It Just Got More Difficult to Qualify For Subchapter V Bankruptcy

Subchapter V of Chapter 11 of the Bankruptcy Code, which took effect four years ago, creates a more streamlined and less expensive Chapter 11 reorganization path for small business debtors. 

Popular from the jump, under the original law to be eligible for Subchapter V, a debtor (whether an entity or an individual) had to be engaged in commercial activity and its total debts—secured and unsecured—had to be less than $2,725,625.  At least half of those debts had to come from business activity. 

In March 2020, in response to the COVID-19 pandemic, Congress raised the Subchapter V debt ceiling to $7.5 million for one year.  Congress extended the higher limit twice, with the last expiration date on June 21, 2024. 

Although a bipartisan bill circulated in Congress to extend the higher debt ceiling for two more years, nothing was passed, and the law reverted to the original, lower limit.  After adjusting for inflation, the debt ceiling has dropped to $3,024,725.  So, at least for now, businesses with over $3 million in debt are on the outside looking in.

Subchapter V has proven popular both nationally and in North Carolina.  It is the "chapter of choice" for small-business debtors.  The American Bankruptcy Institute has reported that Subchapter V accounted for around one-third of all Chapter 11 bankruptcy filings since it took effect, with the number of cases steadily increasing each year. 

More than 25% of those small business debtors would not have qualified for Subchapter V under the lower $3 million debt limit. 

The American Bankruptcy Institute has also reported that Subchapter V cases have higher plan-confirmation rates, speedier plan confirmations, more consensual plans, and improved cost-effectiveness compared to traditional Chapter 11 cases. 

Now that Subchapter V's new (old) threshold is in effect, we will have to wait and see the response from distressed businesses.  They may decide they have no choice but to file a traditional Chapter 11, or they may throw in the towel with a state-court wind-down or Chapter 7 liquidation.  Or they may attempt to tread water in the hope that Congress passes a law reinstating the higher debt ceiling.

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