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THIS ARTICLE ANALYZES THE SMALL BUSINESS Reorganization Act of 2019 (SBRA)1 and the revisions to the SBRA contained in the Coronavirus Aid, Relief, and Economic Security Act (CARES Act).2 The SBRA was enacted into law on August 23, 2019, and became effective on February 19, 2020. The CARES Act was signed into law on March 27, 2020.
The SBRA contains significant changes to the laws governing small business Chapter 11 bankruptcies. The goal of the SBRA is to improve the reorganization process for small business Chapter 11 debtors. The opportune timing of the SBRA may provide much-needed relief for small businesses impacted by the COVID-19 pandemic.
Before 2005, many small business debtors did not take advantage of the benefits of Chapter 11 because of the high costs, lengthy delays, and labor-intensive nature of Chapter 11 cases. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) introduced measures that were meant to alleviate some of these issues for small business debtors. In practice, the BAPCA provisions only partially addressed these issues, and Chapter 11 still remained too costly and time-consuming for many small business debtors. The SBRA addresses these issues by adding a new Subchapter V to Chapter 11 titled Small Business Debtor Reorganization. The CARES Act expanded this relief by making the small debtor Chapter 11 provisions accessible to a greater number of small businesses.
The SBRA does not repeal existing Chapter 11 provisions regarding small business debtors, but instead creates an alternative procedure that small business debtors may elect to use. Thus, small business debtors have the option to proceed under the current small business Chapter 11 laws or under the new Subchapter V.3 Although the existing Chapter 11 small business debtor provisions remain a viable option, it is difficult to imagine small businesses choosing this option given the significant benefits of proceeding under Subchapter V.
This article is meant as a summary and analysis of the significant revisions contained in the SBRA.
The SBRA revises the requirements to qualify as a small business debtor. First, the debtor must be engaged in commercial or business activities (consistent with the pre-SBRA law). Prior to the SBRA, a debtor whose primary activity was the business of owning or operating real estate did not meet this requirement. However, the SBRA revised Section 101(51D) of the Bankruptcy Code to only exclude a debtor whose primary activity is the business of owning single asset real estate.4
Second, the debtor’s aggregated debts (the total noncontingent, liquidated secured, and unsecured debts) must not exceed $2,725,625 as of the date of the order for relief. The debts that the debtor owes to affiliates or insiders of the debtor are not included in this aggregation. Under the CARES Act, a debtor with aggregate debts up to $7,500,000 can qualify as a small business debtor—up from $2,725,625. This amendment applies to all cases filed on or after the enactment of the CARES Act and lasts for one year. Therefore, a greater number of businesses are now eligible to file as small business debtors because of the CARES Act.
The SBRA replaced the third requirement (concerning an active creditors’ committee) with the requirement that not less than 50% of the debt (i.e., $7,500,000 under the CARES Act) arises from commercial or business activities. The SBRA also revised the definition of a small business debtor to exclude any corporate debtor or corporate affiliate of the debtor that is subject to the reporting requirements under Section 13 or 15(d) of the Securities Exchange Act of 1934.5 The CARES Act contains a technical correction to this part of the definition which now excludes any debtor that “is an affiliate of an issuer (as defined in section 3 of the Securities Exchange Act of 1934 (15 U.S.C.S. § 78c).”6
Under the SBRA, a Chapter 11 small business debtor retains possession of its assets and is permitted to continue business operations during the bankruptcy. However, small business bankruptcy cases will now have a bankruptcy trustee akin to the trustee appointed in Chapter 12 and 13 bankruptcies.
The trustee must perform some of the same tasks as a Chapter 7 trustee (such as objecting to claims) and certain additional tasks.7 The additional tasks include, among others:
In sum, although the trustee must perform certain duties, the trustee’s primary responsibility is to guide a Chapter 11 small business debtor through Subchapter V by facilitating a consensual plan among the debtor and its creditors.
The SBRA reduces the costs of and quickens the timeframe for a small business Chapter 11 bankruptcy. The bankruptcy court must hold a status conference within 60 days of the bankruptcy filing “to further the expeditious and economical resolution of a case under this subchapter.”9 The debtor must file the plan within 90 days after the bankruptcy filing (as opposed to the 300-day outside deadline under the existing Chapter 11 provisions regarding small business debtors).10 The court can extend this deadline if the need for the extension is attributable to circumstances for which the debtor should not justly be held accountable.11 Courts will, therefore, have the discretion to find that the COVID-19 pandemic is a sufficient reason to extend the deadline for filing a plan.
Unless the court orders otherwise, there is no creditors’ committee in cases under Subchapter V.12 In a traditional Chapter 11, the estate pays the fees and expenses of counsel and professionals retained by the creditors’ committee. Small business debtors filing under Subchapter V can avoid this additional expense. The small business debtor is also not required to file a disclosure statement unless the court orders otherwise.13 By removing this requirement, a small business debtor can expeditiously confirm a plan without incurring the time and costs of preparing and disseminating a disclosure statement.
The SBRA revises the plan and confirmation requirements for cases under Subchapter V of Chapter 11. The debtor is the exclusive party that can file a plan. Further, the debtor is no longer required to solicit votes on the plan. Instead, creditors have the right to object to the plan. A plan must still be fair and equitable to each class of claims or interests and not discriminate unfairly. However, the definition of fair and equitable has been revised. The SBRA provides that a plan is fair and equitable if, among other things, the plan provides that the debtor’s projected disposable income will be applied to make payments under the plan during a three- to five-year period. Disposable income is defined as debtor income after deducting payments for domestic support, living expenses, and business operation expenses.14 Unlike a traditional Chapter 11, the debtor can pay administrative expenses over the life of a plan (as opposed to the requirement that such claims be paid on the effective date of the plan).
The SBRA allows an individual small business debtor to modify the mortgage on his or her principal residence if the mortgage was primarily used for the small business rather than purchasing a residence. This means that an individual who borrowed against the equity in his or her home to invest in the small business can modify the home equity loan by, for example, proposing a lower interest rate or extending the maturity on the loan. Notably, this relief is not available to individuals who file Chapter 13.
The court must also find that the debtor will be able to make all payments or there is a reasonable likelihood that the debtor will be able to make all payments under the plan. The plan must also provide appropriate remedies to protect the holders of claims or interests in the event that the payments are not made (which may include the liquidation of nonexempt assets).
Under these provisions, the small business debtor can keep its business if the debtor satisfies the confirmation requirements. The debtor receives a discharge of pre-confirmation debts after completing all payments required under the confirmed plan. In sum, the SBRA (1) provides for the appointment of a trustee to assist the small business debtor that remains in possession, (2) requires the debtor to pay its disposable income to creditors over three to five years, and (3) allows the small business debtor to keep its business.
Many small businesses have experienced significant financial losses as a result of the COVID-19 pandemic. As compared to large businesses, small businesses generally have fewer resources to weather a prolonged economic downtown. The new streamlined small business bankruptcy provisions became effective just in time to assist small business debtors dealing with this crisis. Counsel to companies with aggregate debts up to $7,500,000 should explore whether filing under Subchapter V will afford such companies the relief needed to endure the economic conditions caused by the pandemic. The ability to stretch out payments to creditors over a three-to-five-year period, while significantly reducing the costs of a bankruptcy filing, may provide a lifeline for many small businesses. Eligible small businesses can also use the possibility of a bankruptcy filing as leverage in negotiations with creditors.
When advising small businesses, counsel must also determine whether the company has applied for or intends to apply for the Paycheck Protection Program (PPP). The PPP is part of the CARES Act. The program is designed to incentivize businesses to keep their workforce during the ongoing pandemic by providing forgivable loans to eligible businesses. Although the CARES Act contains no limitation on providing PPP loans to debtors in bankruptcy, the Small Business Administration (SBA) has released an interim rule saying that companies in bankruptcy are not eligible for PPP loans, and companies with pending PPP applications must cancel their applications if such companies file bankruptcy. Bankruptcy courts are already considering whether to follow this rule. In the Southern District of Texas, the bankruptcy court issued a temporary restraining order enjoining the SBA from preventing the Chapter 11 debtor from receiving a PPP loan.15 Bankruptcy courts in Vermont, Maine, and New Mexico have issued similar orders.16 Conversely, the bankruptcy court in the District of Delaware denied a similar request, reasoning that the court lacks the statutory power to enjoin the agency.17
Arguably, companies that have already received PPP loans do not appear to be affected by this interim rule. For this reason, a few debtors have moved to voluntarily dismiss their bankruptcy cases and refile after receiving the PPP loans. Thus, the timing of the filing may impact whether the small business debtor is entitled to these loans. Counsel to small businesses should closely monitor these new and evolving issues when advising a company considering applying for a PPP loan and filing for bankruptcy. Some small businesses that received PPP loans may be able to avoid bankruptcy, but others may need to file once the funds are exhausted or if such companies end up unable to meet the loan forgiveness criteria.
Mark Haut is a Content Manager for Lexis Practice Advisor®. Prior to joining LPA, he was counsel at Norton Rose Fulbright, where he advised clients on a variety of bankruptcy matters. Previously, he was an associate in the Bankruptcy and Reorganization Practice Group at Morgan, Lewis & Bockius, LLP. Prior to joining Morgan Lewis, he clerked for Judge Stuart M. Bernstein in the U.S. Bankruptcy Court for the Southern District of New York.
To find this article in Lexis Practice Advisor, follow this research path:
RESEARCH PATH: Bankruptcy > Trends & Insights > First Analysis > Articles
For an overview of practical guidance on COVID-19, see
> CORONAVIRUS (COVID-19) RESOURCE KIT
RESEARCH PATH: Bankruptcy > Trends & Insights > First Analysis > Practice Notes
For more information on small business bankruptcy, see
> CHAPTER 11 SMALL BUSINESS DEBTOR
RESEARCH PATH: Bankruptcy > Commencing a Bankruptcy Proceeding > Bankruptcy Fundamentals > Practice Notes
For more information on the duties performed by a Chapter 7 trustee, see
> CHAPTER 7 TRUSTEE DUTIES
For a discussion of the provisions applicable to small businesses under the Small Business Reorganization Act, see
> SMALL BUSINESS REORGANIZATION ACT CHART
RESEARCH PATH: Bankruptcy > Commencing a Bankruptcy Proceeding > Bankruptcy Fundamentals > Checklists
For an analysis of the changes to the U.S. Bankruptcy Code contained in the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), see
> CARES ACT’S EFFECT ON BANKRUPTCY
For a review of the bankruptcy provisions contained in the CARES Act, see
> CARES ACT BANKRUPTCY CODE REVISIONS CHART
RESEARCH PATH: Bankruptcy > Trends & Insights > First Analysis > Checklists
1. 11 U.S.C.S. § 1181-1195. 2. Pub. L. 116-136, 134 Stat. 281 (Mar. 27, 2020). 3. See 11 U.S.C.S. §§ 101(51C), 103(i). 4. 11 U.S.C.S. § 101(51D)(A). 5. 15 U.S.C. §§ 78m, 78o(d). 6. 11 U.S.C.S. § 101(51D). 7. 11 U.S.C.S. § 1183(b). 8. 11 U.S.C.S. §§ 1183(b), 1194. 9. 11 U.S.C.S. § 1188(a). 10. 11 U.S.C.S. § 1189(b). 11. Id. 12. 11 U.S.C.S. § 1181(b). 13. 11 U.S.C.S. §§ 1181(b), 1187(c). 14. 11 U.S.C.S. § 1191(d). 15. Hidalgo Cty. Emergency Serv. Found. v. Carranza (In re Hidalgo Cty. Emergency Serv. Found.), 2020 Bankr. LEXIS 1174 (Bankr. S.D. Tex. Apr. 25, 2020). 16. Springfield Hosp., Inc. v. Carranza (In re Springfield Hosp., Inc.), 2020 Bankr. LEXIS 1205 (Bankr. D. Vt. May 4, 2020); In re Calais Reg’l Hosp., 2020 Bankr. LEXIS 1212 (Bankr. D. Me. May 1, 2020); In re Roman Catholic Church of the Archdiocese of Santa Fe, 2020 Bankr. LEXIS 1211 (Bankr. D.N.M. May 1, 2020). 17. Cosi Inc. v. Small Business Administration et al., Case No. 1:20-ap-50591 (Bankr. D. Del. Apr. 28, 2020).