Article contributed by Paul H. Aloes
With the pandemic impacting small businesses, especially those in the food industry which have seen disrupted supply lines and struggled to retain staff. Many of these businesses have yet to recover from the economic shutdowns caused by the pandemic. While many businesses have been fortunate to have creditors such as owners, banks, and sellers working with them and providing the necessary assistance to debtors, many businesses have not been so fortunate. These companies can end up with overwhelming debt that simply cannot be paid off 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 company liquidates all of its assets, which are then distributed among its creditors, and ceases operations. Chapter 7 involves the termination of the business and the appointment of a trustee, who, among other responsibilities, is responsible for recovering funds for creditors. Armed with so-called âforcibleâ powers, the trustee can sue owners and others to recover preferential payments and âfraudulent transfersâ under federal or state law. These aspects often make Chapter 7 an unappealing option for many small business owners, who may choose to liquidate without the benefit of a Texas bankruptcy courts application.
Under Chapter 11, the debtor business retains control of its business while entering into payment agreements with creditors, allowing it to continue in business. Chapter 11 allows the company to restructure and stay in business. It allows the debtor to get rid of unprofitable leases and enforceable contracts. Many large companies have successfully reorganized under Chapter 11.
Chapter 11 bankruptcy has been the typical option for large companies. But the downside is that it is very expensive. The debtor usually has to pay not only for his own lawyer and other professionals, but also for lawyers and professionals retained by a creditors committee. There are costly and time-consuming reporting requirements. And in most cases, the business must obtain the affirmative vote of various categories of creditors – for each category, two-thirds in amount and a majority in number. In many cases, owners, in order to retain equity in the business, must bring in new capital, or ânew valueâ in Texas bankruptcy courts parlance. From a practical standpoint, Chapter 11 is often too expensive and time consuming for a typical small business. It is generally used for large companies, often with stocks traded on public markets.
This changed with the passage of the Federal Small Business Reorganization Act (TAGS) of 2019 and the introduction of Subchapter V. Subchapter V creates a presumption that no creditors committee should be appointed. . It streamlines other costs and eliminates trustee fees. The provisions repeat certain aspects of a Chapter 13 (reserved for individuals), but can be used to restructure the business or, if necessary, sell it to a new buyer without the burden of existing debts. Although subchapter V still has a trustee, the role of the trustee is different – essentially helping the debtor to restructure. More importantly, Subchapter V removes a provision that prohibits owners from retaining an interest in the reorganized debtor. Thus, many small, closed businesses can successfully reorganize themselves, ensure that their owners retain their equity and not be overwhelmed by the costs of the process. In this author’s experience, many businesses that could never survive a full Chapter 11 can successfully reorganize under Subchapter V.
As originally enacted when it came into effect in February 2020, a business could seek subchapter V bankruptcy protection if it 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 cap to $ 7,500,000 until March 27, 2021. Subsequent legislation this year extended the cap to $ 7,500,000 until March 27, 2022.
For a food service business, Subchapter V could be a lifeline. If you have a strong, underlying business that was doing well until last year and you are having issues due to supply or personnel issues, reorganizing under subchapter V is a good option.
Whatever business difficulties the company is going through right now, it is important to know that there are options and a way to reorganize the company’s debt while retaining control of the company. Subchapter V gives small businesses a process similar to Chapter 11, but at a fraction of the cost. There are situations where the underlying business and its future are healthy, but its debt crushes its prospects. Once debt is restructured, a previously failing business can grow and prosper. Additionally, a business often faces one or two creditors who are unwilling to be reasonable with the business. Bankruptcy can help create a plan that can overcome the unreasonable position of a handful of creditors, especially when other creditors are in favor.
It’s important to keep in mind, however, that bankruptcy is hard medicine, and not always good medicine. Experienced advisers will explore various options for reorganizing a business. Often, when there are few creditors, a restructuring can be carried out with the consent of the creditors without the need to file for bankruptcy. But it is important that a business experiencing financial difficulties quickly seeks professional help. Many businesses wait too long, until their accounts are completely dry and they have nothing left. Unfortunately, many companies that could have been saved are forced to liquidate because they wait until it is too late.
Additionally, for businesses with debts of less than $ 7.5 million but greater than $ 2,725,625, the upper limit should now expire on March 27, 2022. Distressed businesses with debts that match these two numbers should consider filing Subchapter V by the deadline.
Often times with small businesses it’s not just the business that’s in trouble, but the owners as well. Unfortunately, business owners are forced to give guarantees to banks, owners and even sellers. While the business deposit alone does not create a stay for owners, a plan can often provide relief for owners as well. And when there are guarantees, if the business is liquidated or goes into Chapter 7, the owners remain subject to the guarantees.
Finally, bankruptcy is not a solution for a company that does not have the prospect of being profitable. Bankruptcy can help right the mistakes and woes of the past, including the impact of the pandemic. Whichever route a business owner chooses, most businesses have more options than they realize.
Paul H. Aloes is partner of Kudman Trachten Aloe Posner LLP. He focuses his practice in the following areas: litigation, bankruptcy, zoning and land use planning, commercial real estate, corporate reorganization, business law and employment litigation. He graduated from the Maurice A. Deane School of Law at Hofstra University in 1983. He received his BA from George Washington University in 1980. You can reach Paul at [email protected]