Impending Changes to the Bankruptcy Code Improve the Ability of Small Businesses to Reorganize and Add Restrictions to Efforts to Recover Preferential Transfers

09.10.2019

The Small Business Reorganization Act of 2019 (the “SBRA”) was signed into law on August 26, 2019 and will take effect February 22, 2020. The SBRA represents a significant, and welcome, effort to streamline the legal and practical ability of small businesses to reorganize their financial affairs under the federal Bankruptcy Code. The SBRA, contained within a new subchapter 5 of Chapter 11 of the Bankruptcy Code, will be available to any “small business debtor,”  which includes a business enterprise or individual engaged in commercial or business activities (excluding a person whose primary activity is the business of owning or operating real property) whose total unsecured and secured debt does not exceed $2,725,625.00. Some of the notable provisions of the SBRA include: 

• The requirements to confirm a Chapter 11 plan are more relaxed and debtor-friendly. A debtor will be able to confirm a Chapter 11 plan over the objection of the debtor’s creditors, so long as the plan does not “discriminate unfairly” and is “fair and equitable,” with respect to each class of claims or interests that is impaired (i.e., have its rights altered by the plan) under, and has not accepted, the plan. In a significant change from current Chapter 11 law, the SBRA does not require that, if a plan impairs a class or classes of creditors, at least one impaired class must affirmatively accept the plan. Accordingly, it will be possible for a small business debtor to confirm a plan without the acceptance by any class of creditors.  

• A plan must be “fair and equitable” as to each class of creditors. The SBRA requires that a plan be “fair and equitable” as to any class of unsecured creditors, which means that the plan must provide that all projected disposable income of the debtor for 3 years (or such longer period the bankruptcy court may fix, but not to exceed 5 years) must be applied to make payments under the plan. Alternatively, the plan must provide that the value of property to be distributed under the plan during its 3 to 5-year duration have a value that is not less than the debtor’s projected disposable income. Disposable income is defined as income not reasonably necessary for the maintenance and support of the debtor and dependents, payment of domestic support obligations, and payments necessary for the continuation, preservation, or operation of the business of the debtor.     

• A plan will typically be at least 3 years in length.  In light of the requirement that a plan be fair and equitable as to any class of unsecured creditors, a plan under the SBRA a plan will usually be 3 years in length, or such longer period not to exceed 5 years as fixed by the bankruptcy court. The SBRA does not, however, set forth a standard for when a bankruptcy court should direct that a plan exceed 3 years in length. The debtor will receive a discharge only upon the debtor’s completion of all payments due under the plan.  

• Only the debtor may file a plan. Under the SBRA, only the debtor may file a Chapter 11 plan, which is a departure from the laws governing typical Chapter 11 cases where, under certain circumstances, any party in interest, other than the debtor, can file a competing Chapter 11 plan. 

• The debtor must file a plan within 90 days after filing. There is a strict 90-day limit for the debtor to file its Chapter 11 plan after the filing of the bankruptcy case; however, the debtor has the ability to request an extension for “circumstances for which the debtor should not justly be held accountable.” 

• No disclosure statement or official committee of unsecured creditors is required. In order to limit the procedural requirements of Chapter 11 for small businesses, the SBRA provides that a debtor does not need to file a disclosure statement in support of its plan of reorganization. Additionally, an official committee of unsecured creditors will not be appointed, unless the bankruptcy court orders the appointment of a committee for cause. 

• The United States Trustee must appoint a trustee to oversee the case. The powers of a trustee under the SBRA will largely mirror those of a trustee under Chapter 12 of the Bankruptcy Code and are not as expansive as those of a Chapter 7 Trustee. Under the SBRA, unless a plan provides otherwise, the debtor will remain in possession of all property of the bankruptcy estate. Nonetheless, after the confirmation of a plan, the trustee will distribute payments to creditors under the plan, among other duties.

Some of the notable provisions of the SBRA relating to preference actions for all cases under the Bankruptcy Code include: 

• There are two heightened prerequisites regarding the avoidance of preferential transfers applicable to cases under all Chapters of the Bankruptcy Code. The SBRA makes two changes to efforts to recover preferential transfers under all cases under the Bankruptcy Code. First, a trustee or debtor-in-possession must engage in due diligence prior to filing any preference actions and may only file preference actions that are “based on reasonable due diligence in the circumstances of the case and [that] tak[e] into account a party’s known or reasonably knowable affirmative defenses.” Second, a preference action can only be brought in the district where the defendant resides if the amount is less than $25,000 (the previous minimum threshold was $13,650).

Full text of the SBRA can be found here. 

Experienced legal counsel can help you understand the impact of the SBRA on small businesses, affected creditors, and parties in interest. Please contact the Hirschler Bankruptcy and Creditors’ Rights Group for more information.