Key Takeaways “A Discussion about Subchapter V Hurdles and PPP Loans with Two Subchapter V Trustees, a Financial Advisor, and a Banker”
The Business Advisor
Subchapter V Updates
Under the Consolidated Appropriations Act of 2021 (“CAA”), effective for a period of two years from date of enactment (12/27/20):
- Subchapter V debtors may apply for a PPP loan while in chapter 11 upon application to the court for approval under Section 364. Such post-petition loans are accorded administrative expense priority but can be paid in accordance with the terms of the PPP loan – over the 3- or 5-year term of the plan, as applicable. Caveat: This amendment is effective only if the SBA submits a written determination regarding eligibility to the Office of the US Trustee.
- Subchapter V Debtors now have a 4-month lease moratorium, as the 60-day period for deferral of post-petition rent under Section 365(d)(3) has been extended for an additional 60 days and the arrearages may be paid over the life of the plan.
Subchapter V Eligibility Issues
- Courts have determined that lease rejection damages are excluded from the $7.5 million debt ceiling, as they are deemed to be “contingent” as of the filing date.
- There is a split of authority as to whether PPP loans are “contingent and unliquidated” or liquidated for purposes of the $7.5 million debt ceiling calculation. A majority of courts however, have found such loans to be contingent as of the petition date because they are subject to forgiveness.
- For multiple affiliated debtors that file sequential petitions in bankruptcy, the $7.5 million debt ceiling calculation is not measured as of the filing date but is aggregated each time another petition is filed (even if the affiliate does not elect Subchapter V treatment). Once the debt limit is exceeded, all affiliated debtors are ineligible to be Subchapter V debtors.
- A debtor cannot be an affiliate of an “issuer” as defined in the 1934 Securities Act. Lack of control over the debtor is not relevant so long as the affiliate meets the definitions of “issuer” and “affiliate.”
- Reliability of disposable income projections in light of Covid-19 impacts Plan feasibility.
- Subchapter V disposable income requirement does not do away with the requirement that creditors must receive under the Plan as much as they would be entitled to receive in the event of a chapter 7 liquidation of the debtor. Additionally, value of potential insider avoidance actions may impact the debtor’s liquidation analysis.
- The timing of the debtor’s PPP loan forgiveness may impact Plan feasibility.
Subchapter V Tax Points
- Businesses in this space are generally not financially sophisticated; early intervention pre-filing to understand the finances and tax issues is critical.
- Plan early and plan often, and understand the consequences of a potential disposition of assets to the entity, owners, and lenders.
- Current depreciation rules have been liberalized, allowing for accelerated depreciation.
- The result is very low tax basis and a potential taxable gain on sale.
- Cancellation of debt (COD) should be reviewed for its impact on the entity and partner/members if a partnership or LLC.
- The sale of property with debt exceeding the fair market value may have COD, as well as a taxable gain.
- Timing of bad debt deductions needs to be considered by creditors.
Payroll Protection Program (PPP) Updates
Under the Economic Aid Act provisions of the CAA, an additional $284.45 billion has been appropriated for borrowers who apply by March 31, 2021.
- Authorized uses of PPP loan proceeds that qualify for forgiveness have been expanded to include operations expenditures, supplier costs, property damage costs from vandalism or looting, and Covid-19 related worker protection expenditures.
- Eligible borrowers have been expanded to include telephone cooperatives, housing cooperatives, tax-exempt news organizations, destination marketing organizations, and 501(c)(6) entities.
- To obtain forgiveness, borrowers must still apply at least 60 percent of loan proceeds towards “payroll costs” (as defined in the original CARES Act).
- A streamlined forgiveness process has been created for all loans of $150,000 or less.
- A select set of borrowers who received PPP loans under the CARES Act qualify for “Second Draw” loans, as follows:
- Borrowers must show a 25 percent or greater reduction in “gross receipts” in any quarter of 2020 as compared to 2019.
- Borrowers must employ no more than 300 employees.
- Borrowers must certify that their “First Draw” loans have been spent or will be spent on qualified expenses prior to the funding of the Second Draw loan.
- Loan size is based on 2.5 times monthly payroll costs (except for businesses with NAICS Code 72, which can apply for 3.5 times monthly payroll).
- Maximum loan size is $2 million.
- EIDL Advances are no longer deducted by SBA from forgiveness proceeds.
PPP Tax Updates
- PPP funded expenses are deductible for federal income tax purposes even if the loan is forgiven. However, states may not align with that treatment.
- Forgiven PPP loans are excluded from gross revenue for federal income tax purposes. However, states may not align with that treatment.
- Employee Retention Credit (ERC) has been enhanced, retroactive to March 13, 2020, and is available for PPP borrowers as long as the same payroll costs used for PPP loan forgiveness are not used for the ERC.
Thank you for your attendance.
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