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Small Business Reorganization Act: What It Means for Businesses in Current Economy

Widerman Malek
Nov 2nd, 2020
Bankruptcy, Business Law, News

Timing is everything as the saying goes. It is unlikely Congress had the foresight of COVID-19 to enact legislation on August 23, 2019, with an effective date of February 19, 2020, that would make it easier for a “small business” to reorganize under Chapter 11 of the Bankruptcy Code.1 The goal of the Small Business Reorganization Act (SBRA) is to streamline the process for a small business debtor to reorganize under Chapter 11.

SBRA Provisions

To achieve that goal, the SBRA contains a number of provisions that are favorable to the debtor, including:

  1. Debtor’s management will continue to operate the business absent fraud, dishonesty, incompetence or gross mismanagement.
  2. The trustee (generally a practicing attorney or CPA) is appointed in each case with the responsibility of facilitating a consensual plan.
  3. There is a mandatory status conference with the judge, U.S. Trustee, Trustee and the Debtor within the first 60-days of the case. Fourteen days prior to the status conference, the debtor is required to file with the court and serve on all parties a report detailing the debtor’s past and anticipated efforts to attain a consensual plan of reorganization.
  4. There is no unsecured creditor committee and the creditors do not vote on the approval of the plan.
  5. The debtor must file a plan of reorganization within 90-days which is designed to speed up the reorganization process.
  6. The “absolute priority rule” is abolished.2 This permits the owner-operator to retain full ownership without giving new value. The judge approves the plan as long as the plan does not discriminate unfairly and is deemed to be fair and equitable with respect to each class of claims. To be fair and equitable, the debtor must commit its projected disposable to be received over the length of the plan to the creditors. The period of repayment is either 3 or 5 years.
  7. As a general matter, with a consensual plan, the discharge occurs upon the effective date of the plan. If the plan is non-consensual, the discharge does not happen until the debtor completes all payments due under the plan.
  8. Debtors are not required to pay quarterly fees to the U.S. Trustee, while a debtor in a Chapter 11 must pay fees.
  9. Debtor’s counsel or other professionals are not disqualified so long as the fees owed to the professional are less than $10,000.

Under the SBRA, a small business is defined as a business that has no more than $2,725,625 of debt.3 The CARES Act temporarily increased the debt limit to $7,500,000 until March 27, 2021. This means that any cases filed before March 27, 2021, can qualify as a small business if the aggregate debt is less than $7,500,000. If the business is a single-asset real estate, it cannot elect to be treated as a small business under the SBRA.4

The SBRA did not change the benefits of Chapter 11. So why would you file for bankruptcy under Chapter 11? Here are a few of the reasons:

  1. The debtor steps into the shoes of the trustee.
  2. The ability to terminate “bad” contracts. For example, large retailers like J Crew, Ann Taylor and Neiman Marcus are using Chapter 11 to sever expensive long-term leases.
  3. The filing of the bankruptcy petition triggers the automatic stay. Upon filing, any and all collection activities must stop absent a court order.
  4. Most importantly it permits the business to achieve a “fresh start.”

Importance of Business and Financial Records

When you file for Chapter 11 under Subchapter V, it is important that your books and records be in order. In fact, when the debtor files a bankruptcy petition under Subchapter V, it is required to provide a profit and loss, balance sheet and cash flow statement. There is also ongoing monthly reporting. If the debtor is an individual and/or sole proprietorship, the debtor is required to file a monthly operating report for an individual. If the debtor is a corporation, partnership or limited liability company, it must file the small business operating report (Form 425C).

WM Takeaway

The SBRA opens the door for more small businesses to reorganize under Chapter 11 who could not otherwise avail themselves of the benefits of Chapter 11. It is important to plan upfront for the process as the reporting due to the court and/or U.S. Trustee’s office is time-sensitive. The first 60-90 days will be intense and require additional time on the debtor but if planned properly, the time spent during those first 60-90 days from the filing of the petition can be reduced. As such, it is highly recommended that the debtor retain an accountant and/or financial advisor that is well versed in the process.5 This will help smooth the process and ultimately set the debtor up for success post-emergence from bankruptcy.

 

[1] The Small Business Reorganization Act of 2019 (“SBRA”), Pub. L. No. 116-54.
[2] In a Chapter 11 reorganization that does not qualify under the SBRA, in order for the plan to be approved, it must be fair and equitable with respect to each impaired, nonaccepting class of claims or Interests (referred to as the “absolute priority rule”). The absolute priority rule provides that a nonaccepting class of creditors or interest holders cannot be compelled to accept less than what they are entitled to while a more junior creditor or equity holder receives anything or retains its interest in the debtor under the plan. The policy of the absolute priority rule is to ensure that the priority of payment rules set forth in 11 U.S.C. § 507 are followed.
[3] 50% or more of the debt must relate to business or commercial activities.
[4] A “SARE” is a single property or project other than residential real property with fewer than four (4) residential units which generates substantially all of the debtor’s gross income on which no substantial business is being conducted by a debtor other than the business of operating the real property. A SARE is subject to a separate set of rules. See related article, “Real Estate Investors & Bankruptcy: SARE and Economic Crisis Impacts,” on our blog.
[5] Professionals, including debtor’s counsel, will need court approval to perform services for the debtor while in bankruptcy and those fees will need court approval as well before the debtor can pay those fees.

Disclaimer: We are a debt relief agency. We help people file for bankruptcy relief under the Bankruptcy Code.

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