustee, creditors, and with the Court.”

In the New York Hand & Physical Therapy PLLC case, the bankruptcy court emphasized the important role Subchapter V trustees play and the benefits received by debtors when the bankruptcy court entered a structured dismissal order. The bankruptcy court found cause to dismiss the case due to the debtor’s failure to file monthly operating reports, but required the debtor to pay the Subchapter V trustee fees in full prior to dismissal upon threat of conversion to a case under Chapter 7. While the court focused its structured dismissal order on the payment of the Subchapter V trustee’s fees, noting that payment of administrative expenses is consistent with other structured dismissals, it is possible that we may see more structured dismissals in Subchapter V cases, raising additional issues.

A Developing Subchapter V Circuit Split Over Nondischargeability of Corporate Debts

Recent scholarship on the initial Subchapter V cases demonstrates how some courts and practitioners interpret the subchapter as unfair to creditors and far too lenient to debtors. A circuit split may be developing regarding whether 11 U.S.C. § 523(a) limits the discharge provided by 11 U.S.C. § 1192 solely as to debts for individual debtors and does not affect the dischargeability of corporate debts. For proper context, section 523(a) identifies a list of nondischargeable debts, but specifically states that applies to an “individual debtor.” Whereas section 1192 provides for a discharge of debts of both individual and corporate debts, “except any debt . . . of the kind specified in section 523(a).” 

In 2022, the Fourth Circuit held in In re Cleary Packaging, LLC that the exceptions to dischargeability in section 523(a) apply equally to both individual and corporate debtors. The Fourth Circuit conducted a textual analysis of the two provisions and determined that the language of section 1192, which expressly provides for discharges for both individual and corporate debtors, more properly governed the application of section 523(a) in Subchapter V cases. However, on July 6, 2023, the Ninth Circuit Bankruptcy Appellate Panel (BAP), in In re Off-Spec Solutions, LLC, rejected this approach. The BAP noted that aside from the Fourth Circuit’s Cleary ruling, other courts addressing the issue have held that section 523(a) does not apply to corporate debtors. The BAP conducted its own textual analysis and concluded that section 523(a)’s limitation on individuals controlled section 1192.

It is unclear how the Ninth Circuit will rule on these issues (if given the chance), but the Fourth Circuit’s Cleary ruling and the growing number of bankruptcy courts rejecting the Cleary approach indicate that this will remain an issue that courts will continue to struggle with in the future.

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While it remains to be seen how other courts will interpret the provisions of Subchapter V, Congress clearly made its intention known that, for small businesses, efficiency and cost-effectiveness are the priorities when reorganizing under this subchapter. As the subchapter continues to grow in popularity, the questions of how it will be interpreted along with the rest of the Bankruptcy Code remain a hot issue for future debtors and practitioners.