Senate Proposal Would Grow Small Business Bankruptcy Eligibility

An expansion of bankruptcy eligibility rules is moving toward a potential revival through a Senate proposal that would bring back a more lenient standard for Chapter 11 relief designed for small businesses.

The language, drafted as an amendment to the annual defense policy bill, would restore higher debt limits and allow more businesses to take advantage of “Subchapter V,” a special section under Chapter 11 of the US Bankruptcy Code that Congress created in 2019. If the previously unreported amendment becomes law, companies with up to $7.5 million in debt could file Subchapter V, compared to the current limit of about $3 million.

The potential expansion would allow more businesses to use Subchapter V, which bankruptcy lawyers, judges and professors have said allows companies to restructure more cheaply and quickly than traditional Chapter 11s. The expiration of the higher debt limit meant businesses that would have been previously eligible for Subchapter V’s benefits have been unable to since June, when the $7.5 million limit expired.

Until then, Subchapter V filings were up 66.2% in 2024 compared to the first six months of 2023, according to Epiq AACER, a bankruptcy data and services firm. Then, from the end of June through the end of August, Subchapter V filings were only up 4.5% from the year before, according to the Epiq data.

“The impact of the lower debt eligibility limit on subchapter V filings has been substantial,” Epiq said in a September statement. An October update from Epiq found that “the monthly pace of small businesses electing to restructure under subchapter V has slowed considerably.”

When Congress added Subchapter V to the bankruptcy code in 2019, it applied to businesses with less than about $2.7 million in debt. Congress raised that threshold in 2020 to $7.5 million as part of Covid-era business relief, which was extended in 2022. Once it expired, the the eligibility requirement reverted to about $3 million, adjusted slightly higher from the original limit.

The renewed $7.5 million cap would be retroactive to when the previous extension expired, according to the draft amendment to the National Defense Authorization Act. It would increase the two-year debt limit extension from 2022 to four years, effectively extending the higher threshold into 2026.

Opportunities, Hurdles Remain

House and Senate negotiators are holding informal talks on the defense authorization bill to craft a final version in the lame-duck session. If the language isn’t added to that measure, a year-end government funding bill could provide another opportunity, a Senate Judiciary Committee aide said. The bankruptcy provision could be attached to the bill that Congress must pass to keep the government open beyond Dec. 20, when current funding runs out, the aide said.

The bankruptcy amendment also faces a procedural hurdle. It was flagged by the House of Representatives for potentially violating the US Constitution’s origination clause, which requires revenue bills to originate in the House, not the Senate, the aide said. The higher debt limit could result in more bankruptcies, meaning more fees paid to the government.

The Senate aide said the Judiciary Committee is expecting a decision from the House on whether the amendment raises a constitutional issue by Nov. 8. The 2022 bankruptcy limit bill originated in the Senate and was retroactive because that bill, like the current effort, came after the $7.5 million standard had elapsed.

Sen. Rand Paul (R-Ky.) blocked a bipartisan bill to increase the eligibility limit earlier this year. Paul prevented the bill from passing via unanimous consent, but the defense policy bill or the funding bill could pass without his approval.

Subchapter V Benefits

Subchapter V creates more flexibility for small businesses in bankruptcy by removing requirements to file disclosure statements on their bankruptcy plans or work with a committee of creditors. It also modifies the so-called absolute priority rule that requires senior creditors, like banks, to be paid in full before other, unsecured creditors.

The American Bankruptcy Institute and the Justice Department have said Subchapter V leads to more confirmed bankruptcy plans and that those cases proceed to confirmation faster than traditional Chapter 11s.

Bob Keach, a member of ABI’s Subchapter V task force, said he was optimistic the legislation could get through Congress between the election and when new lawmakers are sworn in in January.

“I’m hopeful that this is going to get done either between now and year end or very soon into the new year,” Keach, who has been involved in ABI’s efforts to educate Congress about the task force’s findings, said.

Some companies that would have otherwise filed under the higher limit are waiting to do so, Keach, co-chair of Bernstein Shur’s restructuring group, said.

Regular Chapter 11 is too expensive for a lot of smaller debtors, Stephen Sather, the leader of Barron & Newburger PC’s bankruptcy practice group, said.

“Whatever the limit is, we’ll adjust,” Sather said. “But being able to help more clients is always a better thing.”