November 7, 2019
COUNTDOWN TO THE SMALL BUSINESS REORGANIZATION ACT OF 2019: NEW LAW TAKING EFFECT IN FEBRUARY 2020 MAY MAKE CHAPTER 11 REORGANIZATION A VIABLE OPTION FOR SMALL BUSINESSES
In February, a new bankruptcy chapter directed at small businesses will take effect. The Small Business Reorganization Act of 2019 (SBRA) was signed into law on August 23 by President Trump and should help make bankruptcy a more attractive and realistic option for small businesses in financial distress. The SBRA will create a new subchapter of title 11 of the United States Code (Subchapter V) that will define a small business debtor as an entity with an aggregate of noncontingent liquidated secured and unsecured debt of not more than $2,725,625. Under current law, small business debtors are companies with less than $2.5 million of debt; however, until now, small business bankruptcies have been too expensive and procedurally complicated for effective reorganizations. The new law is designed to address these issues and make small business bankruptcies quicker and less expensive.
So how does the new law make chapter 11 less expensive and more attractive to small businesses? First, the SBRA shortens the time to file a plan to 90 days (as opposed to the 120 days provided for under section 1121 of the Bankruptcy Code). Additionally, the new law eliminates the requirements of filing a disclosure statement and solicitation of votes of creditors. The SBRA truncates this two-step process by requiring only that the small business debtor propose and confirm a plan. For example, under the new law, a small business debtor will be required to file a plan within 90 days (subject to an extension based on circumstances for which the debtor should not “justly be accountable” or, in other words, based on circumstances beyond the debtor’s control).
The SBRA also contemplates that a small business debtor’s plan be streamlined but must (i) include a brief history of the business operations of the debtor; (ii) contain a liquidation analysis; (iii) include projections with respect to the ability of the debtor to make payments under the proposed plan; and (iv) provide for the submission of all or such portion of future earnings or other future income of the debtor to the supervision and control of a trustee who will be tasked with ensuring that the reorganization stays on track. Further, the SBRA provides that the rights of secured creditors may be modified if the claim is secured only by a security interest in real property that is the principal residence of the debtor and new value received in connection with such security interest was not used primarily to acquire the real property. This provision is almost identical to the anti-modification provisions applicable to chapter 13 debtors and would protect purchase money mortgage lenders from modification of their rights in a small business bankruptcy but offers no protection to lenders holding collateral mortgages in connection with monies loaned to the debtor’s small business.
To confirm a small business debtor plan, the plan must meet all the requirements of section 1129 of the Bankruptcy Code (the traditional requirements for all chapter 11 debtors); however, small business debtors will be afforded greater flexibility to force the terms of a plan upon dissenting secured creditors (other than purchase money mortgage creditors). The SBRA provides for funding of any plan to come from all disposable income of the debtor within the plan period, which can range from 3 to 5 years. Disposable income is all income of the debtor that is not reasonably necessary for the payment of expenditures necessary for the continuation, preservation, or operation of the business of the debtor. The new law eliminates the absolute priority rule/new value corollary from prior law so business owners may be able to keep their ownership interests without having to pay senior creditors in full or provide new value through funding plan payments. Currently, a small business debtor generally would need to either put new money into the plan or pay creditors in full to confirm a plan over the objection of creditors. The new law will make small business reorganizations much more attractive to business owners looking to right-size their businesses’ balance sheets while maintaining their equity stakes. Other aspects of the SBRA include an expanded definition of property of the estate to include post-petition income of the debtor (similar to individual chapter 11 debtor cases), the absence of a formal appointment of a creditors’ committee, and appointment of a chapter V trustee.
Traditionally, chapter 11 plans are viewed as contracts of repayment with creditors, with creditor assent to the plan obtained by satisfaction of the voting requirements contained in the Bankruptcy Code. Under the new law, however, there are no solicitation and voting requirements for confirmation, and, similar to a chapter 13 individual debtor plan, creditors do not have a voting right per se but nonetheless have a right to object to confirmation. Unsecured creditors can seek to block confirmation if the plan doesn’t provide for all disposable income to be used for repayment during the plan term. The SBRA recognizes that chapter 11 has proved unworkable for small business debtors given their size and limited financial resources and should provide for a viable path to a fresh start for small businesses in financial distress. Providing small business debtors with a reorganization remedy that is achievable under the Bankruptcy Code is necessary and long overdue.