2023 Bankruptcy Progress: Developing Subchapter V Law Through Court Opinions

By: Donald L Swanson

2023 has been a good year for developing the law of Subchapter V through court rulings and opinions.  Here are some of the highs and lows of that development.

Working as Intended

If 2023 shows us anything, it’s this: Subchapter V is working as intended. 

Subchapter V has developed into the efficient and effective tool for business reorganization it was intended to be.  That’s true, whether the reorganization is in the form of continued operations or liquidation.  Such a tool did not exist before Subchapter V.

Subchapter V has also developed into an efficient and effective tool for entrepreneurs to deal with personal liabilities arising from their failed businesses—and to get a fresh start.  Such a tool did not exist before Subchapter V.

It is the rulings and opinions of the bankruptcy courts and their appellate overseers, in 2023 and before, who have made this development happen.

Trustee Facilitation

Subchapter V introduces a new trustee role and duty: to “facilitate the development of a consensual plan of reorganization.” 

Subchapter V experiences in 2023 demonstrate that this trustee facilitation role and duty is working well.  And the courts are enabling the development of that role and duty through their rulings.

But there are still problems, like assuring that Subchapter V trustees are compensated for their services.  There are around 250 Subchapter V trustees.  And it appears that a common experience is the absence of full payment for all trustee services rendered. 

But the good news is this:

• Subchapter V trustees are continuing to perform their services; and
• the courts, the trustees, the bankruptcy practitioners, etc., are working on how to best assure full payment for trustee services in the future.

Commercial or Business Activities for Eligibility

Subchapter V eligibility requires that a debtor be engaged at the petition filing date in “commercial or business activities.”  

The trend occurring in 2023 is toward easier eligibility—i.e., almost anything will do, that might conceivably fit within the “commercial or business activities” phrase.

One specific 2023 trend of this type involves a debtor’s struggles with legacy business debt (i.e., an entrepreneur struggling with personal liability for business debts that remain after the business is closed and liquidated).  Under 2023 court rulings, such struggles can qualify as “commercial or business activities”:

• especially when included as one of multiple factors under a totality of circumstances test; and
• maybe even as a stand-alone activity.

Affiliate Filing and Eligibility

The $7.5 million debt limit computation on Subchapter V eligibility does not include separate debts owed by affiliated entities.  But that rule changes when two or more affiliated entities are all in bankruptcy—then, the debts of the affiliated entities are combined for the Subchapter V debt limit calculation under § 1182(1)(B)(i).

But there is a timing issue for combining the separate debts of affiliated debtors in bankruptcy.  What about this chronology?

• The first debtor files Subchapter V bankruptcy with total debts of $5 million—this debtor is eligible for Subchapter V relief; but
• then two months later, an affiliate debtor files Subchapter V bankruptcy with total debts of $4 million—this debtor is not eligible for Subchapter V relief, because its own $4 million debts, combined with the affiliate’s $5 million debts, exceeds the $7.5 million debt limit.

Here’s the issue:

• Does the second debtor’s filing two months later deprive the first debtor of Subchapter V eligibility—and bounce the first debtor out of Subchapter V?  

The issue seems to be answered in 2023 like this:

• Subchapter V eligibility is determined on the petition filing date; and
• so, a later affiliate’s bankruptcy filing has no effect on the Subchapter V eligibility of the first debtor to file.

Here’s hoping that answer sticks!  

Plan Voting v. Not-Voting

This is a tough one.

Subchapter V has a focus on achieving consensual plan confirmation.  It even imposes a duty on the Subchapter V trustee to “facilitate a consensual plan.”

But in most bankruptcy courts, a consensual plan requires an affirmative vote accepting the plan from all classes of claims. 

• The one major-and-broad exception is the Tenth Circuit Court of Appeals and all bankruptcy courts in that circuit—the Tenth Circuit rule, applicable in all Chapter 11 cases (including Subchapter V cases), is that the failure of an entire class of claims to vote on a plan is deemed an acceptance of that plan by that not-voting class; but
• Most courts outside the Tenth Circuit are uncomfortable with such a rule.  

The problem arises most acutely in Subchapter V cases when secured creditors are involved, like U.S. government lenders, (i) whose claim must be separately classified, but (ii) who will never vote on a plan. 

• The mere existence of such a claim will, in and of itself, prevent the consensual confirmation of a plan in most bankruptcy courts; and
• The confirmation of a plan as non-consensual has significant negative consequences for everyone involved, including a delayed discharge, keeping the trustee in place and incurring additional administrative fees, etc.

2023 case law struggles with this voting v. not-voting issue.  But it seems that progress has been made during 2023 toward ignoring a not-voting class in the consensual v. not-consensual context, without specifically adopting the Tenth Circuit’s “deemed acceptance” rule.  

Dischargeability

Debtor’s discharge of a particular debt can be be denied under § 523, for such things as fraud, defalcation by a trustee, larceny, willful or malicious injury, domestic support, personal injury from intoxication, etc.

However, such denials are explicitly limited, in § 523(a) and § 1141(d)(2), to the discharge of “an individual debtor”—they don’t apply to non-individual debtors in Chapter 11.

Most courts in Subchapter V cases apply the “individual debtor” limitation. 

However, things started getting squirrely in 2022 when a Fourth Circuit opinion goes the other way: declaring the § 523(a) grounds for denying a discharge apply to corporate and LLC debtors in Subchapter V.  That’s despite the seemingly-obvious statutory restrictions to “an individual debtor” in § 523(a) and § 1141(d)(2). 

It appears that most courts, who can, are now rejecting the Fourth Circuit’s opinion.  But there is a 2023 exception:

• a Colorado district court reverses a bankruptcy court ruling on this issue; and  
• “finds the Fourth Circuit’s analysis persuasive.” 

That’s unfortunate.

Conclusion

2023 was a good year, by and large, for the development of Subchapter V case law.

There have been some ups and downs—and some opinions got a little squirrely.  But the overall trend has been decidedly in a favorable direction, making Subchapter V the effective and efficient tool for business reorganization it was intended to be.

** If you find this article of value, please feel free to share. If you’d like to discuss, let me know.