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The COVID-19 pandemic and resulting public health crisis will have devastating effects for countless small businesses, as “social distancing” – undoubtedly the phrase of the year 2020 – has caused dramatic reductions in demand in the airline, restaurant, hotel, oil and gas, and retail industries. The National Bankruptcy Conference, an advisory body comprising scholars, lawyers, and judges, told congressional leaders in a letter dated March 22, 2020, that the pandemic will inevitably cause many bankruptcies. In its letter, the NBC asks lawmakers to take drastic measures to help Americans and their businesses.
Among the NBC’s recommendations is raising the debt limit under which small businesses must fall to qualify for relief under the newly effective Small Business Reorganization Act, which took effect in February 2020. Even without higher limits, however, the Act may have come just in time for many affected by Coronavirus.
The overarching goal of U.S. bankruptcy law is to provide the honest-but-unfortunate debtor with a fresh start. Chapter 11 of the Bankruptcy Code is designed to allow businesses breathing room from creditors while they reorganize. However, many small businesses, due to their size and limited resources, have failed to find relief under chapter 11 and are the least likely to successfully reorganize under the bankruptcy code.
Enter the Small Business Organization Act of 2019 (“SBRA”). The SBRA adds a new subchapter V to chapter 11, with the aim to provide a fast and less expensive path for small business to successfully restructure, save jobs, and increase recoveries to creditors. The Act went into effect February 19, 2020.
To be eligible to file under subchapter V, the debtor’s secured and unsecured debts, subject to certain qualifications, must be less than $2,725,625, and the debtor cannot be a single-asset real estate business. The debtor must affirmatively elect subchapter V; otherwise, the bankruptcy case will be administered under the small business provisions of chapter 11 in effect since 2005.
The SBRA removes significant hurdles, procedural and otherwise, that have tripped up small businesses in chapter 11 in the past:
Speedy Action Required:
The SBRA requires a status conference within 60 days of the petition date and that the debtor file its plan of reorganization within 90 days of the petition date. Subchapter V debtors will be well advised to “do their homework” before they file, to ensure they meet these deadlines. Although the SBRA authorizes the bankruptcy court to extend the deadlines, delays will give creditors ammunition to attack the debtor’s right to enjoy the benefits of subchapter V.
Exclusive Right to File Plan
Only the debtor may file a plan in a subchapter V bankruptcy. A form plan will be available and should save much of the time and expense often incurred in preparing plans of reorganization, which easily run dozens or even hundreds of pages. Moreover, no disclosure statement is required, but some of the information normally presented here is required in the form plan.
A Trustee Will Be Appointed
A chapter 11 trustee is appointed to help facilitate the development of a consensual plan of reorganization. These trustees should be motivated to help the debtor succeed, as their compensation depends on whether the debtor emerges from bankruptcy with a confirmed plan. Thus, the trustee should be a powerful resource and ally for small business debtors as they negotiate with creditors.
No Quarterly U.S. Trustee Fees
The SBRA eliminates the quarterly fees chapter 11 debtors normally pay to the United States Trustee. In a normal chapter 11 bankruptcy, this fee is based on disbursements to creditors and ranges from $325 up to $250,000 per quarter.
Homestead Mortgage Modification Possible
Many debtors under subchapter V will likely be sole proprietors who personally back their business, often with loans against their homes. When their businesses struggle or fail, these entrepreneurs may end up in bankruptcies and, until now, they could not modify the rights of creditors holding a security interest in their homes. Under the new subchapter V, the plan may modify the rights of such creditors, as long as the loan secured by the mortgage was not used to acquire the home but was used for the debtor’s business.
Benefits of a Consensual Plan
In subchapter V, it is in the debtor’s best interest to propose a consensual plan with the support of all creditors. If all creditors whose claims are compromised accept the plan, claims are discharged upon confirmation of the plan, the appointed trustee will be terminated (and no longer cost the debtor money) upon substantial consummation of the plan, and the reorganized debtor will be bound to make payments under the plan. Conversely, if a nonconsensual plan is confirmed, the trustee will continue to serve (and be compensated) for the three- to five-year term of the plan. Debtors will make payments to the trustee, who make distributions under the plan.
Nonconsensual Plans Are Easier to Confirm
The ability of creditors to block the debtor’s proposed plan is significantly weakened in subchapter V. For example, the absolutely priority rule does not apply. Generally, under this rule, holders of equity in the debtor cannot retain their equity unless all creditors are paid in full. In the small business context, that means a business owner cannot retain his business without bringing new value to the company. Of course, if this were an option, the debtor might not be in bankruptcy in the first place. The SBRA does away with this rule; instead, the court can confirm the plan if it is fair and provides that all of the debtor’s disposable income goes toward plan payments for the benefit of creditors.
Although its impact will not be known for some time, the Small Business Reorganization Act removes numerous hurdles for small businesses looking to reorganize in a chapter 11 bankruptcy and aims to save these debtors time and money. Eligible small businesses and their attorneys should seriously consider electing to proceed under the new subchapter V. SBRA’s elimination of hurdles and reduction of expense may just be enough help some small business weather this storm.