It's Time To Revisit the Small Business Reorganization Act 

10.09.2020

Chapter 11 can be a daunting challenge for a small business with limited financial resources. A typical reorganization case requires multiple hearings in bankruptcy court; out-of-court negotiations; voluminous document and financial disclosures; and agreement with each class of creditors to avoid plan-related litigation and to allow the owner to retain the equity in the business. Small businesses may simply lack the time and manpower required of the process, let alone have the cash or a lender to fund a case.

With the recent enactment of the Small Business Reorganization Act (SBRA), 11 U.S.C. § 1181-1195, Congress has given small businesses the option to proceed under chapter 11 with streamlined procedures and substantial cost-saving advantages. Moreover, as part of the CARES Act, the debt limit increased to $7.5 million, making even more small businesses eligible for the SBRA.

COVID has brutalized the small business world, causing thousands of otherwise profitable companies to shut down temporarily and at worst, forever. Of those that have survived so far, many will continue to struggle so long as the pandemic persists. A recent market watch survey reported that while 72% of small businesses show optimism that they will be able to stay in business at least six months, 55% have concerns about staying afloat financially long term with social distancing regulations that limit business capacity.

In the first six months after it became effective in February, only 658 small businesses filed bankruptcy under the SBRA nationwide. In the Mid-Atlantic region during this period, only 13 cases were filed in Virginia, nine in Maryland, and one in Washington, D.C. This may be due to a number of factors, among them “stay at home” orders which shut down businesses and bankruptcy courthouses for a period of time; the CARES Act which kept businesses funded; state and local moratoria on creditor remedies; and the reluctance of banks to foreclose and landlords to evict during the initial months of COVID.

At this point, government aid has stalled, protections have expired, creditors have become less patient, and the Payroll Protection Program  (PPP) “loans” may or may not eventually be forgiven. Although most debtors were unable to qualify for a PPP loan while in bankruptcy under the SBRA, a chapter 11 may now be used to discharge a pre-bankruptcy unsecured PPP loan. For those small businesses that are constrained by debt caused by COVID but remain optimistic that they can again generate positive cash flow, an SBRA case may be the vehicle for short and long term survival. Simply put, it is time to revisit the SBRA and its potential benefits.

Here are some of the most important features of the SBRA, also referred to as “subchapter 5” of the Bankruptcy Code.

1. The Plan – The debtor has the exclusive right to file a plan of reorganization. The plan must be filed within the first 90 days of the case. Unlike under a traditional chapter 11 case, there is no requirement that any class of creditors approve the plan. Even if creditors reject a plan, the bankruptcy court may approve it, so long as, among other things, the plan provides that the next three to five years of the “disposable income” (i.e., net income or profits) be distributed to unsecured creditors. The length of the plan will typically be determined by how quickly a business can repay back taxes or other priority debt, which must be paid in full but over time.

2. Retention of Ownership – In a major change from prior law, the owners of the debtor may retain their full ownership of the business even if trade vendors and other unsecured creditors are not repaid in full under the plan. Thus, while the design of SBRA encourages consensual plans, the new law shifts negotiating leverage toward the small business and its owner.

3. A Streamlined Process – Unless the court orders otherwise, there is no creditors committee, creditors may not file a competing plan, and the debtor is not required to file a disclosure statement with the plan, all of which shortens and simplifies the plan confirmation process. Also, the debtor is not required to pay quarterly fees to the U.S. Trustee.

4. The Trustee – The debtor remains in possession and control of the business and its operations. Nonetheless, a trustee is appointed in each case to serve as a financial monitor and facilitate the development of a consensual plan of reorganization.

5. Home Equity Loan Modification – Another unique feature of the SBRA is that it allows the small business owner to modify a home equity mortgage, if it was not a purchase money loan but rather was a loan used primarily in connection with the business.

This is only a brief overview, and there may be situations where a small business should not elect to proceed under subchapter 5. Generally speaking, however, the SBRA is debtor-favorable, and promotes speed and consensus, saving the small business valuable time, reducing costs, and enhancing the prospects of success.

The SBRA increased debt limit is set to expire in March 2021 and there is no certainty it will be extended. Have questions? The Hirschler bankruptcy team would be pleased to discuss whether the SBRA is a viable course of action.