Trade-Off Theory: For Minimizing Debtor Benefits In Subchapter V

By: Donald L Swanson

There is trade-off theory going around for construing Subchapter V statutes.  The theory is used to minimize benefits that Subchapter V statutes provide to debtors.

The Theory

The theory goes like this:

• elimination of the absolute priority rule is a huge-and-generous benefit bestowed upon small businesses in Subchapter V; and
• so, in trade-off, other Subchapter V statutory benefits for debtors must be minimized.

An Example

Here’s an example of the trade-off theory, from a controversial opinion making corporate debtors in Subchapter V subject to discharge exemptions otherwise applicable only to individual debtors. The trade-off theory’s explanation goes like this:

• “Given the elimination of the absolute priority rule, Congress understandably applied limitations on the discharge of debts to provide an additional layer of fairness and equity to creditors to balance against the altered order of priority that favors the debtor.”[Fn. 1]

The theory has an obvious appeal because Subchapter V:

• is both a subpart of and a variation on regular Chapter 11; and
• eliminates the absolute priority rule.

Misplaced

But the trade-off theory is misplaced.  Here’s why.

The absolute priority rule’s elimination for Subchapter V is NOT an act of sympathy or generosity for poor-little small businesses.

Instead, there is a very practical reason for eliminating it: because the absolute priority rule makes no sense for small businesses and is harmful for all concerned.  

Here’s why:

• for large businesses with passive owners, the absolute priority rule does make sense—getting rid of passive owners has no effect upon the debtor’s future operations; but
• for small businesses, the owners and the business are one and the same (i.e., without the owners, there is no business)—and getting rid of them means that the debtor’s business will cease to exist.

Conclusion

So, here’s hoping the trade-off theory goes away as a rationale for construing Subchapter V statutes against debtor interests.

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Footnote 1. This quotation is from the Fourth Circuit Court of Appeals opinion, In re Cleary Packaging, LLC, Case No. 21-1981, at 15, decided June 7, 2022,

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