Recent Developments in Subchapter V of Chapter 11 of the Bankruptcy Code
This article was originally published on May 17, 2023, and was updated on August 23, 2023.
Subchapter V of chapter 11 of the United States Bankruptcy Code, which took effect in 2020, has undergone significant developments since its enactment, as courts continue to interpret its provisions, intended to streamline the chapter 11 process for smaller debtors in bankruptcy. Recent data and judicial decisions have given greater context to not only the popularity of Subchapter V, but also its substantive boundaries, with some of these key developments discussed below.
Disagreement as to Impact of Future Lease Obligations on Eligibility for Subchapter V
A recent decision from the Bankruptcy Court for the Eastern District of Virginia throws into question how landlord claims for future rent should be treated when considering a debtor’s eligibility to elect Subchapter V treatment.
In In re Macedon Consulting, Inc., the bankruptcy court held that all of a debtor’s future liability under an unexpired lease is considered noncontingent and unliquidated debts subject to the Subchapter V eligibility requirements of section 1182 of the Bankruptcy Code.
In Macedon, the debtor had a long-term lease with its landlord that, if honored through the end of its term, gave rise to nearly $14.4 million in future lease payment liabilities. When the debtor filed its bankruptcy petition and elected Subchapter V treatment, it simultaneously filed a motion seeking to reject this lease, arguing that the rejection (effective as of the debtor’s bankruptcy filing date) extinguished the debtor’s future liability under the lease and therefore future rent amounts could not be counted as qualifying debts included in calculating a debtor’s Subchapter V eligibility.
The court disagreed and went a step further, noting that a debtor’s full future liability under an unexpired lease controls this analysis, rather than the Bankruptcy Code’s formula for determining “rejection damages” for a lease that is rejected prior to the conclusion of its term, which in many cases acts as a cap on the total liability a debtor has to its landlord. Debtors and their counsel should be mindful of this analysis as they weigh distress options.
Subchapter V Filings Increase 81% Year-Over-Year in April
Small business bankruptcy filings under Subchapter V increased 81% year-over-year from April 2022 to April 2023, according to Epiq Global. The increase is due in part to the increased debt limits that Congress extended in June 2022, bringing the debt limit back up to where it was under the CARES Act at $7.5 million, making Subchapter V available to a far greater number of debtors. The CARES Act of 2020 had previously increased the debt limit from approx. $2.7 million to $7.5 million, and the CARES Act sunset in March 2022. The June 2022 increase restored the debt limit of $7.5 million. All chapter 11 filings are up 32% year-over-year from April 2022 to April 2023, and the share of those filings that have proceeded under Subchapter V is a strong indicator of its popularity for debtors eligible to take advantage of its provisions.
InfoWars Parent Free Speech Systems, LLC Allowed to Proceed Under Subchapter V
On March 31, 2023, the United States Bankruptcy Court for the Southern District of Texas held in In re Free Speech Sys., LLC, 649 B.R. 729 (Bankr. S.D. Tex. 2023) that founder Alex Jones’s personal bankruptcy filing did not affect the eligibility of his company Free Speech Systems, LLC, to proceed under Subchapter V of the Bankruptcy Code when it filed chapter 11. In July 2022, Free Speech Systems, LLC, the parent company of far-right website InfoWars, filed for bankruptcy and elected to proceed under Subchapter V. In December 2022, Alex Jones, the owner of Free Speech Systems, filed his own chapter 11 bankruptcy case, not electing to proceed under Subchapter V. A group of plaintiffs in defamation lawsuits against Jones filed a motion asking the court to revoke the Subchapter V election of Free Speech Systems, arguing that its debts should be combined with those of Jones as an affiliate, putting Free Speech Systems above the Subchapter V debt limit.
Section 1182(1)(B)(i) provides that in order to proceed under Subchapter V, the debts of all affiliated debtors must be less than or equal to $7.5 million. The court denied the plaintiff’s motion to revoke the Subchapter V election, holding that eligibility is measured as of the debtor’s petition date only.
Circuit Split Brewing Over Section 523(a) Non-Dischargeability
The Fourth Circuit Court of Appeals held in June 2022 that the non-dischargeability provision of section 523(a) of the Bankruptcy Code applies to the debts of a Subchapter V corporate debtor. Four bankruptcy courts and one district court have now held the opposite, and the Fifth Circuit is set to hear the issue soon.
Section 523 exempts the debts of “an individual debtor” from being discharged in a bankruptcy if the debts were incurred by fraud; certain tax debts; fines or penalties payable to a governmental unit; or for willful and malicious injury, among other things. Section 1192(2), applicable to Subchapter V cases, exempts from dischargeability debts “of the kind specified in section 523(a) of this title.” Individuals and businesses can file under Subchapter V, and section 1192(2) does not specify whether it applies to individuals only or all Subchapter V debtors.
The Fourth Circuit is the only court that has held that section 1192(2) makes section 523(a) applicable to all Subchapter V debtors. The other courts to rule on the issue have held that section 1192(2) makes section 523(a) applicable to only individual Subchapter V debtors, not corporate Subchapter V debtors.
Courts Holding That 523(a) Does Apply to Corporate Subchapter V Debtors:
- Fourth Circuit: In re Cleary Packaging, LLC, 36 F.4th 509 (4th Cir. 2022)
Courts Holding That 523(a) Does Not Apply to Corporate Subchapter V Debtors:
- Western District of Texas (currently on appeal in the Fifth Circuit): In re GFS Indus., LLC, 647 B.R. 337 (Bankr. W.D. Tex. 2022), motion to certify appeal granted, No. 22-50403-CAG, 2023 WL 1768414 (Bankr. W.D. Tex. Feb. 3, 2023)
- Middle District of Florida Bankruptcy Court (two separate cases): In re Hall, No. 3:22-AP-00062-BAJ, 2023 WL 2927164 (Bankr. M.D. Fla. Apr. 13, 2023); In re 2 Monkey Trading, LLC, No. 6:22-BK-04099-TPG, 2023 WL 3145124 (Bankr. M.D. Fla. Apr. 28, 2023) ()
- Eastern District of Michigan Bankruptcy Court: In re Lapeer Aviation, Inc., No. 21-31500-JDA, 2022 WL 1110072, at *2 (Bankr. E.D. Mich. Apr. 13, 2022)
- District of Idaho Bankruptcy Court: In re Rtech Fabrications, LLC, 635 B.R. 559, 564 (Bankr. D. Idaho 2021)
- District of Maryland Bankruptcy Court: In re Satellite Restaurants Inc. Crabcake Factory USA, 626 B.R. 871, 876 (Bankr. D. Md. 2021)
LP’s Financial Services & Restructuring Group is available to answer any questions about Subchapter V.