In late August of last year, the usually dysfunctional and bitterly divided Congress did something unusual: it passed a bill that was signed into law by the President (it was only the fifty-fourth law enacted in more than a year and a half of effort by the 116th Congress) . The subject matter of the new legislation was also a bit surprising, given that the economy was roaring along at the time: it added provisions to the Bankruptcy Code to make it easier and faster for small businesses to get Chapter 11 bankruptcy relief.
The new law was set to take effect in February, 2020 and so it did: just in time to help out both individuals and businesses struggling with the startling economic collapse in the spring of 2020.
The legislation, formally called the Small Business Reorganization Act, creates a whole new subpart of Chapter 11 that didn’t exist previously. The act eliminates some of the more costly elements of traditional Chapter 11 relief, and in some ways borrows from the expedited procedures used in Chapter 12 (family farmer) and Chapter 13 (wage-earner) cases. The act was designed to provide a simpler an more efficient path to reorganization for small business debtors and certain individuals.
Highlights of the act include the following:
- The first thing to consider is what constitutes a “small” business. Smallness is judged by debt level. To file under the new law a business (or individual) must have total debts of less than $7 million dollars. This means all secured and unsecured debt added together. The dollar figure will be adjusted for inflation in three years.
- In a big departure from traditional Chapter 11 practice, a trustee will be appointed to every case. Assignment of a trustee was previously rare in Chapter 11, invoked only in cases of suspected fraud or other unusual circumstances. Under the new subchapter V, the trustee will not operate or close the business (as in Chapter 7), but will serve a role similar to a Chapter 13 trustee in disbursing plan payments. A standing (i.e. permanent) trustee can be appointed to serve a specific geographic area. In smaller districts, this may be the same lawyer who is the Chapter 12 or 13 trustee.
- Under the small business law, there will not be an unsecured creditors committee to cause mischief to debtors — a big plus for using the new section.
- The bankruptcy court will hold a status conference within 60 days of the petition date to determine specific procedures for each case.
- A plan must be filed within 90 days of the petition date unless there are extenuating circumstances.
- Only the debtor may file a plan. This is another important departure from prior practice, as Chapter 11 traditionally allows creditors or the government to file competing plans, which are put to a vote. This removes another potential headache for those seeking bankruptcy relief.
- Some of the information that was found in costly disclosure statements will instead be shifted into the plan, simplifying the drafting chores of the debtor’s attorney. The plan must include a history of the company’s business operations, a liquidation analysis that calculates how much money would go to creditors in a hypothetical liquidation situation, and a mathematical projection of the debtor’s ability to make payments under the plan.
- The length of the plan must be between three and five years, identical to the requirement of Chapter 13. This is an imposition on debtors, as the time limit does not apply in existing Chapter 11 law. This is a trade-off that debtors should consider when deciding whether to use the new section.
- The debtor must contribute all disposable income (read: future profits) to the creditors for the duration of the plan. This is a concept borrowed directly from Chapter 13.
- A very important provision for some debtors will allow them to modify home equity loans and second mortgages on their principal residence. This is extremely valuable to persons who may have mortgaged their house to get access to venture capital funds. The modification is called a “cram-down,” which reduces the amount due on this particular type of secured loan to the amount of equity available. Most Chapter 7 judges will not allow this, and Chapter 13 has severe restrictions on its use, so this could possible be a big win for small business debtors.
- The plan will be approved (“confirmed” in bankruptcy lingo), if the judge determines it is feasible, does not unfairly discriminate, and is fair and equitable to non-consenting classes of creditors. Gone is the applicability of the so-called “absolute priority rule,” which often threatened to give veto power to a single disgruntled creditor.
- A discharge of debts is granted to debtors who complete their plan payments in the contemplated 3-5 year period. The usual list of exceptions (e.g. student loans) applies. One sticking point is that debts on which the last payment is due after the 3-5 year length of the plan are not discharged. However, most arrearages racked up during the corona virus shut-down will be eligible for discharge.
- As with any new law, there are unanswered questions. For instance, it is unclear what interest rate will be applied to payments on secured debts under a plan: contract rate, a rate imposed by local fiat, or a “Till” rate (usually slightly higher than the prime rate), are all viable options. It also remains to be seen whether judges will borrow concepts and precedents from Chapters 12 and 13 when interpreting the new section.
- This new law, passed during the best of times, could end up being a life preserver for small business people hurt by this unexpected and swift global slowdown. It will allow them to clear out much of the financial carnage wrought by corona virus business interruptions, while allowing them to continue operating and to participate in the recovery. Maybe not quite a gift from God, but for once, a timely gift from Washington!
- By Doug Beaton