What expanded access to small business bankruptcy means for credit and financial executives

More of your business customers could soon qualify for a faster, less expensive version of Chapter 11. If you extend trade credit, that affects how you evaluate accounts, monitor exposure, and respond when a customer gets into trouble.

Congress has passed H.R. 7730, the Bankruptcy Threshold Adjustment Act, and sent it to the President for signature. The bill permanently restores the $7.5 million debt limit for Subchapter V, which expired in June 2024, and expands eligibility for Chapter 13. For suppliers and other commercial creditors, the change is both an opportunity to keep viable customers in business and a good reason to revisit payment protections before they are needed.

What the bill changes

Subchapter V. The eligibility ceiling rises from $3,424,000 to $7.5 million. The calculation generally counts noncontingent, liquidated secured and unsecured debts, but not debts owed to affiliates or insiders. At least half of the qualifying debt must arise from the debtor’s commercial or business activities. Three groups remain ineligible:

• public reporting companies and their affiliates;
• members of an affiliated group whose combined qualifying debt exceeds the ceiling;
• businesses whose primary activity is owning single asset real estate.

Chapter 13. One combined limit replaces the separate caps on secured and unsecured debt. Otherwise eligible individuals with regular income will qualify if their noncontingent, liquidated debts total less than $2.75 million.

Timing. The new limits apply only to cases filed on or after the date the bill becomes law. Until then, the current limits govern.

What creditors should understand about Subchapter V

Subchapter V was designed to make reorganization affordable for smaller businesses, and that has a real upside for suppliers. A less expensive case preserves value that would otherwise go to professional fees or be lost in liquidation. A viable customer that survives may keep buying from you. When you weigh your options, consider that possibility alongside the expected recovery on the existing balance.

The same features that keep costs down, however, also limit what creditors can do.

The debtor controls the plan. Only the debtor can propose a plan, and creditors cannot file a competing one. Your influence comes from scrutinizing the debtor’s proposal and the financial projections behind it.

The case moves quickly. The debtor generally must file its plan within 90 days of the filing, and the court holds a status conference within 60 days. A separate disclosure statement usually is not required, so a plan can go to a confirmation hearing soon after it is filed. Creditors who wait to see how the case develops may find a plan on file before they have looked at the debtor’s numbers. Get involved at the start of the case.

The plan can be confirmed over creditor objection. The court can confirm a plan even if no impaired class of creditors accepts it, as long as the statutory requirements are met. This is called a nonconsensual plan, and several of the issues discussed below depend on it.

Owners can keep their equity without paying unsecured creditors in full. The absolute priority rule does not apply to a nonconsensual Subchapter V plan. Instead, the plan generally must commit three to five years of projected disposable income, or property of equivalent value, and it must be feasible.

There usually is no official creditors’ committee. Do not assume that a committee and its professionals will investigate the business or negotiate on your behalf. Individual participation matters.

A trustee is appointed, but not to represent you. The debtor keeps running the business. The Subchapter V trustee is a neutral fiduciary whose main job is to help the debtor and its creditors reach a consensual plan. In practice, the role often looks more like a mediator than a watchdog. Unless the court orders otherwise, the trustee does not investigate the debtor’s finances or conduct and does not advocate for unsecured creditors the way an official committee would. Raise your concerns about the debtor’s disclosures, projections, or conduct with the trustee, but don’t count on the trustee to pursue them for you.

Taken together, these features call for a realistic view of your negotiating strength. Your position may depend on:

• your collateral and lien rights;
• any third-party payment obligations;
• how much the customer needs your continued supply;
• whether its plan actually meets the legal requirements.

Four issues that are easy to overlook

1. Administrative priority does not mean prompt payment

Suppliers may hold an administrative expense claim under Section 503(b)(9) for goods the debtor received within 20 days before the filing, if the goods were sold in the ordinary course of the debtor’s business. The date the debtor received the goods is what counts. An invoice date or shipment date may not establish eligibility.

In a traditional Chapter 11 case, administrative claims generally must be paid in full on the plan’s effective date unless the creditor agrees otherwise. Subchapter V is different. Under Section 1191(e), a nonconsensual plan can pay administrative claims through the plan, which can mean payments spread over several years. That can include obligations the debtor incurred after filing, such as invoices for goods you continued to ship.

Do not treat administrative priority as a promise of immediate payment. Before you keep shipping:

• understand how you will be paid;
• watch the postpetition balance;
• consider whether cash terms or other protections make sense.

2. Whether a fraud claim survives may depend on the court

Section 523(a) lists debts that are excepted from discharge. The list includes debts for credit obtained by fraud or through a materially false written financial statement. Courts disagree about whether those exceptions apply when a corporate debtor receives a discharge under a nonconsensual Subchapter V plan.

The Fourth, Fifth, and Eleventh Circuits have held that they can apply. The Bankruptcy Appellate Panel for the Ninth Circuit hears many bankruptcy appeals from California, Nevada, and the other western states. It reached the opposite conclusion in In re Off-Spec Solutions (2023). The BAP is a separate court from the Ninth Circuit Court of Appeals, and its decisions do not carry the same weight.

An allegation that a corporate customer obtained credit by fraud does not automatically preserve the debt. Have counsel evaluate:

• the law that controls where the case is pending;
• the facts supporting the claim;
• any deadline for filing a nondischargeability complaint.

3. Preference exposure remains

A Subchapter V filing does not eliminate the risk of a demand to return payments you received before the bankruptcy. Your best defenses are typically ordinary course of business and subsequent new value. Both depend on records:

• the parties’ payment history;
• invoice terms;
• collection communications;
• shipments made after each payment.

Those records are far easier to assemble while the account is active than after a demand letter arrives. A payment pattern that looks unusual in isolation may make sense when viewed against the parties’ actual course of dealing.

4. Personal guaranties still require real underwriting

Expanded Chapter 13 eligibility could give more business owners with guaranty exposure access to that process. Whether a particular guaranty counts toward the debt limit can depend on whether the obligation is contingent or unliquidated when the guarantor files.

A guaranty is still a valuable protection, but the signature is only the beginning. Review the guarantor’s financial condition, know what assets may support collection, and update that information as the relationship grows.

The financial statement can also help in another way. A debt obtained through a materially false written financial statement made with intent to deceive may be nondischargeable, even in Chapter 13. The creditor must prove the required elements, including that it reasonably relied on the statement. A financial statement that sits in the file unread provides little of that protection.

What I would tell credit teams to do now

While the account is current:

• Review your credit application and terms of sale. Your documents should establish clear payment obligations and govern future transactions.
• Obtain appropriate personal guaranties and financial information. Document the credit decision and revisit it as exposure changes.
• Where spousal signatures or community property are involved, have counsel address enforceability and Equal Credit Opportunity Act requirements.
• Consider whether a properly perfected security interest is commercially practical. Purchase-money priority in inventory depends on strict timing and notice requirements.
• Watch payment trends, requests for extended terms, and changes in the customer’s financing. Take a hard look at repeated exceptions to your credit policy before they become the new normal.

When a customer files:

• Review the schedules and confirm how your claim is listed. Calendar the claims deadline and address any omissions, disputed amounts, or misclassifications.
• Evaluate your Section 503(b)(9) and reclamation rights promptly.
• Read the early motions that may affect your position, including requests to use cash collateral or obtain financing.
• Participate in the meeting of creditors and contact the Subchapter V trustee when appropriate.
• Test the plan’s projections against the business’s actual performance.
• Decide whether to keep selling separately from how to recover the existing balance.

That last point is easy to lose sight of. The hope of recovering an old balance can cloud judgment about new exposure.

For construction suppliers and subcontractors

Construction creditors often have payment protections beyond the customer’s promise to pay. Preliminary notices, mechanics liens, stop payment notices, and payment bonds should be part of ordinary credit administration.

A customer’s bankruptcy does not necessarily eliminate those rights, but it can change how and when you must preserve or enforce them. Do not assume the filing suspends your deadlines.

Sections 362(b)(3) and 546(b) generally allow a creditor to perfect or maintain qualifying lien rights despite the automatic stay. In some circumstances, state law would require a lawsuit to maintain the lien, and a notice filed in the bankruptcy case may take the place of that lawsuit. State law and bankruptcy procedure have to be considered together.

Payment bond claims call for a separate analysis. Because the surety is not the debtor, the automatic stay generally does not prevent a claim against it. Identify every potential source of recovery early, rather than treating the customer’s bankruptcy as the end of the collection analysis.

The bottom line

I support making an affordable reorganization process available to more viable small businesses. Preserving a customer’s operations can benefit its employees, its suppliers, and its other creditors.

But a workable reorganization process cannot make up for payment protections a supplier never put in place. Your credit applications, guaranties, security interests, and lien rights need attention while the account is current. By the time the bankruptcy notice arrives, many of your most important decisions have already been made.

Read the full text of H.R. 7730, the Bankruptcy Threshold Adjustment Act.

#CreditManagement #Bankruptcy #SubchapterV #ConstructionLaw #TradeCredit

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For more information contact:

Christopher Ng

cng@gibbsgiden.com

310-374-3367

Christopher Ng is the managing partner of Gibbs Giden. Chris primarily represents companies in a wide range of business, commercial and construction transactions and disputes.

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