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Expiring Debt Cap to Limit Small Business Bankruptcy Fast Lane

March 3, 2021, 11:01 AM

A temporary Covid-era measure that lets small businesses with up to $7.5 million in debt file Chapter 11 under a new, streamlined process is set to expire this month, stirring attorneys’ anticipation that more companies will declare bankruptcy before the window closes.

Businesses that meet the current debt threshold qualify for expedited bankruptcies as outlined in Subchapter V of the bankruptcy code. The debt cap was $2.7 million until Congress raised it via temporary legislation last year to allow more struggling business owners to use bankruptcy protection measures to deal with the pandemic’s economic fallout. The threshold is set to drop back to the original cap March 27 unless lawmakers extend it.

If they don’t, distressed companies with more than $2.7 million in debt will be looking at a longer, more expensive Chapter 11 process, attorneys say.

Many small businesses that piled on debt during the pandemic could file for bankruptcy at the last minute if they think they won’t qualify after March 27, said Donald L. Swanson, a bankruptcy attorney and shareholder at Koley Jessen in Omaha, Neb.

“Everybody is terrified that if Congress doesn’t act, there’s going to be a wave” of Subchapter V filings, Swanson said.

Bipartisan legislation (S. 473) recently introduced by Sens. Richard Durbin (D-Ill.) and Charles Grassley (R-Iowa) would extend the $7.5 million threshold for another year. The bill is still in committee.

Companies have taken advantage of the increased debt limit, data indicate. A Bloomberg Law analysis of Subchapter V filings in Delaware through October 2020 showed that 20% of filers listed debt loads between $2.7 million and $7.5 million.

The looming March expiration date is starting to spark increased Subchapter V filings, said Bloomberg Law legal analyst Teadra Pugh.

More than 40 new cases were filed in the last week of February, compared to 75 filings for all of January, she said.

Still, Pugh cautioned that pandemic uncertainties have made bankruptcy filings difficult to predict. “Covid has blown all the rules out of window.”

Greater Availability

Subchapter V of the bankruptcy code, which went into effect in February 2020, eliminates many expenses of a traditional Chapter 11. The process doesn’t require companies to file a disclosure statement, pay U.S. Trustee fees, or form an official committee of unsecured creditors.

The subchapter also allows a debtor to pay off debts and attorneys’ fees gradually over three to five years, and retain equity in the business even if creditors aren’t paid in full.

Some creditors might not support extending the higher threshold because that would open up the debtor-friendly process to more companies, said James D. Silver, a partner at Kelley Kronenberg in Fort Lauderdale, Fla.

Unlike some other forms of bankruptcy, Subchapter V doesn’t allow creditors to force amendments to a confirmed plan if the debtor’s circumstances later improve, Silver said. “There’s no vehicle to come back and change things,” he said.

For small businesses in distress, however, it’s “critical” that Congress extend the $7.5 million threshold, said James Bailey, a restructuring attorney and partner at Bradley Arant Boult Cummings LLP in Birmingham, Ala.

The increased limit has made Subchapter V available to a host of businesses that wouldn’t have qualified otherwise.

Sunglasses retailer Solstice Marketing Concepts LLC squeaked in under the threshold with $7.259 million in qualifying debt when it filed for bankruptcy Feb. 18. The company said in its filing that it’s trying to get through its Subchapter V bankruptcy quickly before the increased debt ceiling expires.

‘Small’ Businesses Qualify

Distressed companies are torn between whether to file for bankruptcy or wait and see if they can get help from the recently passed American Rescue Plan Act, said Alan Crane of Furr & Cohen PA in Boca Raton, Fla.

Subchapter V is still new, so many companies may not even know that it exists, or that the $7.5 million threshold is about to sunset, he said.

Business owners also may not know that they qualify for Subchapter V, said Bethany Simmons, a bankruptcy attorney and senior counsel at Loeb & Loeb LLP in New York. A company actually can have more than $7.5 million in total debt obligations and still take advantage of the streamlined process, she said.

That’s because the debt limit only applies to “noncontingent liquidated” debt, such as money owed to trade vendors or payments due on a bank loan. But other contingent debts—certain debt obligations that may come due in the future—aren’t included in the threshold, Simmons said.

Courts have found that contingent debt excluded from Subchapter V’s limit includes future rent payments under a lease and Paycheck Program Program loans, Simmons said. Money owed to insiders and business affiliates also doesn’t count toward the debt limit, she said.

Limits on the types of debt included in the threshold allowed Greylock Capital Associates LLC, the parent of hedge fund Greylock Capital Management LLC, to use Subchapter V to cancel an expensive Manhattan lease. The company, which has invested in more than 100 countries on six continents, was able to show that it had less than $7.5 million in debt because the majority of overall debt belonged instead to non-bankrupt affiliates.

Companies in financial distress should look at Subchapter V and consider filing “sooner rather than later,” Simmons said. “A well-organized filing doesn’t happen overnight,” she said.

To contact the reporter on this story: Leslie A. Pappas in Wilmington, Del. at lpappas@bloomberglaw.com

To contact the editors responsible for this story: Laura D. Francis at lfrancis@bloomberglaw.com; Roger Yu at ryu@bloomberglaw.com

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