Changes to the Bankruptcy Code May Offer Relief for Small Businesses as the Financial Impact of COVID-19 Grows

April 12, 2020 Philip R. Rudd Gregory P. Gillis Bankruptcy

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 reorganization.

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.

Importa/wp-content/uploads/subchapter-v-webinar-052120.pdfntly, 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 Act are:

  • 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 reorganizations.
  • 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 reorganization.
  • 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.