We also resolve small business bankruptcy matters under the Small Business Reorganization Act of 2019, a recent addition to Chapter 11 of the Bankruptcy Code.
Small Business Bankruptcy
Small business bankruptcy became easier and more affordable than every before, thanks to the Small Business Reorganization Act. The Small Business Reorganization Act was passed on Feb. 20, 2020. The Act added a new Subchapter V to Chapter 11 of the Bankruptcy Code, precisely to benefit small businesses faced with reorganizing.
In addition, Congress temporarily raised the qualifying aggregate debt limit under the Small Business Act as part of the CARES Act (Congress’s first response to COVID-19). This means more small businesses can take advantage of the benefits of the Act.
Until the Small Business Reorganization Act went into effect, small business bankruptcies had been too expensive and procedurally complicated for effective reorganizations. The new law makes small business bankruptcies quicker and less expensive, primarily by eliminating creditors’ committees (in most cases) and streamlining Plan confirmation options.
Subchapter V applies in any Chapter 11 case of a small business debtor that elects to have it apply. Highlights are as follows:
Qualifying Amount Temporarily Raised
Under the CARES Act, Congress temporarily raised the allowed aggregate debt of secured and unsecured claims under Chapter 11 Subchapter V to $7.5 million for all business reorganization cases filed within the 1-year period after March 27, 2020.
This allows businesses that don’t otherwise qualify under the statutory definition of “small business debtor” to file under Subchapter V for this one-year period. (Presumably, after March 27, 2021, only small business debtors with an aggregate debt limit of $2,725,625 will be able to file under Subchapter V).
Debtors Must Opt-In to Subchapter V
Small Business Debtors who wish to proceed under Subchapter V must opt in by checking the appropriate box on the Chapter 11 voluntary petition.
Time Deadlines are Shorter
Subchapter V requires that the court hold a status conference within 60 days of the petition date and that the debtor file its plan within 90 days of the petition date (as opposed to 120 days under a standard Chapter 11 filing).
A Trustee is Typically Appointed in place of Creditors’ Committees
Under Subchapter V, a trustee is ordinarily appointed as a replacement for creditors’ committees and generally acts as a fiduciary on behalf of all creditors. (Committees are possible, but unlikely.)
This significantly lowers administrative costs for the small business debtor (since the Chapter 11 debtor must typically pay expenses for the committees, including professional fees).
Further, the Subchapter V trustee does not operate the business of the small business debtor. This draws a favorable balance for the small business debtor, since the expense and complications of a creditors’ committee are avoided, while the small business debtor still operates the business.
Only the Small Business Debtor may File a Plan of Reorganization
Subchapter V gives greater control to the small business to manage its own reorganization process and reduces the cost of fighting over competing plans that creditors might otherwise submit.
The reorganization plan must:
- include a brief history of the business operations of the debtor;
- contain a liquidation analysis;
- include projections with respect to the ability of the debtor to make payments under the proposed plan; and
- provide for the submission of future earnings or other income of the debtor to the supervision and control of a trustee who will supervise restructuring.
The SBRA typically eliminates the requirement for the small business debtor to prepare a disclosure statement or solicit creditor votes for its proposed Plan. The Plan itself serves as the disclosure, and creditors thereafter have the right to object to the Plan as filed.
Plan Confirmation is Easier
As noted above, unless the court orders otherwise, there are no unsecured creditors’ committees. Even though creditors do not have a voting right per se, they still have a right to object to confirmation.
Essentially, a plan will be confirmed so long as it provides that all projected disposable income for three years (or up to five years if approved by the court) will be used to make plan payments.
Modification of Residential Liens
Under Subchapter V, a small business debtor is allowed to modify a mortgage secured by his or her residence if the underlying loan was not a “purchase money mortgage” (i.e., was not used to acquire the residence) and was primarily used in connection with the small business of the debtor. This provision offers no protection to lenders holding collateral mortgages on residences in connection with monies loaned to the debtor’s small business.
The Absolute Priority Rule Is Inapplicable
Standard Chapter 11 bankruptcies prevent equity owners retaining their interests in the debtor company without paying holders of non-consenting impaired creditor classes. However, this provision does not apply in cases under Chapter 11, Subchapter V (the SBRA).
This means business owners may be able to keep their equity ownership interests without having to pay senior creditors in full or provide new value through funding plan payments.
Thus, the SBRA makes small business reorganizations much more attractive to business owners looking to right-size their businesses’ balance sheets while maintaining their equity stakes.
The Term Fair and Equitable Has Been Modified re: Unsecured Claims
While a Subchapter V plan must treat secured creditors the same as in a standard Chapter 11 filing, unsecured claims are treated differently under the plan. Under a Subchapter V plan, the term “fair and equitable,” with respect to unsecured claims, is limited to income of the debtor.
This acknowledges that a small business debtor can pay no more than “disposable income” available to it. So, under section 1191(c), fair and equitable in a Subchapter V Small Business Case means, with respect to classes of unsecured claims:
- All of the projected disposable income of the debtor to be received in payout period (typically 3 years) will be applied to make payments under the Plan; or
- The value of property to be distributed under the Plan in the payout period is not less than the projected disposable income of the debtor.
Discharge Limitations are Modified
The court must grant the debtor a discharge after completion of all payments due within the first three years of the plan, or such longer period as the court may fix (not to exceed five years).
The discharge relieves the debtor of personal liability for all debts provided under the plan. All exceptions to discharge in Section 523(a) of the Bankruptcy Code apply to the small business debtor.
This is a departure from a standard Chapter 11 case which requires a more detailed evaluation by the court before granting discharge of an individual debtor.
Many Requirements Remain the Same
Notwithstanding the streamlined structure outlined above, while in bankruptcy, the debtor is still required to obtain the court’s approval of all non-ordinary course-of-business transactions and must comply with the U.S. trustee’s monthly reporting requirements, among other things.
But in all, the SBRA provides welcome relief to small businesses needing to restructure debts.