October 26, 2020 Article

Bankruptcy Alert: Time's Running Out on Higher Debt Limits of the Small Business Reorganization Act

As we head in to year-end holidays and activities, the clock is ticking on the CARES Act provisions that could help businesses in financial distress and save creditors’ customers – the higher-debt limit that makes more businesses eligible as debtors under the Small Business Reorganization Act.

In February 2020, the Small Business Reorganization Act of 2019 (H.R. 3311) (the “SBRA”) went into effect.  Lenders and businesses in financial distress should be aware of the ramifications of the SBRA, as the new law will likely result in increased bankruptcy filings by smaller, family-run businesses that had previously been unable pursue reorganization under Chapters 11 and 13 of the Bankruptcy Code.

In the past, smaller companies were forced to choose between liquidating their assets under Chapter 7 of the Bankruptcy Code or pursuing the time-consuming – and increasingly-expensive – procedures for reorganization under the current version of Chapter 11.  Similarly, registered business entities, such as corporations and limited liability companies, have been ineligible to pursue reorganization under Chapter 13, which allows “individuals” to commit their “excess monthly income” to a court-approved repayment plan and receive a discharge of their pre-bankruptcy debts at the end of the plan.

The SBRA introduces and applies aspects of the Chapter 13 process in Chapter 11 proceedings.  The stated aim of these changes is to streamline and expedite the reorganization of “small business debtors,” a term defined as businesses entities or individuals operating businesses with aggregate secured and unsecured debts totaling not more than $2,725,625 (which number is adjusted for inflation).  The more recent CARES Act, however, increased the debt limit to $7.5 million for cases filed by March 2021 (unless Congress extends it).  That may seem in the distant future, but it is sooner than you think.

Significant aspects of the SBRA provisions include:

  • Subject to certain limitations, debtors remain in possession of their property and assets and may continue to operate their businesses.
  • The small business debtor must file a reorganization plan within 90 days of the bankruptcy petition date, which the Court may extend based on circumstances “for which the debtor should not justly be held accountable.”
  • Only the debtor may file a reorganization plan.  Creditors are not permitted to file competing plans.
  • Unless the Court orders otherwise, no creditor’s committee is appointed.
  • A trustee will be appointed in the case.  Much like a Chapter 13 trustee, the trustee in SBRA cases is charged with examining the debtor’s management, assisting with the formulation of a reorganization plan, monitoring the debtor’s compliance with statutory requirements, and receiving and disbursing payments to creditors under the plan.
  • An initial status conference must be conducted within 60 days from the bankruptcy petition filing date, subject again to court extension based on circumstances “for which the debtor should not justly be held accountable.”
  • The debtor must file a report at least 14 days prior to the status conference, detailing the efforts that have been undertaken to formulate a consensual plan of reorganization.
  • The SBRA requires the small business debtor to commit such future earnings and income to the supervision of the standing trustee as is necessary to consummate the reorganization plan.
  • The SBRA debtor’s plan may modify the rights of creditors whose claims are secured solely by a mortgage on the debtor’s principal residence if: (a) the loan secured by the mortgage was not used “primarily to acquire” the residence; and (b) the loaned funds were “used primarily in connection with the small business of the debtor.”
  • The SBRA also creates a new mechanism for approval of the debtor’s plan over a creditor’s objection.  The modified provisions for ‘cram-down’ permit the Court to approve the plan over creditor objection if the plan does not “discriminate unfairly” and is “fair and equitable” as to each class of dissenting impaired creditors that votes against the plan.
  • For secured creditors, a plan is “fair and equitable” if it meets the requirements of current Section 1129(b)(2)(A) of the Bankruptcy Code (i.e., lien retention and payments having a present value at least equal to the value of their collateral).
  • For unsecured creditors, a plan is “fair and equitable” if: (A) it requires the debtor to submit all of its projected disposable income to make the payments called for under the plan; or (B) the value of the property to be distributed during the life of the plan is “not less than the projected disposable income of the debtor.”
  • “Disposable income” is defined as income minus operating expenses, living expenses, and any domestic support obligations.
  • Notably, the SBRA appears to eliminate the so-called “absolute-priority” rule for SBRA cases under current 1129(b)(2)(B)(ii), such that ownership may retain control of the small business debtor post-confirmation even when claims of the debtor’s unsecured creditors have not been repaid in full.
  • The debtor will be eligible for a discharge upon completion of all plan payments, except for non-dischargeable debts or debts on which the last payment is due after the plan period (3-5 years, as applicable).

The SBRA also changed certain aspects of preference cases (90-day claw back) for debtors in possession and trustees:

  • The preference statute will now require that debtors-in-possession and trustees perform reasonable due diligence and consider the preference recipient’s known or reasonably knowable affirmative defenses before filing suit.
  • The SBRA amends the venue statute for recovery actions like preference and fraudulent transfer cases by providing that any such action against a non-insider to recover less than $25,000 must be brought in the judicial district were the defendant resides.

These provisions apply to all bankruptcy cases.