By the Small Business Reorganization Act of 2019, which became effective February 1, 2020, a new Subchapter V was added to Chapter 11 of the Bankruptcy Code, which relieves debtors of certain requirements, with the intention of streamlining Chapter 11 cases for small business debtors with debt below a specified threshold. (Under the CARES Act, the threshold was increased from approximately $2.73 million to $7.5 million, until March 21, 2021.)
One of the more interesting, less discussed features of Subchapter V is changes made to the absolute priority rule. In typical Chapter 11 cases, to confirm a plan that has been rejected by at least one class, the plan must be “fair and equitable” to the rejecting class. Pursuant to Bankruptcy Code section 1129(b)(2), “the condition that a plan be fair and equitable with respect to a class includes the following requirements … (B) With respect to a class of unsecured claims—(i) the plan provides that each holder [in the rejecting class] receive … property of a value as of the effective date of the plan, equal to the allowed amount of such claim; or (ii) [that equity receive no recovery].” The present value requirement is satisfied by paying creditors in the subject class, the allowed amount of their respective claims plus “cramdown interest.” In determining an appropriate cramdown interest rate, courts typically begin with the prime rate (currently 3.25%) and add a risk premium, based on risk factors presented. In small business Chapter 11 cases, cramdown interest disputes can be hotly contested, in that a high cramdown interest rate limits otherwise available value from flowing to equity classes.
Subchapter V includes a modified fair and equitable requirement, for unsecured rejecting classes. Pursuant to Bankruptcy Code section 1191(c), the fair and equitable requirement “includes” distribution of all of the debtor’s “projected disposable income” over the 3-year period following the conclusion of the bankruptcy case; or equivalent value over an up to 5-year period. Significantly, there is no present value requirement in Subchapter V, unlike in regular Chapter 11 cases; and in In re Factom, Inc., Case No. 20-11602 (BLS) (Bankr. D. Del.), the Court confirmed a plan that provided for creditors to receive post-effective date interest of just 1%/year on their respective allowed claims, over a 3-year period following the effective date of the plan, enough to satisfy the requirements of the best interests test under Bankruptcy Code section 1129(a)(7) in an otherwise solvent debtor case.
It remains to be seen whether a court would import section 1129(b)(2)’s present value requirement via the inclusory proviso in section 1191(c). However, to date that has not occurred, leaving open a useful tool for preserving value for equity classes in Chapter 11 cases.
Amini LLC represented the Debtor in Factom, Inc. The case was the first Subchapter V case confirmed by the U.S. Bankruptcy Court for the District Court of Delaware.