Small businesses are revising strategies to meet a bankruptcy filing eligibility limit after a higher threshold expired last year, narrowing the pool of qualifiers for faster reorganization.

After a temporary provision allowing Subchapter V bankruptcy filings for debts up to $7.5 million expired in June, bankruptcy practitioners say businesses are now trying to “creatively” reduce their debt to the reinstated $3 million threshold.

Strategies include negotiating with major lenders and revising claim classifications. If debts can’t be reduced to the maximum threshold, many businesses might consider liquidation or wait for a potential extension due to the high costs and lengthy process of traditional Chapter 11 bankruptcy, which often isn’t viable, the practitioners said.

Filings under Subchapter V, part of Chapter 11, have surged since 2020, spurred by Congress temporarily raising the debt limit shortly after its enactment as many businesses sought bankruptcy protection from the economic fallout of the Covid-19 pandemic.

Those filings nearly doubled to 2,582 last year, according to the American Bankruptcy Institute. Florida recorded the highest number of cases, followed by Texas and California.

When the threshold expired in June, Subchapter V filings represented 12% of all 2024 cases, but they slowed in the latter half of the year.

“I had a lot of filings back in June because everybody was trying to get in under the higher threshold,” said Daniel A. Velasquez, a partner in Latham Luna Eden & Beaudine LLP in Orlando, who has handled more than 50 Subchapter V cases.

“A lot of folks that were sitting the sideline, deciding whether or not to get involved in Chapter 11, or maybe trying to work out an arrangement with their creditors, really ran out of time and had to make a decision,” he said.

A bill (S. 4150) introduced by Sen. Dick Durbin (D-Ill.) in the past session of Congress to extend the heightened limit for another two years was stalled by Sen. Rand Paul (R-Ky.).

Efforts to reinstate the higher debt limit were unsuccessful after House Republicans opted not to include renewal language in must-pass spending legislation.

Durbin said in a statement to Bloomberg Law that he plans to introduce a new bill that would reinstate and extend the limit and that he’s working with “bipartisan cosponsors to find a path forward.”

Advocates for Subchapter V have expressed a preference for a permanent, weighted cap. Durbin’s office said he is “open” to either making a higher cap permanent or considering another short-term extension.

‘Getting Creative’

With no extension, practitioners say businesses have employed maneuvers that effectively lower the company’s debt, helping it qualify for Subchapter V.

Eyal Berger, a partner at Akerman LLP, said that for some small companies owned by just one or two people, an owner might personally take out loans to pay down part of the company’s debt. That allows the company to become indebted to the owner rather than to external creditors. And because debts owed to insiders don’t count towards the threshold, this helps get below the Subchapter V debt limit.

“That’s one tactic some small businesses have undertaken to qualify, but it’s not without risk,” he said. “It’s complicated, and sometimes it might take too long for the owner principal to get that loan.”

Another tactic practitioners are increasingly using is converting certain larger debts into contingent obligations, Berger said. That may ultimately provide the debtholder with a larger recovery but would make some or all of the debt contingent on certain outcomes achieved by the small business after the start of the bankruptcy.

The contingent portion of the indebtedness isn’t counted toward the debt limit.

“Courts have deferred as to what is and is not contingent, what is and is not a liquidated debt. And that provides uncertainty because it’s a radical difference whether you qualify for this law or not, and some companies would be better off not filing Chapter 11 altogether if they can’t use the remedy of Subchapter V,” Berger said.

In June, Judge Lori V. Vaughan of the US Bankruptcy Court for the Middle District of Florida dismissed Paydirt Gold Co.’s objection to Burdock and Associates Inc.’s Subchapter V election. Paydirt argued that, because it had a claim against Burdock exceeding $14 million, Burdock shouldn’t be eligible.

But despite Paydirt’s assertion that the debt was liquidated, Vaughan ruled that Paydirt’s claim was unliquidated because it couldn’t be readily determined.

“If you could find a way to make them contingent or unliquidated, then you can be creative and keep them out of the calculation altogether,” Velasquez said. “Attorneys are getting creative to work around the threshold.”

Faster Reorganization

Subchapter V cases have roughly double the confirmed plan percentage and a 20% lower dismissal rate than non-Subchapter V small business cases, according to US Trustee data from fiscal 2020-23.

Additionally, Subchapter V cases have a shorter median time to confirmation at 6.6 months, compared to 10.4 months for non-Subchapter V cases.

“The failure to extend the higher cap has taken a viable restructuring option away from a substantial number of these businesses,” Alexandra Sickler, a bankruptcy law professor at the University of North Dakota, said.

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