Navigating the Small Business Reorganization Act as a Creditor
Authors:
Matthew R. Johnson, Esq.
Charles R. Powell III, Esq.
Keelan Forey, Esq.
July 7, 2020
On February 19, 2020, the Small Business Reorganization Act of 2019 (SBRA) went into effect and streamlined the Chapter 11 bankruptcy process for small businesses. The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) expanded the SBRA making it possible for more small business debtors to file under the new process. Creditors should be aware of the SBRA’s key provisions because the economic fallout from the COVID-19 pandemic and expansion of the SBRA under the CARES Act make it likely that now, more than ever, small business debtors will seek relief under the new, debtor-friendly law.
The SBRA adds a new subchapter to Chapter 11 of the Bankruptcy Code: subchapter V. A debtor that qualifies as a small business debtor may elect to proceed under subchapter V or proceed under the traditional Chapter 11 provisions that apply to small businesses. Thus, in instances where a qualifying debtor does not elect the new subchapter, the well-known, non-subchapter V provisions of Chapter 11 apply.
Before the CARES Act was signed into law on March 27, 2020, to qualify as a small business debtor under the SBRA, a debtor engaged in commercial or business activities could not have more than $2,725,625 in noncontingent, liquidated, secured or unsecured, debt (excluding debts owed to affiliates or insiders). The CARES Act substantially increased the eligibility debt threshold under the SBRA to $7,500,000 (effective for one year). As a result, many more debtors can and likely will file under the SBRA because of its debtor-friendly attributes including the ability to retain control of the business and to avoid the administrative expenses associated with traditional Chapter 11 bankruptcy filings.
Unlike a traditional Chapter 11 case where a trustee is only appointed where the debtor has behaved improperly, the SBRA provides for the appointment of a trustee in all subchapter V cases. Although the SBRA allows a debtor to remain in possession of assets and operate the business, if the court removes the debtor from possession, the trustee may operate the debtor’s business. The trustee must also appear at case-related proceedings. For example, the trustee must be heard at hearings concerning the value of property subject to a lien, confirming the reorganization plan, or modifying the plan after confirmation. Some of the trustee’s other duties under the SBRA include receiving and distributing plan payments; investigating the financial condition of the debtor; reporting fraud or misconduct to the bankruptcy court; and confirming the debtor’s compliance to the court-approved plan. Once a debtor has successfully made all necessary payments under the plan, the trustee’s services are terminated.
The SBRA is designed to streamline the plan confirmation process and reduce the debtor’s administrative expenses. To this end, many requirements of a traditional Chapter 11 plan confirmation are eliminated. First, only a debtor may file a reorganization plan. Creditors and other interested parties may not file a competing plan. The SBRA also does not require a debtor to file a disclosure statement with the bankruptcy court that explains key provisions of the debtor’s plan (whereas such statements are required in all non-subchapter V, Chapter 11 cases). Further, an impaired consenting class of non-insider creditors is not required for plan confirmation. This means that the debtor’s plan may be confirmed over the objection of unsecured creditors so long as the plan is “fair and equitable.” Since a subchapter V plan is deemed fair and equitable so long as all of the debtor’s projected disposable income (or property) is used to make plan payments for a three to five year period, this is a low bar.
For creditors, the changes to plan confirmation may seem jarring. Other procedural changes may mitigate these concerns. For example, a status conference with the court must be held no later than sixty days after the petition date (the date the bankruptcy petition is filed). Fourteen days prior to this status conference, the debtor must file a report with the court outlining the debtor’s efforts to confirm a plan. Further, the plan must incorporate some of the information that would have been required in a Chapter 11 disclosure statement including a brief history of the debtor’s business operations; a liquidation analysis; and projections about the debtor’s ability to make payments under the proposed plan.
Other provisions of the SBRA include elimination of the absolute priority rule applicable in all non-subchapter V, Chapter 11 cases. In other words, there is no requirement that equity holders of the debtor provide “new value” in order to retain their interests in the debtor without paying senior creditors in full. The SBRA also permits modification of certain residential mortgages. A debtor may modify the rights of a creditor whose claim is secured only by a mortgage on the debtor’s principal residence if the loan was not used to acquire the residence, but was instead used in connection with the debtor’s business.
Under the SBRA, a discharge is only granted after all plan payments are made. Thus, because a plan term is three to five years, a debtor must complete all plan payments prior to receiving the discharge. The discharge relieves the debtor of personal liability for debts provided under the plan with the exception of any debt on which the last payment is due after the plan term or is otherwise a non-dischargeable debt.
Finally, although not under the SBRA, other changes to the Bankruptcy Code include creditor-friendly modifications to preference laws. Trustees and debtors in possession have authority to file lawsuits to recover preferential transfers made ninety days before the petition date. Before, if the claim was under $13,650, it had to be brought in the district where the defendant resided. The new law raised the threshold to $25,000. In other words, if the claim is less than $25,000, the trustee or debtor in possession must file the lawsuit to recover in the federal district court where the defendant resides and not the district where the bankruptcy case is pending. In addition, the new law adds the requirement that any preference claims asserted by the trustee or debtor in possession must be based on reasonable due diligence and take into account a party’s known or reasonably known affirmative defenses. Both the $25,000 threshold and due diligence requirement will likely reduce the number of preference lawsuits that creditors often face during small business bankruptcy cases.
The SBRA brought major changes to small business owners and their creditors. Creditors with questions about how to successfully navigate a bankruptcy case under the SBRA should contact Charles Powell, Matthew Johnson or Keelan Forey, at (603) 669-1000 or cpowell@devinemillimet.com, mjohnson@devinemillimet.com, kforey@devinemillimet.com.
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