Changes to the Bankruptcy Code
May Offer Relief for Small Businesses as the Financial Impact of COVID-19 Grows
In light of the COVID-19 virus, a newly enacted
section of the Bankruptcy Code, Subchapter V of Chapter 11 (“Small Business
Reorganization”) may suddenly become, depending on your perspective, a lifeline
for many small businesses or a curse for creditors.
The Small Business Reorganization Act of 2019 took
effect February 19, 2020. It creates a less expensive, more streamlined, and
more expedited way for “small businesses” to reorganize without many of the more
legally challenging, and more expensive, obstacles of a traditional Chapter 11
A “small business debtor” can be (a) an individual or an
entity, (b) engaged in commercial or business activities, (c) whose total
aggregate, non-contingent and liquidated, debts, both secured and unsecured,
are not more than $2,725,625, (d) not less than 50% of which arose from
commercial or business activities.
Importantly, the recent CARES Act increases this
debt threshold, for a period of one year, to $7.5 million. This increase
in the debt threshold will increase the number of businesses that can take
advantage of the Small Business Reorganization provisions.
Among the benefits of the Small Business Reorganization
The small business debtor remains in
possession of its assets and operates its business, as a
debtor-in-possession, during the pendency of the case (just as in a
traditional Chapter 11).
Only the small business debtor may file a plan of
reorganization, but it has to be filed within 90 days of the bankruptcy
filing. There is no ability of creditors to file a competing plan of
reorganization or liquidation.
The Bankruptcy Court may confirm a plan of
reorganization even if no class of creditors votes in favor of it and all
classes reject it.
The Court may confirm a plan over unsecured
creditors’ objections, and allow the small business debtor’s owners to
retain their ownership interests, even if the unsecured creditors are not
paid in full, so long as the small business debtor commits all of its
“projected disposable income” for a period of three to five years to
payments to creditors. There is no need for a small business debtor’s owners
to contribute “new value” in order to retain their ownership interests. This
change abolishes the prior “absolute priority rule,” which proved very
challenging for small businesses to overcome in traditional Chapter 11
A disclosure statement is not required, so long as
the plan of reorganization provides (i) a brief history of the debtor, (ii)
a liquidation analysis, and (iii) projections demonstrating the small
business debtor’s ability to make payments under the plan.
No creditors committee will be appointed, unless
otherwise ordered by the Court.
The small business debtor does not have to pay fees
to the United States Trustee’s Office.
These provisions will make it much easier and
less expensive for small business debtors to reorganize.
In exchange for these benefits, there are some
requirements imposed on the small business debtors that do not apply in a
traditional Chapter 11 case, such as:
The small business debtor’s bankruptcy
estate includes all property acquired by the debtor pre- and post-bankruptcy
filing until the bankruptcy case is closed, dismissed, or converted,
including earnings for services performed post-bankruptcy filing.
The small business debtor’s earnings must be
included in the plan of reorganization and used to pay debts.
Small business debtors must attach to their
bankruptcy petition their most recent balance sheet, statement of
operations, cash-flow statement, and federal income tax return, or declare
under penalty of perjury no such documents have been prepared.
A mandatory status conference is held not less
than 60 days after the small business debtor’s bankruptcy filing to discuss
the expenditures and an economical resolution of the case. Fourteen days
before the status conference, a report must be submitted detailing the small
business debtor’s efforts undertaken to achieve a consensual plan of
A standing trustee is appointed in the bankruptcy
case who supervises the case, helps the small business debtor formulate a
plan, reports fraud/misconduct, and monitors distributions to creditors
under the small business debtor’s plan of reorganization until substantial
consummation of the plan is achieved.
These primarily administrative burdens are
relatively insignificant compared to the significant benefits to small business
debtors afforded by the Small Business Reorganization Act.
It is likely that many small businesses will now meet
the debt limitations, and potential debtors and creditors should familiarize
themselves with the Act’s provisions as part of addressing creditor/debtor
issues arising from the COVID-19 pandemic.