CARES Act Enhances Viability of Chapter 11 Reorganizations for Small BusinessesApril 1, 2020
Enhancing economic relief options for small and medium-sized businesses, the recently passed Coronavirus Aid, Relief and Economic Security Act (CARES Act) amends the Small Business Reorganization Act (SBRA) to permit businesses with debts of less than $7.5 million (both secured and unsecured) to file a Chapter 11 case under sub-chapter V provided that 50% or more of those debts arise from business or commercial activities.
In August 2019, Congress passed the Small Business Reorganization Act (SBRA), which became effective on February 19, 2020 – just as the world outside of China began to learn of the devastating effects that the COVID-19 pandemic would wreak on the health of millions of people, and bring the world economies to a near standstill.
The primary objective of SBRA is to enable small businesses to successfully emerge from bankruptcy with a Court-approved plan of reorganization that must be filed not later than 90 days of a bankruptcy filing absent circumstances beyond a debtor’s control. The benefits offered to businesses that file Chapter 11 bankruptcies, including a debtor's ability to right-size its balance sheet, reduce liabilities, reject or restructure burdensome leases and executory contracts, renegotiate funded debt, and sell its assets, will now be available for smaller companies without having to incur the costs associated with larger Chapter 11 filings.
To implement those objectives, the SBRA created sub-chapter V of the Bankruptcy Code, which provided small businesses (companies including sole proprietorships with non-contingent, liquidated debts in an amount not greater than $2,725,625) with an opportunity to restructure their liabilities through a streamlined and cost effective Chapter 11 bankruptcy process. The SBRA also offered small business owners the opportunity to retain their ownership interest in the reorganized company. This is beneficial when compared to non-small business Chapter 11 cases, which generally result in the cancellation of equity (unless equity holders provide new value to fund a Chapter 11 plan of reorganization or the chapter 11 plan provides for payment in full to all unsecured creditors). The SBRA is also favorable when compared to Chapter 7, receivership proceedings or Assignments for the Benefit of Creditors, which are tools for liquidating a company.
Many bankruptcy professionals and professional associations including the American Bankruptcy Institute, however, had urged Congress to expand the debt cap from $2,725,625 to $10 million, noting that under the debt limits under the SBRA was simply too low to benefit most small and medium-sized businesses.
CARES Act Amendments to SBRA
In light of the economic impact of COVID-19 virus on U.S. businesses (both large and small), Congress passed the CARES Act on March 27, 2020, which amends the SBRA to increase the debt limit for debtors filing under sub-chapter V from $2,725,625 to $7.5 million. The debt limit will revert back to $2,725,625 after one year unless further extended by Congress. This change will substantially increase the number of businesses that are eligible for relief under the SBRA.
The SBRA, as amended by the CARES Act, permits businesses with debts of less than $7.5 million (both secured and unsecured) to file a Chapter 11 case under sub-chapter V provided that 50% or more of those debts arise from business or commercial activities. The SBRA seeks to provide a much more streamlined, cost-effective reorganization for eligible debtors and sub-chapter V contains certain provisions not otherwise available under Chapter 11. Some of the key features include:
“Small Business Debtor” Defined
Although sub-chapter V does not define a "small business debtor," the Bankruptcy Code defines a small business debtor as:
- ". . . a person [defined as an individual partnership, and corporation] engaged in commercial or business activities (including any affiliate of such person that is also a debtor . . . excluding a person whose primary activity is the business of owning or operating real property or activities incidental thereto) that has aggregate noncontingent liquidated secured and unsecured debts as of the date of the filing of the petition or the date of the order for relief in an amount [not more than $7,500,000] (excluding debts owed to 1 or more affiliates or insiders). . ." ; and
- "does not include any member of a group of affiliated debtors that has aggregate noncontingent liquidated secured and unsecured debts in an amount greater than [$7,500,000] (excluding debt owed to 1 or more affiliates or insiders)."
11 U.S.C. § 101(51D) (emphasis added).
- Although titled the “Small Business” Reorganization Act, the SBRA is also available to individuals who may not otherwise meet the requirements of a filing under Chapter 13 of the Bankruptcy Code.
Chapter 11 Debtor as Exclusive Plan Proponent
Unlike the current version of the Bankruptcy Code, which allows any party-in-interest to file a Chapter 11 plan once the debtor's "exclusivity period" has expired, the SBRA only authorizes the small business debtor to file a Chapter 11 plan of reorganization.
Streamlined Process to File and Confirm Chapter 11 Plan
The SBRA imposes the following truncated timeline to file a Chapter 11 plan of reorganization, significantly reducing administrative expenses in bankruptcy:
- Not later than 60 days after the bankruptcy filing, the Bankruptcy Court will hold a status conference "to further the expeditious and economical resolution of a case under this subchapter."
- Not later than 14 days before the status conference, the debtor's bankruptcy counsel is required to file a report that details the steps the company and its advisors have taken to attain a consensual plan of reorganization.
- Unless the debtor requests an extension related to circumstances outside of its control, the chapter 11 plan of reorganization must be filed not later than 90 days after the bankruptcy case is filed.
- Once the debtor completes all payments according to the plan, the reorganized debtor will receive a discharge from all of its pre-confirmation debts.
Chapter 11 Plan Requirements
The Chapter 11 plan of reorganization must provide the following:
- All projected disposable income of the debtor to be received within a 3-5-year period (i.e., 3 years "or such longer period not to exceed 5 years as the court may fix"), beginning on the date that the first payment is due under the plan, will be applied to make payments under the plan; or
- The value of property to be distributed under the 3-5-year plan, beginning on the date on which the first distribution is due, is not less than the projected disposable income of the debtor.
Continued Ownership and Management
The chapter 11 plan may permit the owners of the small business debtor to retain their stake in the reorganized debtor, as long as the plan does not discriminate unfairly, and is "fair and equitable," with respect to each class of claims and interests.
- A debtor may satisfy the fair and equitable requirement in one of the following ways:
- The debtor's advisors must identify the debtor's "disposable income," and the plan of reorganization must explain how the disposable income will be distributed to the standing trustee during a 3-5 year period in order to effectuate payments to creditors under the plan; or
- The plan may require the debtor to distribute some or all of its property to the standing trustee for the benefit of its creditors, provided that such property "is not less than the projected disposable income of the debtor" during the 3-5 year period.
- The debtor's management will continue to operate the business, but may be removed for fraud, dishonesty, incompetence, or gross mismanagement.
The Chapter 11 plan may be modified by the reorganized debtor upon a showing of changed circumstances, after notice and a hearing.
Appointment of a "Standing Trustee"
A "standing trustee" will be appointed and will remain throughout the payment period set forth in a confirmed Chapter 11 plan to account for all of the property received by the debtor, examine and object to the allowance of claims, review the debtor's financial condition and business operations, report fraud or misconduct, appear at hearings, prepare a final report and account, help facilitate a plan of reorganization, distribute property in accordance with a confirmed plan, and ensure a debtor's compliance with the confirmed plan. The Chapter 11 trustee's role is similar to that of a Chapter 13 trustee applicable to individual debtors.
No Official Committee of Unsecured Creditors
An official committee of unsecured creditors will not be appointed unless the Bankruptcy Court for cause orders otherwise. This reduces the administrative burden on the small business debtor of having to pay fees and expenses incurred by committee professionals.
Employment of Estate Professionals
Unlike the current version of the Bankruptcy Code, which disqualifies professional persons from being employed if they hold a pre-petition claim against the bankruptcy estate, the SBRA provides that professional persons are not disqualified from employment by a small business debtor if the professional is owed less than $10,000 prior to the date of the bankruptcy filing.
No United States Trustee Fees
Sub-chapter V exempts small business debtors from paying United States Trustee fees, which are fees based on a company’s disbursements, further reducing the costs of administration.
The small business debtor can seek to modify a mortgage against a principal residence, provided that the mortgage loan was not used primarily to acquire the residence. The SBRA will make it harder for creditors to take away a business owner’s residence pledged as collateral to support the business.
For any questions about SBRA bankruptcy filings, processes or this alert, please contact or any member of the firm’s national Financial Restructuring & Bankruptcy Practice Group.