The Creditor's Playbook for Subchapter V Bankruptcies

Key Takeaways:

• Subchapter V was designed to help small-business debtors reorganize in Chapter 11 with less cost and on a faster timetable than a traditional Chapter 11. But Subchapter V’s benefits to the debtor can come at an expense to creditors. Among other things, Subchapter V eliminates the absolute priority rule (a key protection for creditors) in favor of a requirement that debtors commit their projected disposable income over the life of the plan, allowing for a debtor to cram down a plan over the objection of all creditors, and creating the role of a Subchapter V Trustee as an advocate for a plan’s confirmation instead of the interests of creditors.

• That said, creditors can strategically object to the plan, including on the basis that it’s not fair and equitable because the debtor has failed to commit its full disposable income under the plan. Creditors should adequately investigate a debtor’s finances through tools such as a Rule 2004 examination and work with the Subchapter V trustee to make sure their interests are being represented.

Subchapter V can be problematic for creditors. Congress designed Subchapter V to benefit debtors and facilitate confirmation of small business debtors, as, historically, only one-third of Chapter 11 plans are confirmed. However, the innovations to Subchapter V that assist debtors and make it a faster, cheaper bankruptcy process can also harm creditors if they are not aware of the unique features of Subchapter V and how to navigate them.

These unique features include: 

1. The elimination of the absolute priority rule: Under 11 U.S.C. § 1191(b), a court may “cram down” or confirm a plan over creditors’ objections if the plan “does not discriminate unfairly” and “is fair and equitable with respect” to each class of impaired classes that have not voted to accept the plan. However, 11 U.S.C. § 1191(c), which defines “fair and equitable” under Subchapter V, replaces the traditional absolute priority rule with a requirement that all of the debtor’s disposable income between the three to five year period of the plan, as determined by the bankruptcy court, will be distributed to creditors or the value of the property to be distributed under the plan is not less than the value of the debtor’s disposable income during the plan period. Disposable income for an entity debtor is defined by 11 U.S.C. § 1191(d) as an entity debtor’s income that is “not reasonably necessary. . . for the payment of expenditures necessary for the continuation, preservation, or operation of the debtor’s business.” This change affects secured and unsecured creditors alike, but especially hurts unsecured creditors whose claims do not qualify for administrative expense priority, because it allows equity holders of the debtor to retain their interests even though the debtor’s plan does not provide payment for unsecured classes of creditors in full. And 11 U.S.C. § 1191(d)’s definition of disposable income gives debtors incentives to overestimate their business expenses to reduce the amount of “disposable income” they have to commit under the plan.

2. The elimination of the creditors’ committee for most cases: Under Subchapter V, the bankruptcy court will usually not appoint an unsecured creditors committee, unless the court orders the creation of the unsecured creditors committee “for cause.”  11 U.S.C. § 1181(b)  In theory, the Subchapter V trustee, which is appointed in all Subchapter V cases, could serve to advocate for the interests of unsecured creditors, but the role of the Subchapter V trustee is primarily to assist the parties in achieving a consensual confirmation, not to advocate for the rights of creditors. A Subchapter V trustee’s fees are part of the case’s administrative expenses and could serve as a further obstacle to unsecured creditors receiving distributions under the plan if the Subchapter V Trustee remains in the case for a lengthy period. If a plan is confirmed consensually, a Subchapter V trustee’s services are terminated upon “substantial consummation of the plan;” if the plan is confirmed non-consensually, the Subchapter V Trustee remains in the case as an administrator and distributes payments to creditors.   

3. The absolute cramdown: Under Subchapter V, a debtor may confirm a plan non-consensually or “cramdown” the plan on its creditors, even if NO class of creditors vote to accept the plan, as long as the Court finds that the plan is fair and equitable. 11 U.S.C. § 1191(b).

4. The debtor’s exclusivity to file a Subchapter V Plan: Only a debtor may propose a Subchapter V Plan. The debtor has ninety days from confirmation to propose this plan.

5. No disclosure statement: Under Subchapter V, the debtor does not have to prepare and serve a disclosure statement providing information regarding the plan before it files its plan. This leaves little time for creditors to investigate a debtor’s financial projections and representations before having to make their decision on whether to object to the plan and/or vote to accept or reject the plan.

6. Administrative expenses: Under 11 U.S.C. § 1191(e), creditors holding administrative expense priority claims, including creditors who hold a claim under 11 U.S.C. § 503(b), such as trade creditors and lessors of the debtor, can be paid throughout the life of the plan instead of being paid upfront on the effective date of the plan in a traditional Chapter 11 case. See 11 U.S.C. § 1129(9)(A).

Conclusion

Nonetheless, creditors are not without hope in Subchapter V. As scholars have identified, creditors still have the tool of a Rule 2004 examination to investigate the financial affairs of the debtor before the debtor proposes its plan and to prepare for any objections to the plan. This will especially assist creditors in calculating the Debtor’s disposable income to ensure that creditors can timely object to any plan that commits less than a debtor’s full disposable income to the plan and over-estimates a debtor’s expenses. Additionally, creditors should communicate with the Subchapter V Trustee early in the case and establish a working relationship with the Trustee. In this way, both the creditor’s interests and the Trustee’s interests in achieving a consensual confirmation may be better aligned. 

However, the best tool for creditors is to object to the plan on the basis that it does not treat their claims “fair[ly] and equitabl[y]” or contribute all of the debtor’s disposable income under the plan. As scholars point out, there are few incentives for a creditor to consent to a plan. But the debtor has an incentive to craft a plan that can be consensually confirmed to rid itself of the twin burdens of the Subchapter V Trustee’s oversight and fees. Thus, secured creditors can use the threat of a cramdown to advocate for better treatment for their interests under the plan, such as a higher rate of interest to compensate them for the value of their secured claim.