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Small Businesses Adapt to New Bankruptcy Filing Limits

Small businesses are facing a significant shift in their bankruptcy strategies as they adjust to a newly reinstated eligibility limit for bankruptcy filings. Following the expiration of a higher threshold last year, these businesses are narrowing down their options to streamline the reorganization process more effectively.

The Impact of Expired Thresholds

After a temporary provision that allowed Subchapter V bankruptcy filings for debts up to $7.5 million expired in June, bankruptcy practitioners have observed a marked change in how businesses approach their financial challenges. With the reinstated threshold now set at $3 million, there has been a palpable urgency among companies to "creatively" reduce their debts to qualify for faster reorganization under Subchapter V. This has become especially crucial as traditional Chapter 11 bankruptcy processes can be both costly and time-consuming, often rendering them unfeasible for many small businesses.

Strategies to Meet the New Requirements

In light of the recent developments, small businesses are employing various strategies to achieve the lower debt threshold. Key approaches include negotiating directly with major lenders and revising existing claim classifications. For businesses unable to decrease their indebtedness to meet the new limits, options are dwindling. They may need to consider liquidation or await potential extensions of the debt limit as they grapple with the high costs and extensive timelines associated with traditional Chapter 11 filings, which may not present a viable path forward.

Subchapter V filings, a segment of Chapter 11 designed to aid small businesses in financial distress, have seen a remarkable surge since 2020. This increase was largely spurred by legislative efforts to temporarily raise the debt limit, enabling many companies to seek necessary bankruptcy protection during the economic upheaval caused by the COVID-19 pandemic. Data from the American Bankruptcy Institute shows that filings under Subchapter V nearly doubled last year, reaching a total of 2,582, with Florida, Texas, and California leading in case numbers.

Recent Trends and Legislative Challenges

With the expiration of the higher threshold in June, Subchapter V filings accounted for approximately 12% of all bankruptcy cases in 2024; however, these filings witnessed a slowdown in the latter half of the year. Daniel A. Velasquez, a partner at Latham Luna Eden & Beaudine LLP in Orlando, noted in June that many businesses were eager to file under the higher limit, but as time ran out, they were forced to make quick decisions about their financial futures.

In response to the situation, Senator Dick Durbin (D-Ill.) introduced a bill aimed at reinstating the higher debt limit for another two years. Unfortunately, this bill faced opposition in Congress, particularly from Senator Rand Paul (R-Ky.), resulting in a stalled legislative process. Advocates continue to push for a more permanent or higher debt cap, emphasizing the need for accessible bankruptcy options for small businesses.

Getting Creative to Qualify

With the absence of an extended debt limit, businesses are increasingly employing innovative tactics to qualify for Subchapter V. Eyal Berger, a partner at Akerman LLP, emphasized that some small companies owned by individuals may take personal loans to reduce company debt. In doing so, they effectively shift the obligation from external creditors to an insider, which does not count against the Subchapter V threshold.

However, such approaches come with inherent risks. They can be complex and often require substantial time to secure the necessary loans. Furthermore, practitioners have begun to convert larger debts into contingent obligations, separating the company’s financial liabilities and making some of those debts depend on specific outcomes that the business must achieve post-bankruptcy. Notably, contingent debts do not count toward the debt limit.

Navigating legal Uncertainty

legal practitioners caution that the lack of clarity around what constitutes contingent or unliquidated debt introduces considerable uncertainty into the process. For some companies, this ambiguity means they might remain better off avoiding a Chapter 11 filing altogether if they cannot utilize the Subchapter V provisions effectively. A notable case highlighted this issue in June, when Judge Lori V. Vaughan ruled that a claim exceeding $14 million against Burdock and Associates was indeed unliquidated, allowing the company to move forward with its Subchapter V election despite the substantial debt.

Benefits of Subchapter V and AI legalese decoder

The benefits of Subchapter V filings are clear, as they typically yield better outcomes than traditional Chapter 11 cases. Data from the US Trustee’s office indicates that Subchapter V cases enjoy about double the confirmation plan percentage yet experience a 20% lower dismissal rate compared to non-Subchapter V small business cases. Additionally, the median time to confirmation is about 6.6 months, significantly shorter than the 10.4 months typically seen in non-Subchapter V cases.

Despite these advantages, many businesses are now feeling the impact of the lapse in the higher cap, which has removed a crucial restructuring option for a large number of firms. As bankruptcy law continues to evolve, resources like the AI legalese decoder can assist small business owners by translating complex legal jargon into easily understandable terms, ensuring they make informed decisions as they navigate these challenging waters. The AI tool can guide users through the intricacies of bankruptcy filings, helping them understand their options and streamline their bankruptcy processes with greater clarity and efficiency.

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