Owners of hospitality properties, which are considered “operating businesses,” owing less than $7.5 million may want to consider filing for Subchapter V bankruptcy to restructure their business and relieve their financial troubles. Bankruptcy has often carried a grave stigma that many businesses have wanted to avoid, but that notion should be abandoned. Using bankruptcy to resolve financial misfortune caused by the coronavirus pandemic should carry little disgrace. Deciding to utilize bankruptcy is a difficult decision for any company. After learning how bankruptcy can absolve seemingly insurmountable debt and restore business prosperity, many owners may conclude it to be a rational solution.
Since America’s first reported COVID-19 case last year, half a million people in the United States have perished. To slow the transmission of COVID-19, states implemented a variety of regulatory strategies with moderate success. Nevertheless, hospitalizations and deaths surged to a very high level. Two vaccines have been approved, the daunting logistics issues associated with their roll-out suggest that COVID will be with us and impacting the economy at least during the first six months of 2021.
Hotel, lodge, and B&B owners are often unfamiliar with bankruptcy as a legal process and unaware of recent changes within Chapter 11 that are set forth in Subsection V of the Federal Bankruptcy Code. By allowing a business to restructure debts, recover financial stability, and resurrect commercial operations while retaining business ownership, Chapter 11 serves as an incredibly useful tool for struggling businesses.
Unfortunately, Subsection V cannot be used by single asset real estate entities, such as leased income properties, etc. But we believe the Subsection V can be used by operating real estate-related businesses, such as lodging properties (bed & breakfasts, lodges, hotels).
Last year Congress passed the Small Business Reorganization Act of 2019 (SBRA), creating an expedited bankruptcy process for Small Business Debtors. SBRA defines a Small Business Debtor as a person or entity engaged in commercial activity with total debts of less than $2,725,625. Fortuitously, this definition was expanded by the Coronavirus Aid, Relief, and Economic Security Act in March of 2020. This Act increased allowable total debts to $7.5 million. This modification remains in place until March 21, 2021, but may be extended as Congress hopefully tries to provide small businesses with continuing financial relief.
The legal nuances and procedural intricacies of Chapter 11, its 45 relevant statutes, along with fifteen newly implemented Subsection V statutes, are far too expansive and complex to entirely address in this article. However, we describe some of Subsection V’s useful new features. Of course, any interested party needs to understand how tremendously important it is to engage experienced legal counsel and obtain specialized financial advice before proceeding—this cannot be stressed enough.
A Subsection V plan of reorganization—detailing a restructuring plan—will be confirmed if a court deems it as having a reasonable probability of success. A business can become a “debtor in possession,” allowing a debtor to continue to operate and manage cash flow under oversight of the court. A debtor in possession may receive reasonable compensation, pay salaries, vendor expenses, and certain legal fees. Also, a debtor in possession designation serves to forestall creditor collection actions by imposing a “stay” on creditor collection efforts until plan confirmation. The Department of Justice’s local U.S. Trustee appoints a Small Business Trustee, who works to facilitate a consensual plan of reorganization. A trustee appears in court during plan confirmation, assists with plan development outside of the often-contentious litigation forum, and acts as a consultant and mediator. Plan development and confirmation can be a very combative court process, and a trustee serves to alleviate inherent hostile inefficiencies.
Subchapter V also eliminates Chapter 11’s often constraining “absolute priority rule,” by setting in place a flexible legal standard of fairness and evenhandedness. A Subchapter V plan will be confirmed if it does not unfairly discriminate against any creditor and is perceived as fair and equitable to all creditors. This permits a debtor to retain business ownership even if creditors oppose a proposed plan of reorganization. In addition, Subsection V implements an extensive variety of other Chapter 11 modifications. Examples include note due-date extension, interest rate modification, loan principal reduction, accumulated deferred lease payment relief, pre-COVID pandemic equipment and real estate lease termination, and delayed repayment of bankruptcy administrative expenses.
Being able to restructure a company’s seemingly insurmountable debt, renegotiate unaffordable contracts, and restore business prosperity will make bankruptcy a rational decision. This is particularly true as society suffers from a once-in-a-generation pandemic. Before proceeding, a company should seek counsel and guidance from a trusted attorney, accountant, and other business owners who are familiar with Chapter 11. Bankruptcy is a complicated and difficult procedure, and a company will most certainly need all the help it can get.
Disclaimer: Every effort has been made to ensure the accuracy of this publication at the time it was written. It is not intended to provide legal advice or suggest a guaranteed outcome as individual situations will differ, and the law may have changed since publication. Readers considering legal action should consult with an experienced lawyer to understand current laws and how they may affect a case. For specific technical or legal advice on the information provided and related topics, please contact the author.