As we approach the end of 2020, there is an important bankruptcy law set to expire early next year. The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) and the Small Business Reorganization Act of 2019 (SBRA) provide useful options for small business debtors (i.e. those whose debts are less than $7.5 million) considering Chapter 11 bankruptcy protection. To reap the benefits of these Acts, small business debtors may need to act quickly, as some of the key benefits of the CARES Act are scheduled to sunset on March 27, 2021.
For small businesses, the SBRA (a/k/a Chapter 5) offers an alternative to Chapter 11 reorganizations that can be expensive, time-consuming, and risky. The purpose of the SBRA, which became effective on February 19, 2020, is to streamline the bankruptcy reorganization process for small business debtors by helping them resolve their outstanding debts through a condensed and cost-effective Chapter 11 proceeding. The goal is to get through the process quickly and successfully emerge from bankruptcy on better financial footing.
The SBRA offers several benefits for small business debtors and eliminates some of the more costly elements of traditional Chapter 11 relief. For example, in a Subchapter V proceeding:
- The debtor does not need to file a disclosure statement unless the bankruptcy court orders otherwise. This saves time and money.
- The debtor is exempt from paying costly United States Trustee Quarterly Fees that are required in traditional Chapter 11 cases.
- A disinterested Standing Trustee is appointed in every case to monitor its progress and facilitate the confirmation of a plan.
- The absolute priority rule does not apply in a “cramdown” case, and existing equity holders are more likely to retain their equity interests. In other words, creditors do not need to receive payment in full on their claims before equity can be retained. This is a drastic change from a traditional Chapter 11 case.
- The debtor has the exclusive right to file a Chapter 11 plan, and acceptance of the plan by an impaired class of creditors is not required.
- A committee of unsecured creditors will not be appointed unless the bankruptcy court, for cause, orders otherwise.
- The SBRA also allows an individual debtor the ability to modify a mortgage on the debtor’s principal residence if that loan was not used to acquire the residence (i.e., the funds were used primarily in the business operations of the debtor).
As originally enacted, a debtor could take advantage of the SBRA only if it had less than $2.7 million in total debt, of which at least 50% has arisen from commercial or business activities, excluding debts owed to affiliates or insiders. Importantly, the CARES Act, which became effective March 27, 2020, revised the definition of “small business debtor” in section 1182 of Subchapter V of the Bankruptcy Code such that any business with less than $7.5 million in total eligible debt can benefit from the SBRA. This increase, however, is temporary and will terminate on March 27, 2021 unless Congress takes further action, which in our current political climate, is highly speculative.
Eligible small business debtors should promptly consider whether to take advantage of Subchapter V before the CARES Act modifications expire and the eligibility debt ceiling returns to $2.7 million. Unless the March 27, 2021 deadline is extended by Congress, we expect a sharp increase of Chapter 11 filings under Subchapter V at the end of 2020 through Q1 2021.