The Small Business Reorganization Act: Prescription For Small Business Financial Distress?

04/1/2020

Lawyers who advise clients in financial distress are searching for answers for their clients. Ultimately, cash flow and fundamentals are critical to business survival, but other tools can help. Is it coincidence that the Small Business Reorganization Act became effective as the nation unknowingly was headed to financial crisis?

The SBRA attempts to simplify and streamline chapter 11 bankruptcy for small businesses. Here are the major provisions and an evaluation of their utility as prescriptions in the current crisis.

New Chapter 11? The SBRA creates subchapter V of chapter 11 of the Bankruptcy Code. It was effective February 19, 2020. Rather than create a new form of chapter 11, the SBRA attempts to streamline chapter 11 for small businesses.

Eligibility. Subchapter V cases can be filed by debtors with no more than $2,725,625 of total (secured and unsecured) debt. (This amount was increased for one year to $7,500,000 for cases filed after signing of the “Coronavirus Aid, Relief and Economic Security Act” (CARES Act). This changes opened Subchapter V to virtually all small business, non-single asset real estate entities, where at least 50% of the debt arose from commercial or business activities.) Companies may use it, as may individuals for debts whose debts are mostly commercial or business debts. An eligible debtor must elect application of Subchapter V.

Why Subchapter V? Bankruptcy offers an automatic stay, use of cash collateral, tools for lending, picking and choosing contracts to keep or discard, sale of assets, and ultimately reorganization. Traditional problems with bankruptcy involve time and expense. SBRA attempts to help in these ways:

Plan exclusivity. In traditional chapter 11, the debtor has a limited, exclusive period to file a plan, which can be terminated. In Subchapter V, only the debtor can file a plan. Creditors may not hijack the bankruptcy.

No creditors committee. In most chapter 11 cases, a committee of creditors is appointed to watchdog the debtor in possession. The committee can employ counsel and professionals at the debtor’s expense. There generally is no creditors committee in Subchapter V.

Standing trustee. In chapter 13, a standing trustee handles payments to creditors and supervises the debtor and the plan. In Subchapter V, a standing trustee is appointed, and may continue to handle payments after plan confirmation. The idea is for the trustee help the debtor to confirmation.

Speed. The debtor must file a plan within 90 days of the voluntary bankruptcy filing. The disclosure requirements of chapter 11 are simplified and the disclosure statement hearing need not occur separately.

Loans on residences. Loans used primarily in connection with a small business, not used to acquire a residence of the debtor, may be modified. This is not true in chapter 11.

Flexible cramdown. Cramdown is plan confirmation over objection of one or more creditor classes. Subchapter V dispenses with the requirements that all impaired classes accept the plan, and that one such class must be calculated without including insiders. The absolute priority rule, requiring full creditor payment or termination of owners’ equity, does not apply. One price of cramdown under Subchapter V is that post-petition property acquisitions and earnings from services performed by the debtor are included in the debtor’s estate, increasing creditor recoveries. Another is that the cramdown plan can be modified after it is substantially consummated. A third is that the discharge does not occur until completion of all plan payments or a limited hardship discharge is granted.

SBRA and the optional Subchapter V case offers somewhat simpler, quicker reorganization choices with tradeoffs involving a trustee’s control and provisions directing increased creditor distributions. The CARES Act opens Subchapter V to most small businesses. It is not a simple, efficient option to use bankruptcy to cure financial distress, because, other than perhaps chapter 7, there is no such thing.

For more information, please contact Rob Charles at rcharles@lewisroca.com.