The E-Z Pass Bankruptcy Solution for Franchise Companies

May 22, 2020Articles The Legal Intelligencer

The CARES Act has amended the Bankruptcy Code to provide an expedited and easier version of a business bankruptcy proceeding. We now have “Subchapter V” for small business and individual debtors. This process fulfills a sweet spot for small franchisors and franchisees. It anticipates a Chapter 11-type result, without the administrative headaches and expense, within 90 days of filing.

The purpose of this new section of the Bankruptcy Code is to allow business debtors and certain individuals with debts below $7.5 million to reorganize their obligations under in a much less expensive and streamlined manner.

In August 2019, Congress passed the Small Business Reorganization Act (SBRA), which became effective on Feb. 19. 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 no 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, SBRA created Subchapter V of the Bankruptcy Code, which provided small businesses (including sole proprietorships with noncontingent, liquidated debts) 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.

On March 27, the CARES Act amended SBRA to increase the debt limit for debtors filing under Subchapter 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. Here are some novel benefits of Subchapter V.

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 advisers 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 three- to five-year period (i.e., three years “or such longer period not to exceed five 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 three- to five-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 advisers 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 three- to five-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 three- to five-year period.
  • The debtor’s management will continue to operate the business, but may be removed for fraud, dishonesty, incompetence or gross mismanagement.

Plan Modifications

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 US Trustee Fees

Subchapter V exempts small business debtors from paying U.S. trustee fees, which are fees based on a company’s disbursements, further reducing the costs of administration.

Mortgage Modifications

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.

The new “disposable income” requirement may mandate a minimum payment to creditors higher than what is now man under Chapter 11. Some of the normal Chapter 11 requirements, such as monthly operating reports, special debtor in possession bank accounts and supervision by special trustees provide protection to creditors and parties in interest.

We anticipate an uptick in filings after the CARES Act funding and its forgiveness period expires. Because it provides a needed remedy for small business debtors and individuals concerned with the administrative burdens and expense of a Chapter 11 filing, we should be prepared to use Subchapter V to our advantage.

Franchisors should plan now to have a preset protocol for dealing with their franchisees who file Subchapter V because of the compressed deadlines. Franchisors can also suggest or aid struggling franchisees with Subchapter V to maintain their franchise during these uncharted times.

For franchisees and emerging franchisors, Subchapter V is a prescription to save their business from the economic consequences of the pandemic. There are also mortgage modifications provisions that will help guarantors of business debt to save their homes.

As these cases are filed, we will be compiling information and helpful advice in navigating the new bankruptcy world.

Reprinted with permission from the May 22, 2020 issue of The Legal Intelligencer. (c) 2020 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.