Amendment to Subchapter V of Chapter 11 Clarifies Affiliates' Eligibility for Streamlined Restructuring Process
As we reported here, the Bankruptcy Corrections Act revived the $7.5 million eligibility threshold for accessing the popular, streamlined restructuring process set out in Subchapter V of Chapter 11. A less prominent feature of the legislation, however, has important ramifications for parent companies, private equity investors, and other shareholders seeking to restructure struggling subsidiaries and other affiliates. As discussed below, the Bankruptcy Corrections Act clarifies that subsidiaries and affiliates may be eligible for Subchapter V, effectively abrogating caselaw holdings to the contrary. This clarification may be of particular interest to foreign public companies that are not registered with the US Securities and Exchange Commission (SEC), but have privately-held subsidiaries in the United States that they wish (and now may be able) to reorganize, sell, or liquidate through Subchapter V of Chapter 11.
Congress previously defined the “small business debtors” eligible for Subchapter V by excluding any entity that was an affiliate of an “issuer” of securities under the Securities Exchange Act of 1934. Because the Exchange Act defines an issuer as “any person who issues or proposes to issue any security” (which includes stock, bonds, and investment contracts), certain debtors were prevented from accessing Subchapter V simply because of their affiliation with a non-publicly traded corporation that had issued securities.
For example, in In re Phenomenon Marketing & Entertainment, LLC, the Bankruptcy Court for the Central District of California ruled that the debtor did not qualify for Subchapter V and revoked its Subchapter V election based on its affiliation with two non-publicly traded companies that were issuers under the Exchange Act. In re Phenomenon Mktg. & Ent., LLC, No. 2:22-BK-10132-ER, 2022 WL 1262001, at *5-6 (Bankr. C.D. Cal. Apr. 28, 2022), modified, No. 2:22-BK-10132-ER, 2022 WL 3042141 (Bankr. C.D. Cal. Aug. 1, 2022). The court specifically remarked that it was the responsibility of Congress to amend the law if affiliates of issuers were intended to be eligible.
Congress has now done so by reconciling the text of the law with its intended purpose. The Bankruptcy Corrections Act retroactively amends the definition of “debtor” to block Subchapter V elections for (a) “any debtor that is a corporation subject to the reporting requirements under section 13 or 15(d) of the Securities Exchange Act of 1934 (15 USC 78m, 78o(d))”; or (b) “any debtor that is an affiliate of [such] a corporation … .”[1] As a result of the passage of the Bankruptcy Corrections Act, the Phenomenon court granted the debtor’s motion to reinstate its Subchapter V election and access its streamlined restructuring process. In re Phenomenon Mktg. & Ent., LLC, No. 2:22-BK-10132-ER, 2022 WL 3042141, at *3 (Bankr. C.D. Cal. Aug. 1, 2022).
The enactment of the Bankruptcy Corrections Act, together with the phenomenon decision recognizing the import of that legislation, clears a path for an array of parent companies, private equity investors, and other shareholders to restructure distressed affiliates, subsidiaries, and portfolio companies using Subchapter V. The benefits of Subchapter V are significant, allowing equity-holders to maintain their interests in the debtor without new value requirements, while implementing a chapter 11 reorganization or sale process with relaxed confirmation requirements and (typically) without an estate-funded committee of creditors that is a hallmark of the standard chapter 11 process.
Notably, the Bankruptcy Corrections Act does not merely draw a distinction between privately versus publicly-held affiliates. Rather, Subchapter V now excludes affiliates of corporations that are subject to reporting requirements under the Exchange Act. Thus, there may be publicly-held non-US entities that are not registered with the SEC, but have Subchapter V-eligible subsidiaries or other affiliates doing business in the United States and having a domicile or property here. The revisions to Subchapter V create (or at least clarify) important restructuring optionality for these entities, particularly when combined with the $7.5 million debt threshold, which was temporarily extended and will sunset in two years. As equity-holders examine their portfolio assets, there is a window of opportunity to utilize Subchapter V to restructure underperforming assets quickly and efficiently.
