CARES ACT EXPANDS ELIGIBILITY FOR NEWLY EFFECTIVE SMALL BUSINESS REORGANIZATION ACT

The SBRA—we hardly knew you.

The ink was barely dry on The Small Business Reorganization Act of 2019 (“SBRA”) when the CARES Act significantly modified the definition of “who may be a debtor” under the SBRA.  The SBRA, which took effect on February 19, 2020, added a new Subchapter V (five) to the Bankruptcy Code (Sections 1181 through 1195) and is designed to reduce costs and facilitate the bankruptcy process for small business debtors who elect to proceed under the subchapter.  The SBRA expedites the bankruptcy timeline, thereby (at least theoretically) reducing the delays and costs often associated with Chapter 11 bankruptcies.  However, the SBRA is not solely procedural; instead, the SBRA includes major substantive changes to the rights of small business debtors and their creditors under the Bankruptcy Code.

The CARES Act increases the debt ceiling for Subchapter V debtors from $2,725,625 to $7,500,000.  The increase is for a one-year period, only; however, the change in eligibility together with the current financial distress experienced by many small businesses virtually assure that there will be widespread filings under Subchapter V before the provision sunsets.

If at first you don’t succeed…

The SBRA is not Congress’ first attempt at addressing the rights and responsibilities of debtors who are neither “mom and pop” operations governed by Chapter 13 nor billion-dollar corporations undergoing a complex reorganization under Chapter 11.  The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the “2005 Act”) also included special provisions for “small business debtors”. The 2005 Act imposed various additional reporting requirements and shorter time deadlines on small business debtors (see Sections 308 and 1116), which requirements were principally aimed at implementing greater administrative oversight and controls over small business chapter 11 cases.  Despite the changes instituted by the 2005 Act, it appears that, “Chapter 11 may still create difficulties for small businesses, including high costs, monitoring deficits, and procedural roadblocks,” as stated in the U.S. House of Representatives Judiciary Committee press release introducing the SBRA.  These perceived difficulties experienced by small businesses in Chapter 11 resulted in the bi-partisan introduction of H.R. 3311, the SBRA.  Although the additional reporting requirements imposed by Sections 308 and 1116 are incorporated in the SBRA, at least at first blush, the SBRA seems less directed at curbing debtor abuses than was the 2005 Act and instead appears geared toward making a Chapter 11 reorganization “small business friendly”.

What happens in a Subchapter V case?

Appointment of a Trustee.  The Office of the United States Trustee, a component of the Department of Justice that seeks to promote the efficiency and protect the integrity of the Federal bankruptcy system, conducted a nationwide search for qualified candidates to serve as Subchapter V private trustees, ultimately selecting about 250 candidates from more than 3,000 applications.  These trustees offer a diverse set of business, accounting, turn-around management, and legal skills. The Office of United States Trustee for the region in which the Subchapter V case is filed will appoint a trustee from the pool, who will monitor the debtor’s compliance with bankruptcy rules and procedures, oversee the claims distribution process, and act as a fiduciary for creditors; however, the trustee will in most cases not be an operating trustee. Instead the small business will generally operate during the bankruptcy as a debtor in possession.  The Subchapter V trustee’s most significant role is to act as a facilitator in the development of a consensual plan of reorganization.

No Creditors’ Committee The Subchapter V trustee will perform his/her duties in lieu of a creditors’ committee.  Unless the court orders otherwise, Sections 1102(a)((1), (2) and (4),  1102(b),  and 1103 (establishing unsecured creditors’ committees in Chapter 11), do not apply to a small business bankruptcy under the SBRA (Section 1181).

No Quarterly United States Trustee Fees Title 28 of the United States Code, §1960(a)(6)(A) setting forth the quarterly fees paid to the U.S. Trustee in a Chapter 11 case is amended by the SBRA to exclude Subchapter V debtors from the fee requirements.

Transactions with Professionals Section 1195 provides that notwithstanding Section 327(a) of the Bankruptcy Code, a person is not disqualified from employment under Section 327 (relating to employment of professionals in a bankruptcy case) by a Subchapter V debtor solely because that person holds a claim of less than $10,000.00 that arose prior to commencement of the case.  This provision may ease difficulties small business debtors experience in retaining qualified professionals and will permit the post-petition employment of professionals engaged by the debtor prepetition if the professional has a claim for outstanding professional fees in a relatively nominal amount.

Time Deadlines.  The court will hold a status conference within 60 days of the bankruptcy petition date where the debtor elects to be a Subchapter V debtor (Section 1188).  The debtor must file a plan of reorganization within 90 days of the petition date, unless this time period is extended by the court if the need for an extension is attributable to circumstances for which the debtor should not justly be held accountable (Section 1189).

Only the Debtor May File a Plan.  In an important departure from existing law, only the Subchapter V debtor may file a plan of reorganization in a small business Chapter 11 case (Section 1189(a)).  In other Chapter 11 cases, any party in interest may file a plan of reorganization upon expiration of the exclusivity period (the initial time period in which only the debtor may file a plan).  The limitation on who may file a plan in Section 1189(a) of the SBRA is similar to the limitations in Chapter 13 in which the debtor also has the exclusive right to file a plan.

No Separate Disclosure Statement Required.  Unless the court orders otherwise, Section 1125 (requiring that a disclosure statement must accompany the plan of reorganization) is inapplicable to Subchapter V cases (Section 1181(b)).

Modification of Loans Secured by Debtor’s Principal Residence.  A Subchapter V plan may modify a loan secured by the principal residence of the debtor if the proceeds of the loan were used primarily for the small business and not to acquire the residence (Section 1190(3)).  This is a major potential benefit for the small business debtor.

Inapplicability of the “New Value” Rule The SBRA eliminates the requirement that equity interest holders in the Subchapter V debtor provide new value in order to retain their ownership interest in the reorganized debtor without paying creditors in full, and the Subchapter V debtor may retain an equity interest in the reorganized debtor so long as the plan does not discriminate unfairly, and is fair and equitable with respect to each class of claims or interests (Section 1191).

Confirmation of Plan Over Objections.  The court may confirm a Subchapter V plan over the objections of an impaired class so long as the plan does not discriminate unfairly, is fair and equitable with respect to each class of claims or interests, and the plan provides that all of the Subchapter V debtor’s projected disposable income to be received during the plan will be applied to make payments under the plan for a period of 3 to 5 years (Section 1191(c)).

Administrative Expense Claims May Be Paid Under Plan.  Section 1191(e) removes the requirement that a Subchapter V debtor pay all administrative expense claims for post-petition goods and services under 11 U.S.C. §507(a)(2) and (3) upon the effective date of the plan, and instead provides that these claims may be paid over the life of the plan.

Debtor’s Discharge.  Section 1192 provides that the court must grant the Subchpater V debtor a discharge after completion of all payments due during the first three years of the plan or such longer period as the court may fix (not to exceed five years) except any debt on which the last payment is due after the first three years of the plan or such other time not to exceed five years as fixed by the court or a debt excluded from discharge under 11 U.S.C. §523(a).

Who will benefit from the SBRA–Debtors or Creditors?

The SBRA, H.R. 3311, was introduced by Congressman Ben Cline (R-Virginia) and House Judiciary Subcommittee on Antitrust, Commercial and Administrative Law Chairman David Cicilline (D-Rhode Island), along with House Judiciary Ranking Member Doug Collins (R-Georgia) and Congressman Steve Cohen (D-Tennessee) on June 19, 2019, and signed into law by the President on August 23, 2019.  The bill’s bipartisan support indicates that the measure is at least apparently even-handed in terms of its debtor-creditor orientation.  Of course, as the adage goes, the “devil is in the details,” and it remains to be seen how the implementation of SBRA will affect the respective rights of the parties.  The SBRA applies in any Chapter 11 case in which the small business debtor elects to apply the SBRA.  Accordingly, the SBRA is not self-effectuating and it may take some time for there to be a sufficient “track record” of cases in which the debtor elects to be a small business debtor under Subchapter V in order to determine its impact.  Also, of the numerous sections and subsection of Chapter 11 which the SBRA deems ordinarily inapplicable to small business cases, a half-dozen of these sections/subsections may become re-applicable if the court so orders.  Therefore, the practical result of the sweeping statutory changes contained in the SBRA may be limited by the bankruptcy courts’ willingness to re-apply existing Chapter 11 requirements in small business cases.  Certainly, the less stringent plan confirmation standards (such as the elimination of the “new value” requirement, the permissibility of  modification of mortgages on owner-occupied residential property securing small business loans, and the mechanism for confirmation of a plan over the oppositions of an impaired class of creditors) are at least facially debtor-friendly.  The oversight conducted by the Subchapter V trustee, as well as the dates/deadlines for the status conference and filing of a plan of reorganization, may benefit creditors by assuring that the bankruptcy case either moves forward in a timely fashion or is dismissed.   If it is ultimately shown that the SBRA promotes successful reorganizations by small business debtors resulting in prompt, fair and appropriate payments to creditors, the SBRA will benefit both debtor and creditor; however, at less than two months after the effective date, it’s too soon to know for sure.