Some recent – and significant – new amendments to the US Bankruptcy Code, already of interest to small businesses before the COVID-19 pandemic, provide further relief to small businesses under Congress’ recent CARES legislation.

Background

In late 2019, Congress passed bipartisan legislation providing for a new subchapter of “small business” Chapter 11 bankruptcy cases. Those amendments went effective as of February 19, 2020.

The recently amended Bankruptcy Code’s Chapter 11 now has a new “Subchapter V” of (also known as the Small Business Reorganization Act). This subchapter is focused on “small businesses,” and has some unique features, including but not limited to:

Small Business

Under the new law, a business can choose to reorganize as a designated “small-business” case if:

• The debtor is engaged in commercial or business activities other than single-asset real estate;
• The total “noncontingent liquidated secured and unsecured debts” (owed to non-insiders and nonaffiliates) are less than the statutory threshold, which currently stands at $2,725,625 but is inflation-adjusted every three years – importantly, this debt limit was amended upward to $7,500,000 as of March 27, 2020, and the revised debt limits will remain in place for one year from the original (March 27) amendment date;
• At least 50 percent of the debtor’s liabilities arose from commercial or business activities; and
• The debtor is not a member of an affiliated group of debtors (e.g., a corporate group) whose debts together exceed the statutory threshold.

Individuals (i.e., sole proprietors) who meet these criteria can also make a “small business” election.

“Small Business” Reorganization:

Under the Code’s new provisions:

• Only the debtor can file a Chapter 11 plan (i.e., there are no “competing,” creditor-sponsored plans).
• Committees are rare (i.e., no committee is appointed unless the court “for cause orders otherwise.”)
• The plan’s disclosure requirements are reduced, and there is no separate disclosure statement hearing.
• The “absolute priority rule” applicable in other Chapter 11 cases is waived (i.e., the debtor need not pay general unsecured creditors in full in order to retain property under the plan).
• The debtor can modify a non-purchase money security interest in a residence, where the new value received in connection with the granting of the security interest was used in connection with a Debtor’s business.
• Confirmation of a plan can be obtained without the support of any class of claims, so long as the plan meets certain requirements.
• Certain status conference requirements are waived.

In passing this legislation, one of Congress’ primary objectives was to provide small businesses with more cost-effective access to Chapter 11 relief. The amendments further recognize the reality that continued operation of a smaller business is often critical to the livelihood of its owners.

Like any legislation balancing the rights of debtors and creditors, the Small Business Reorganization Act embodies a series of trade-offs. For example:

• The Chapter 11 plan may provide for the debtor’s payment to creditors of projected “disposable income” over 3 – 5 years, and/or the sale of property. At a minimum, however, the debtor must commit (i) 3 – 5 years’ projected disposable income, or (ii) property valued at equal to or greater than the value of 3 – 5 years’ projected disposable income.
• A plan must be filed within 90 days of the filing, “unless the court extends this period because of circumstances for which the debtor should not justly be held accountable.”

What such “circumstances” entail is unclear at this point and will be for the courts to work out.

• A separately appointed Chapter 11 Trustee is responsible for “facilitating the formation” of a plan.

Again, the precise nature of the Trustee’s “facilitation,” and what it will look like in each case, is unclear. But in subchapter V (as in life), “luck favors the prepared.” In other words, it is best practice to commence a Chapter 11 case with a working and well-developed reorganization plan.

• During the period between Chapter 11 plan proposal and confirmation, the debtor must make payments – which are held by the Trustee and distributed upon confirmation.
• If a creditor objects to the Chapter 11 plan, the discharge may be delayed until the completion of plan payments (which, as noted above, extend over 3 – 5 years).

Notably, these 2019 provisions serve as an alternative to the Code’s currently existing ‘small business’ Chapter 11 provisions.

Small businesses that may find themselves struggling or potentially at risk have a growing set of insolvency tools available to assist with a reorganization. To make the most effective use of these tools and evaluate the options that may be best suited for your circumstance, contact AlvaradoSmith at 714-852-6800 or contact Bankruptcy attorney Michael D. Good at mgood@alvaradosmith.com.

Michael D. Good has extensive experience with numerous complex reorganization, liquidation, and municipal insolvency proceedings under the United States Bankruptcy Code, as well as with out-of-court restructurings. He has represented a wide variety of corporate debtors, creditors’ committees, individual creditors, investors, and other parties across a broad range of industries.