Bankruptcy courts nationwide began implementing a new law, the Small Business Reorganization Act, in February, 2020, just in advance of one of the sharpest, swiftest economic swoons in memory.
The new law, sometimes tagged with the initials SBRA, creates a streamlined version of Chapter 11 bankruptcy reorganization for small companies and entrepreneurs who want to continue operations, but are facing the shock of a swift reversal of fortune.
Through the new laws, qualified individuals and firms have the opportunity for meaningful reorganization and a second chance at survival without the fearsome burdens and expenses of “traditional” or “standard” Chapter 11 cases.
Here is a breakdown of the main ways the two paths differ:
1. The new law, found in “subchapter V” of Chapter 11 applies to both individuals and entities: LLCs and corporations can file, and so can self-employed individuals. Commentary: this is identical to standard cases, although the SBRA provisions may be more attractive to individual filers. To use the SBRA, debtors must be under the “debt ceiling” of $7.5 million in total debts. The ceiling is set to go back to $2.3 million when the CARES Act corona virus stimulus law expires in March, 2021.
2. Now there are two (or three) paths for Chapter 11: SBRA or traditional. Note that the traditional path also has small business provisions, which remain in force.
3. To play by the SBRA rules, debtors must opt-in at the time of filing the case. Check boxes on the petition used to start the case have been changed to allow opt-in. Constant switching back-and-forth between options does not seem possible.
4. A SBRA debtor is a “debtor in possession.” SBRA debtors retain physical control over business assets and decisions. This is identical to standard Chapter 11 practice.
5. A debtor in possession can be removed — or re-instated — by a bankruptcy judge for good cause under the SBRA. Fraud or incompetence would be the typical reasons. The procedure is streamlined compared to standard cases.
6. A status conference will be held by the bankruptcy judge within sixty days of filing a case. This will normally be held in the city where the courthouse is located, with attendant expenses. The conference comes up sooner under the SBRA. Fourteen days prior to the conference, the debtor’s attorney must file a report detailing negotiations with creditors. Attorneys should note that civil negotiation with creditors is therefore implicitly encouraged.
7. The SBRA debtor has ninety days to file a plan. A traditional debtor has 300 days to file a plan. Attorneys should note that plans (or at least rough drafts of plans) should be worked on before actually filing the case. Under the SBRA, only a debtor can file a plan. Under traditional Chapter 11 practice, creditors or trustees can file plans too, and then vote on which one they like best.
8. Most SBRA cases will not involve creditor committees. A judge can allow committees “for cause.”
9. Disclosure statements are not used in SBRA cases. Debtors save money because they don’t have to pay their attorney to draft them. Some of the disclosure requirements are handled through the plan, instead.
10. The absolute priority rule does not apply in SBRA cases. The prohibition on equity owners retaining their interests in the debtor without paying holders of non-consenting impaired classes (see sec. 1129(b)), does not apply in cases under Subchapter V. See § 1181(a). For debtors, this is a major advantage to the SBRA, and may alone dictate using the new sections.
11. Plans can be confirmed over the objection of any or all creditors. To accomplish this, the judge must find that the plan is “fair and equitable” to impaired creditors.
12. In turn, the definition of what “fair and equitable” means has been spelled out in the bankruptcy code. A fair and equitable plan is one that distributes all of the debtor’s projected disposable income to the plan for the 3-5 year duration of the plan, in either cash payments or property distribution. The judge must also find that the debtor is likely to have enough income to make the plan payments.
3. For individuals who file as small businesses, the definition of “projected disposable income” has been adjusted. Projected disposable income is net income — after reasonable living expenses and child support payments have been subtracted — which is what is due to creditors.
14. In SBRA cases, income earned after the filing date is part of the bankruptcy estate. Property bought after filing is, too. This is a potential disadvantage for debtors.
15. Mortgages on a debtor’s principle residence can be modified under the SBRA, so long as the loan was obtained for business purposes (i.e. not to buy the house). The type of modification that could benefit the debtor is a split of the mortgage claim into a secured portion (paid in full with interest) and an unsecured portion (paid pennies on the dollar like other unsecured bills). For a debtor with this type of loan, this could be a major advantage of the SBRA, as altering home mortgages is generally forbidden under the other bankruptcy provisions.
16. Discharge: Under the SBRA, discharge occurs when all the plan payments are made (i.e. in 3-5 years). This is later than standard Chapter 11. Excepted from discharge is any debt on which the last payment is due after the end of the plan. This could be a deal-breaker for some debtors. The exclusion is not found in standard Chapter 13 cases.
17. Trustees. A specific trustee is appointed in every SBRA case. Most districts will handle this by appointing a standing trustee to handle all SBRA matters in a given area, similar to Chapter 12 and Chapter 13 practice. Case specific trustees are rare in standard Chapter 11 cases, assigned only where fraud or incompetence has caused a problem. Trustees earn a 5% fee, paid by the debtor through the plan.
18. In SBRA cases, debtors may pay “administrative” expenses through the plan. These typically include the debtor’s attorney’s fees for post-petition work, which may be substantial. In standard cases these must be paid in cash before confirmation of a plan.
Which way to go? If you can get a debtor in under the cap, probably with the SBRA version, unless the prohibition of discharging long-term debts is a deal breaker.