The Coronavirus Aid, Relief, and Economic Security Act, Pub. L. No. 116-136, 134 Stat. 281 (the “CARES Act”), has impacted small business bankruptcy filings in two significant ways: First, the Paycheck Protection Program (the “PPP“) appears to have reduced the number of small business bankruptcy filings through the creation of forgivable government-backed loans designed to help businesses survive the COVID-19 pandemic; and second, a temporary increase in the Small Business Reorganization Act’s, Pub. L. 116-54, 133 Stat. 1079 (the “SBRA”), debt limit from approximately $2.7 Million to $7.5 Million[1] has greatly expanded the number of small businesses who are eligible to file under Subchapter V of Chapter 11, 11 U.S.C. §§ 1181-1195 (“Subchapter V“), which offers a more streamlined, cost-effective, and debtor-advantaged version of Chapter 11 than the relief available through a non-Subchapter V (11 U.S.C. § 101(51C)) small business filing or a traditional Chapter 11 (non-small business) filing.
This article focuses on a debtor’s eligibility to file bankruptcy under Subchapter V. Importantly for planning purposes though, it should be noted that pursuant to an amendment made to 11 U.S.C. § 364 by the Consolidated Appropriations Act 2021, Pub. L. No. 116-260,[2] a Subchapter V debtor is eligible to obtain a PPP loan after it has filed bankruptcy. This is significant because the Small Business Administration had previously issued a rulemaking bankruptcy debtors ineligible for PPP loans and federal courts had upheld that prohibition. See e.g., USF Fed. Credit Union v. Gateway Radiology Consultants, P.A. (In re Gateway Radiology Consultants, P.A.), 2020 WL 7579338 (11th Cir., December 20, 2020).
Eligibility Factors
Due to the advantages offered to small businesses under Subchapter V, creditors are likely to challenge a debtor’s eligibility to file under that subchapter. Simply calculating the aggregate amount of debt owed by a small business to make sure it is equal to or less than the $7.5 million limit is not sufficient to determine eligibility; there are several other factors you must consider due to the revised definition of “small business debtor” in 11 U.S.C. § 101(51D) that is applicable to Subchapter V filings:
- Single asset real estate debtors are excluded and ineligible. See 11 U.S.C. § 101(51D)(A);[3]
- The debtor must be engaged in commercial or business activities See 11 U.S.C. § 101(51D)(A);[4]
- With respect to debt included in the $7.5 million limit, 50% or more of the debt must have arisen from the debtor’s commercial or business activities. See 11 U.S.C. § 101(51D)(A).
- Debts to affiliates (defined in 11 U.S.C. § 101(2)) or insiders (defined in 11 U.S.C. § 101(31)) are not counted in determining whether 50% or more of the debt arises from commercial or business activities. See 11 U.S.C. § 101(51D)(A).
- With respect to debt over the $7.5 Million limit, the debt must be contingent and unliquidated. See 11 U.S.C. § 101(51D)(A).
- Contingent means that the “liability relies on a future extrinsic event which may never occur.”[1] See In re. Parking Mgmt., Inc., 2020 WL 6146476, *5 (Bankr. D. Md., August 28, 2020) (citing to In re. Green, 574 B.R. 570, 577 (Bankr. E.D.N.C. 2017)). By contrast, “[i]f all events giving rise to the debtor’s liability have occurred prior to the filing of the bankruptcy petition, a debt is noncontingent ….” See In re. Tucker, 345 B.R. 37, 3753 (Bankr. M.D. Ala. 2006) (construing eligibility in the context of a Chapter 13 filing).
- Unliquidated means “[t]he amount of the debt is dependent … upon a future exercise of discretion, not restricted by specific criteria….” See United States v. Verdunn, 89 F. 3d 799, 802 (11th 1996).
- PPP loans are considered contingent and unliquidated obligations and, therefore, they are not included (i.e., they don’t count) in the $7.5 Million debt limit. See In re. Parking Mgmt., Inc. at *8-9.
- PPP loan is a contingent obligation because “[t]he debtor’s liability to repay the PPP ‘relies on some future extrinsic event which may never occur’ … [a]dditionally, it is subject to a ‘triggering event or occurrence … reasonably contemplated by the debtor and creditor at the time’ the debtor applied for and obtained the PPP funds …[t]herefore, the debtor’s obligation was contingent as of the date of filing.” See Id. (internal citations omitted).
- PPP loan is an unliquidated obligation because “as of the petition date, it could not be determined the extent to which the debtor might use the PPP funds for ineligible expenses or might fail to maintain employee staffing levels. It turns out the debtor complied with these requirements and anticipates complete forgiveness. But considering the question as of the petition date, there was no way to determine what amount, if any, the debtor might be obligated to repay. Therefore, the debtor’s obligation under the PPP was unliquidated as of the date of the filing, and is excluded from the debt limitation determination under § 1182.” See Id. (internal citation omitted).
Limited Review
Importantly, one of the first bankruptcy courts that has considered the application of these factors in the context of a creditor’s challenge to a debtor’s Subchapter V filing determined that the eligibility inquiry is not meant to be exhaustive but should instead be limited to an “efficient, expedient” process analogous to a federal district court’s review for “the amounts required for diversity jurisdiction under 28 U.S.C. § 1332.” See In re. Parking Mgmt., Inc. at *4 (citing In Comprehensive Accounting Corp. v. Pearson (In re Pearson), 773 F.2d 751 (6th Cir. 1985)).
According to the In re. Parking Management court, this means that bankruptcy courts should determine eligibility “based on debts as of the petition date and not based on ‘computing eligibility after a hearing on the merits of the claims.'” See In re. Parking Mgmt., Inc. at *4. The In re. Parking Management court further cautioned that bankruptcy courts “should neither place total reliance upon a debtor’s characterization of a debt nor rely unquestionably on a creditor’s proof of claim, for to do so would place eligibility in control of either the debtor or the creditor” but should instead “canvass and review the debtor’s schedules and proofs of claim, as well as other evidence offered by a debtor or the creditor to decide only whether the good faith, facial amount of the debtor’s liquidated and non-contingent debts exceed statutory limits.” See Id. (emphasis added).
Takeaways
Subchapter V offers important advantages to debtors that are not available in a traditional Chapter 11 filing or even a non-Subchapter V (11 U.S.C. § 101(51C)) small business filing. Moreover, in response to the COVID-19 pandemic, Congress expanded Subchapter V’s debt limit by almost $5 Million from approximately $2.7 Million to $7.5 Million. As a result, Subchapter V is currently available to a large number of small businesses that were previously excluded from its application. If your small business has already depleted its PPP funds, or if you are considering both a PPP loan plus a bankruptcy filing in order to continue your operations, a Subchapter V filing may be the relief you need.
[1] See Section 1113(a)(1) of the CARES Act.
[2] Signed into law on December 27, 2020. A copy of the text may be found here: https://www.congress.gov/bill/116th-congress/house-bill/133/text
[3] Public companies and affiliates of public companies (affiliate is defined in 11 U.S.C. § 101(2)), subject to the reporting requirements of the Securities Exchange Act of 1934 are also excluded. See 11 U.S.C. § 101(51D)(B)(ii). See also Hall L.A. WTS, LLC v. Serendipity Labs, Inc. (In re Serendipity Labs, Inc.), 620 B.R. 679 (Bankr. N.D. Ga. 2020).
[4] No profit motive is required and non-profit organizations are not excluded based on the “engaged in commercial or business activity” requirement. See In re. Ellingsworth Residential Commercial Ass’n., Inc., 619 B.R. 519 (M.D. Fla. 2020).
[5] Similarly, contingent liabilities are defined as “a class of liabilities in which the obligation to pay does not arise until the occurrence of a ‘triggering event or occurrence … reasonably contemplated by the debtor and creditor at the time the event giving rise to the claim occurred.'” See In re. Parking Mgmt. at *11-12 (citing to In re. Barcal, 213 B.R. 1008, 1013 (B.A.P. 8th Cir. 1997)).
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Debts to affiliates (defined in 11 U.S.C. § 101(2)) or insiders (defined in 11 U.S.C. § 101(31)) are not counted in determining whether 50% or more of the debt arises from commercial or business activities. See 11 U.S.C. § 101(51D)(A).With respect to debt over the $7.5 million limit, the debt must be contingent and unliquidated. See 11 U.S.C. § 101(51D)(A).
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- Contingent means that the “liability relies on a future extrinsic event which may never occur.”[5] See In re. Parking Mgmt., Inc., 2020 WL 6146476, *5 (Bankr. D. Md., August 28, 2020) (citing to In re. Green, 574 B.R. 570, 577 (Bankr. E.D.N.C. 2017)). By contrast, “[i]f all events giving rise to the debtor’s liability have occurred prior to the filing of the bankruptcy petition, a debt is noncontingent ….” See In re. Tucker, 345 B.R. 37, 3753 (Bankr. M.D. Ala. 2006) (construing eligibility in the context of a Chapter 13 filing).
- Unliquidated means “[t]he amount of the debt is dependent … upon a future exercise of discretion, not restricted by specific criteria….” See United States v. Verdunn, 89 F. 3d 799, 802 (11th 1996).
- PPP loans are considered contingent and unliquidated obligations and, therefore, they are not included (i.e., they don’t count) in the $7.5 Million debt limit. See In re. Parking Mgmt., Inc. at *8-9.
- PPP loan is a contingent obligation because “[t]he debtor’s liability to repay the PPP ‘relies on some future extrinsic event which may never occur’ … [a]dditionally, it is subject to a ‘triggering event or occurrence … reasonably contemplated by the debtor and creditor at the time’ the debtor applied for and obtained the PPP funds …[t]herefore, the debtor’s obligation was contingent as of the date of filing.” See Id. (internal citations omitted).
- PPP loan is a liquidated obligation because “as of the petition date, it could not be determined the extent to which the debtor might use the PPP funds for ineligible expenses or might fail to maintain employee staffing levels. It turns out the debtor complied with these requirements and anticipates complete forgiveness. But considering the question as of the petition date, there was no way to determine what amount, if any, the debtor might be obligated to repay. Therefore, the debtor’s obligation under the PPP was unliquidated as of the date of the filing, and is excluded from the debt limitation determination under § 1182.” See Id. (internal citation omitted).