What APR Compliance Actually Requires Under Subchapter V
The absolute priority rule Subchapter V is a statutory provision that allows small business debtors to retain equity without paying dissenting creditors in full, provided the plan meets specific financial requirements under 11 U.S.C. § 1191(b). This shifts the focus from equity retention battles to concrete financial metrics that prove compliance.
APR compliance under Subchapter V does not mean paying unsecured creditors in full. Instead, it requires demonstrating that the plan meets three financial thresholds: the best interest test, projected disposable income commitment, and plan feasibility. Each of these rests on specific numbers that must survive scrutiny from the trustee, the U.S. Trustee (UST), and any dissenting creditor.
The best interest test under 11 U.S.C. § 1191(a) requires that each creditor receives at least as much under the plan as they would in a Chapter 7 liquidation.1 This means the debtor must produce a liquidation analysis showing asset values, exemption amounts, and projected distributions. For a hypothetical Sub V debtor with $500,000 in unencumbered equipment and $200,000 in accounts receivable, the liquidation analysis might show a 15% distribution to unsecured creditors, meaning the plan must offer at least that percentage.
Projected disposable income must cover plan payments for three to five years. The Subchapter V trustee typically reviews the debtor's Schedule I and J, tax returns, and profit-and-loss statements to verify that the projected income is realistic. If a debtor projects $50,000 in annual disposable income but historical financials show only $30,000, the trustee will flag the discrepancy as an APR compliance issue.
The Absolute Priority Rule in Subchapter V Cases
Subchapter V eliminated the traditional requirement that senior creditors be paid in full before equity holders could retain any interest, but only if the plan meets the statutory confirmation requirements under 11 U.S.C. § 1191(b). This means the debtor can retain ownership even if a dissenting class of creditors is not paid in full.
The key financial number here is the projected disposable income calculation. The debtor must commit all projected disposable income to the plan for at least three years, or five years if the court approves a longer period. For a business with $1.2 million in annual revenue and $150,000 in net income, the court would expect to see at least $150,000 per year flowing into plan payments, adjusted for reasonable operating expenses.
Consider a retailer with $2 million in annual revenue and $180,000 in owner compensation. If the owner proposes retaining a substantial portion of that salary while paying creditors only $60,000 annually, the trustee may object that the owner is retaining excessive compensation at the expense of creditors. The debtor must justify each expense line item to demonstrate that the projected disposable income is accurate.
How Plan Feasibility Demonstrates APR Compliance
Plan feasibility under 11 U.S.C. § 1129(a)(11) requires the debtor to demonstrate that confirmation is not likely to be followed by liquidation or the need for further financial reorganization.2 The absolute priority rule Subchapter V compliance hinges on these projections—the court expects concrete numbers showing the debtor can make plan payments while maintaining operations.
The feasibility analysis typically includes a three-year profit-and-loss projection, a balance sheet forecast, and a cash flow statement. For a manufacturer with $3 million in annual revenue and $75,000 in monthly plan payments, the projections must show that the business generates sufficient cash flow to cover both operating expenses and plan payments. If the projections show negative cash flow in any month, the trustee will likely object.
A common error is projecting revenue growth without supporting evidence. If a debtor assumes 10% annual growth but the industry average is 2%, the court will discount the projections. Attorneys should anchor revenue projections to historical performance and industry benchmarks, not optimistic assumptions.
Valuation Methods That Satisfy the Best Interests Test
The best interest test requires comparing the plan distribution to what creditors would receive in a Chapter 7 liquidation. This hinges on asset valuation, and the valuation method matters. Courts typically accept three approaches: market approach, income approach, and asset-based approach.
For a service business with minimal hard assets, the income approach often produces the most defensible valuation. A hypothetical consulting firm with $400,000 in annual EBITDA might be valued at $1.2 million using a 3x multiple, meaning unsecured creditors would receive a higher percentage in a going-concern sale than in a piecemeal liquidation. The liquidation analysis must reflect this.
| Valuation Method | Best For | Typical Application |
|---|---|---|
| Market approach | Businesses with comparable sales data | Use revenue multiples from industry transactions |
| Income approach | Service businesses with stable cash flow | Discount projected cash flows at 15-25% rate |
| Asset-based approach | Asset-heavy businesses | Appraise equipment, inventory, and receivables at forced-sale values |
The liquidation analysis must also account for administrative expenses, trustee fees, and exemption amounts. For a business with $800,000 in equipment appraised at $400,000 in a forced sale, the net liquidation value after costs might be $280,000, establishing the baseline for the best interest test.
Projected Disposable Income as an APR Defense
Projected disposable income is the debtor's income minus reasonably necessary operating expenses and payments for domestic support obligations. This number directly determines how much creditors receive and whether the plan satisfies the APR requirements. The Subchapter V trustee scrutinizes every expense line item.
For a restaurant with $1.5 million in annual revenue, the trustee may question whether the owner's compensation is reasonable. If comparable restaurants pay owners $80,000 but the debtor proposes $50,000, the trustee might argue that the debtor should increase plan payments to bridge the gap. Attorneys should prepare market compensation data to defend owner salary levels.
| Expense Category | Typical Objection | Supporting Documentation |
|---|---|---|
| Owner compensation | Excessive relative to industry | Industry salary surveys, comparable business data |
| Vehicle expenses | Personal use included | Mileage logs, business-use percentage |
| Entertainment | Non-business expenses | Receipts with business purpose noted |
| Professional fees | Duplicative or unnecessary | Engagement letters, fee breakdowns |
The debtor must also account for seasonal fluctuations. A landscaping business earning $200,000 in Q2 but losing $20,000 in Q4 cannot project $180,000 in annual disposable income without adjusting for the seasonal cash flow gap.
The Role of 13-Week Cash Flow in Plan Confirmation
The 13-week cash flow forecast is the most granular tool for demonstrating plan feasibility and APR compliance. It shows the court exactly how the debtor will fund plan payments while maintaining operations over the critical first quarter after confirmation. The UST and trustee rely on this document to verify that the debtor's projections are realistic.
A typical 13-week forecast includes weekly revenue, operating expenses, payroll, tax payments, and plan payments. For a wholesaler with $500,000 in monthly revenue and $25,000 in monthly plan payments, the forecast must show that the business maintains a minimum cash balance of $50,000 throughout the period. If the forecast shows the cash balance dropping below zero in week 8, the plan is not feasible.
The forecast should also account for known timing issues. If the debtor's largest customer pays on net-60 terms but the debtor must pay suppliers on net-30, the cash flow gap must be addressed in the plan. Attorneys should include a sensitivity analysis showing how the plan performs under different revenue scenarios.
MOR Data Points That Support APR Arguments
Monthly Operating Reports (MORs) filed during the Subchapter V case provide the historical financial data that supports APR compliance arguments. When the absolute priority rule Subchapter V is at issue, MOR data becomes the factual foundation that either validates or undermines the debtor's projections. The UST reviews MORs to verify that the debtor's projected income and expenses match actual performance.3 Discrepancies between MOR data and plan projections weaken the debtor's compliance position.
Key MOR data points include gross revenue, net income, operating expenses, tax payments, and professional fees. If a debtor projected $100,000 in monthly revenue but MORs show $80,000, the trustee will question the plan projections. Attorneys should use MOR data to anchor projections to actual performance, not aspirational targets.
The MOR also tracks post-petition tax obligations. A debtor that falls behind on payroll taxes during the case will struggle to demonstrate that it can fund plan payments while staying current on tax obligations. The UST will flag any tax delinquency as a feasibility concern.
What the UST Looks for in Sub V Plan Financials
The UST evaluates Subchapter V plan financials against specific benchmarks: accuracy of projected disposable income, reasonableness of expense assumptions, and consistency with historical performance. The UST also reviews the debtor's compliance with post-petition reporting requirements.
A common UST objection targets owner compensation that exceeds pre-petition levels without justification. Suppose the debtor paid itself $60,000 pre-petition but proposes $90,000 post-confirmation—the UST will demand an explanation. The debtor must show that the increase is necessary for business operations, not a means of reducing plan payments.
The UST also scrutinizes professional fee estimates. If the debtor projects $20,000 in post-confirmation legal fees but the case has already incurred $80,000 in pre-confirmation fees, the UST will question the estimate. Attorneys should provide detailed fee projections based on the anticipated scope of post-confirmation work.
Your Next Step
Review your current Subchapter V plan financials against the metrics outlined above. Identify any gaps in your liquidation analysis, projected disposable income calculations, or cash flow forecasts. If you need a second opinion on whether your numbers will survive a UST objection or dissenting creditor challenge, send the plan summary to [email protected] for a confidential review.