SBA Silence Delays Small Business Bankruptcies, Raises Costs

Small business owners are experiencing delays in their bankruptcy proceedings and rising costs when government creditors fail to vote on their restructuring plans.

Government entities, like the Small Business Administration, that hold debt against a company often abstain from voting on those businesses’ restructuring plans under a section of bankruptcy law called Subchapter V—even if they don’t oppose the proposal. The practice can leave plans without necessary creditor support.

Companies are then frequently unable to access the immediate debt discharge they would otherwise secure in bankruptcy, lawyers say. Instead, they must accept the discharge “as soon as practicable” after completing plan payments.

“When you see an SBA loan, it’s like, ‘Well, crap, I know I’m not going to get a vote from them,’” said Daniel A. Velasquez, a partner in Latham Luna Eden & Beaudine LLP in Orlando. “You fully settled with them, but they still can’t accept what you have agreed on formally via ballot.”

Subchapter V, part of Chapter 11 used by small businesses, requires unanimous acceptance by all impaired creditor classes for consensual plan approvals.

If a creditor like the SBA doesn’t consent to the plan, Subchapter V mandates that debtors commit their projected disposable income to creditors for three to five years. Debtors may incur costs if a trustee remains in place to administer payments.

“I cannot explain why government creditors don’t vote, and I have neither seen nor heard of a formal policy on this matter,” said Donald Swanson, an attorney at Koley Jessen PC who serves as a Subchapter V trustee.

Many small businesses obtain SBA-backed loans for equipment purchases, disaster rebuilding, debt refinancing, or startup funding.

Companies secured SBA-backed capital—including loans, investments, and surety bond guarantees—more than 103,000 times in fiscal 2024, totaling $56 billion, according to the SBA’s capital report. The agency backed over $2.7 billion in 7(a) loans through its primary business loan program.

There have been more than 9,200 Subchapter V cases since 2020, according to data from the American Bankruptcy Institute.

Amid the small bankruptcy voting troubles, layoffs triggered by President Donald Trump’s executive order have caused unrest across agencies. The SBA two weeks ago said it issued erroneous termination notices to probationary staff, only to fire some of them the following day.

The SBA didn’t respond to questions. The Department of Justice’s bankruptcy monitor declined to comment.

Workarounds

Practitioners frequently encountering the “SBA creditor issue” in Subchapter V cases believe the agency and institutional lenders who issue SBA-backed loans abstain from voting to prevent setting precedents that could influence future cases.

Consequently, lawyers are exploring workarounds to show judges that the government entities accept the plan despite failing to vote.

“It doesn’t feel fair from the debtor’s perspective, particularly if a creditor says, ‘I agree with this treatment, I’m just not going to file a ballot,’” said Rebecca Redwine Grow, partner at Hendren, Redwine & Malone PLLC in North Carolina.

With SBA counsel’s involvement, she said she’s used emails in which the agency stated it wouldn’t file an objection to reassure the judge tasked with considering a bankruptcy plan.

“There are creative ways that the courts are finding because, at the end of the day, the bankruptcy court is a court of equity, and so you’re seeing more of those plans confirm, trying to do a workaround,” Redwine Grow said.

Velasquez said about 90% of his clients have an SBA-backed loan. When he encounters this issue, he drafts a stipulation, with SBA counsel’s knowledge, outlining the agreed terms.

Delays caused by the missed votes cause more problems in smaller cases because the timing of debt discharges in Subchapter V is critical, said Robert Keach, co-chair of Bernstein Shur’s business restructuring and insolvency practice group and member of ABI’s Subchapter V task force. The proceedings are intended to be faster than traditional Chapter 11 cases.

There’s interest in amending the law to allow plan approvals despite the “silent class” that didn’t vote, he said. However, it likely won’t happen soon, as the main legislative focus is restoring the temporary provision that allowed Subchapter V bankruptcies for debts up to $7.5 million.

“Once the debt limit is restored, I think there will be an opportunity for a technical corrections bill,” Keach said. “I think this is one of the issues likely to be fixed because it is a technical problem.”

The ‘Silent Class’

Courts have taken different approaches to the “silent class,” but the prevailing view is that silence means rejection, practitioners said.

Redwine Grow said sometimes a court would accept a proffer that the SBA agrees with the treatment, “but it’s a rare circumstance.”

In the bankruptcy of Florist Atlanta Inc., the SBA neither objected to nor voted on the plan. The debtor argued that its plan should be considered consensual anyway, saying that when no creditor in an impaired class votes, “the computation involves dividing zero by zero,” producing an indeterminate result—an outcome they contend is “absurd and could not have been intended by Congress.”

Judge Paul W. Bonapfel of the US Bankruptcy Court of the Northern District of Georgia disagreed, writing in August 2024 that “as most courts do,” the plan required “affirmative acceptance by the class.”

He confirmed the plan under “cramdown” provisions that result in slower debt discharge.

But in Hot’z Power Wash Inc., the US Bankruptcy Court for the Southern District of Texas said the application of a mathematical calculation is “absurd as applied to a nonvoting class,” and bankruptcy law is “silent on the treatment of nonvoting class.”

Judge Eduardo V. Rodriguez wrote in November 2023 that the “Court is left with only one option: when an impaired class of creditors fails to cast a ballot, that class will not be counted.” He approved the plan without the IRS, a creditor that didn’t vote.

“The whole purpose of Subchapter V is somewhat upended by an agency of the government that created this process to facilitate reorganizations,” Velasquez said.