Author: W. Dane Carey
The Small Business Reorganization Act of 2019 will go into effect in February 2020. The Act creates a new Subchapter V under Chapter 11 of the US Bankruptcy Code and is intended to streamline the process for small business reorganizations and make restructuring faster and less expensive.
The Act provides a better path for small businesses to restructure debt, reduce liquidations, save jobs, and increase recoveries to creditors while recognizing the value provided by the entrepreneur. The new rules apply to business debtors with secured and unsecured debts less than $2,725,625, subject to certain qualifications.
Here are some of the highlights of the Act:
- A trustee will oversee bankruptcies. Upon filing, a standing trustee will be appointed to serve as the trustee to oversee the small business’s bankruptcy estate. The role of the trustee will be to review the financial conditions and operations of the business, report any fraud or misconduct, facilitate the small business debtor’s reorganization, and monitor the distributions in accordance with the plan of reorganization.
- Faster and simpler process. There is no longer a creditors’ committee to weigh in on the reorganization plan or the debt disclosure document. Only the debtor will be able to propose a plan of reorganization. The plan must provide the history of the business, financial projections, and a liquidation analysis. But small business debtors will not have to obtain approval of a separate disclosure statement or solicit votes to confirm a plan. The Court can confirm a debtor’s plan without the support of any class of claims, as long as the plan does not discriminate unfairly and is deemed to be fair and equitable with respect to each class of claim.
- Easier for debtors to keep their businesses. The Act removes the requirement that equity holders of the small business put new money into the business in order to retain their equity interest without paying creditors in full. For plan confirmation, the Act instead only requires that the plan does not discriminate unfairly and is fair and equitable. A fair and equitable reorganization plan should be confirmed as long as it provides one of two options for how the company will repay its creditors: (1) by all of the debtor’s projected disposable income being applied to payments; or (2) through distribution of some or all of the company’s property, as long as the value is not less than the projected disposable income of the debtor.
- Longer creditor payment streams. The Act removes the requirement that the debtor pay administrative expense claims (including those claims incurred by the debtor for post-petition goods and services) on the effective date of the plan. Unlike a typical Chapter 11, a small business debtor may now stretch payment of administrative expense claims out over the term of the plan.
- The new value rule is eliminated. Those who hold equity in a small business in Chapter 11 bankruptcy no longer need to establish a “new value” for their share to retain their ownership interest in the business.
- The debtor may be able to modify their residential mortgage. The reorganization plan can modify the rights of a creditor secured by a security interest in the debtor’s principal residence if the loan secured by the residence was used in connection with the debtor’s business but not used to acquire the residence.
- Discharge of debts. Subject to certain exceptions, the bankruptcy court must grant the debtor a discharge after completion of all payments due within the first three years of the plan, or such longer period as the court may fix (not to exceed five years).
There are some questions that remain unanswered under the Act. For example, it is not clear what interest rate will apply to secured loans under confirmed plans—whether the contract rate or some presumptive rate established by local rule, as is the case with Chapter 13 cases in many jurisdictions. It is also not clear how courts will apply prior Chapter 12 and Chapter 13 precedents to new Subchapter V cases.
The Act could also have an impact on many lenders. Lenders should be aware of the ramifications of the SBRA, as the new law will likely result in increased bankruptcy filings by smaller, family-run businesses that had previously been unable pursue reorganization under Chapters 11 and 13 of the Bankruptcy Code. Debtors will be able to more easily obtain confirmation of plans over creditor dissent and to cram lenders down on the value of residential collateral used for business loans.
Nevertheless, the new rules should generally result in a faster process that overall may reduce costs for creditors and provide greater chances of repayment due to the involvement of a trustee. And financially troubled small businesses will certainly have a better opportunity to avoid liquidation and achieve reorganization under the Act.