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April 20, 2023

Bankruptcy Basics for Retail Landlords

Issue 15—"Subchapter V Retail Bankruptcy Cases: Part 2"

In the last issue of Bankruptcy Basics, we provided a high-level overview of the similarities and differences between “traditional” Chapter 11 and Subchapter V retail bankruptcy cases, the latter being an efficient way for certain small businesses to utilize the US bankruptcy system. We’re now taking a closer look at the Subchapter V plan process so you know what’s available for smaller retail tenants that file those cases.

Retaining Equity and Paying Creditors in Subchapter V

In traditional Chapter 11 retail bankruptcy cases, the “absolute priority rule” requires creditors to be treated in accordance with their priorities. Secured creditors must be satisfied first (to the extent of the value of their collateral), followed, in sequence, by administrative claims (i.e., those arising during the case), priority unsecured claims, general unsecured claims (e.g., pre-bankruptcy and rejection damages claims), and, finally, equity interests. Generally speaking, each class of creditors must be satisfied in full before the next class can receive anything. Certain courts have adopted the “new value exception” to the absolute priority rule, which permits equity holders to retain their equity in exchange for contributing “new value” under the plan. For a small business owner that wants to retain its equity, however, the absolute priority rule may be problematic.

Subchapter V offers an alternative, as the absolute priority rule does not apply. This means that current equity owners may retain their ownership interests even without creditors being paid in full. To retain equity in that scenario, though, the plan needs to be consensual—with creditors accepting the plan—otherwise the retailer’s “projected disposable income” or property of equal or greater value must be paid over the life of the plan, which can range from three to five years, regardless of what return that may provide to creditors. To meet the “fair and equitable” test dictated by the Bankruptcy Code, the tenant must show a reasonable likelihood it will be able to make the projected plan payments and that appropriate remedies are available to protect claim holders in the event payments aren’t made. Since Subchapter V plan payments may be entirely dependent on the tenant’s performance, it is especially important to track the plan payments closely.

No Disclosure Statement Required for Subchapter V Plan

Retailers in traditional Chapter 11 bankruptcy cases must file a disclosure statement, which describes the assets, liabilities, history, capital structure, business affairs, and proposed plan of the tenant and enables creditors to make an informed decision about the proposed plan. Typically, the Bankruptcy Court will hold a hearing on the adequacy of the disclosure statement, which, if approved, permits the plan to be solicited.

Subchapter V dispenses with the disclosure statement requirement as an acknowledgment that a Subchapter V plan will be less complex, involves fewer parties, and moves quicker. Summary information about the tenant is disclosed in the proposed plan. Creditors and other parties in interest will then have an opportunity to assess the plan and determine whether it provides acceptable treatment.

Timing and Exclusivity When Filing a Subchapter V Plan

In traditional Chapter 11 retail bankruptcy cases, the tenant has an initial 120-day period, subject to extension, during which only it can file a plan.

Subchapter V bankruptcy does not allow other parties to file a plan. However, it requires the tenant to file a plan within 90 days of the bankruptcy filing as part of the streamlined process, with only one narrow exception. Like any other debtor, the tenant must comply with its post-bankruptcy lease obligations until a lease decision is made.

In the next issue of Bankruptcy Basics for Retail Landlords, we’ll switch gears to cover what landlords can do to enforce their rights during their retail tenants’ bankruptcy cases.

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