Small Business Bankruptcy
Since the 2005 amendments to the Bankruptcy Code, small business debtors have continued to struggle to reorganize effectively under Chapter 11 of the Bankruptcy Code. On Friday, August 23, 2019, President Trump signed the Small Business Reorganization Act of 2019 into law in an effort to address some of these issues.
The act aims to make small business bankruptcies faster and less expensive by creating a new subchapter of Chapter 11 of the Bankruptcy Code specific to small businesses. At this time, the act only applies to business debtors with secured and unsecured debts, subject to certain qualifications, less than $7,500,000.00. The act includes the following provisions:
- Appointment of a Trustee. The act provides that a trustee will serve as the trustee for the small business’s bankruptcy estate. The trustee shall facilitate the small business debtor’s reorganization and monitor the debtor’s consummation of its plan of reorganization.
- Streamlining the Reorganization Process. The act streamlines small business reorganizations and removes procedural burdens and costs associated with typical corporate reorganizations. Notably, only the debtor can propose a plan of reorganization. Small business debtors do not have to obtain approval of a separate disclosure statement or solicit votes to confirm a plan. Unless the court orders otherwise, there are no unsecured creditors’ committees. The act further requires that the court hold a status conference within 60 days of the petition date and that the debtor file its plan within 90 days of the petition date.
- Elimination of the New Value Rule. The act removes the requirement that equity holders of the small business debtor provide “new value” to retain their equity interest in the debtor without paying creditors in full. For plan confirmation, the act instead only requires that the plan does not discriminate unfairly, is fair and equitable, and, similar to Chapter 13, provides that all of the debtor’s projected disposable income will be applied to payments under the plan or the value of property to be distributed under the plan is not less than the projected disposable income of the debtor.
- Modification of Certain Residential Mortgages. Notably, the act also removes the categorical prohibition against individual small business debtor’s modifying their residential mortgages. The act now allows a small business debtor to modify a mortgage secured by a residence if the underlying loan was not used to acquire the residence and was primarily used in connection with the small business of the debtor. Otherwise, secured lenders have the same protections as in other Chapter 11 cases.
- Delayed Payment of Administrative Expense Claims. The act removes the requirement that the debtor pay administrative expense claims – including those claims incurred by the debtor for post-petition goods and services – on the effective date of the plan. Unlike a typical Chapter 11, a small business debtor may now stretch payment of administrative expense claims out over the term of the plan.
- Discharge Limitations. The court must grant the debtor a discharge after completion of all payments due within the first three years of the plan, or such longer period as the court may fix (not to exceed five years). The discharge relieves the debtor of personal liability for all debts provided under the plan except any debt: (1) on which the last payment is due after the first three years of the plan, or such other time as fixed by the court (not to exceed five years); or (2) that is otherwise non-dischargeable. All exceptions to discharge in Section 523(a) of the Bankruptcy Code apply to the small business debtor. This is a departure from a typical corporate Chapter 11 that has limited exceptions to discharge set forth in section 1141.
The benefits of Chapter 11 reorganization have been elusive to small business debtors given their size and limited financial resources. The act attempts to remedy many of these obstacles to successful small business reorganizations. If the act proves to be beneficial to small business debtors, there may be a legislative push to increase the debt limitations and provide even more businesses access to the new subchapter.
The act took effect in February 2020. Small business and consumer lenders should be prepared to protect their interests in this new subchapter of the Bankruptcy Code. Bradley attorneys are experienced in all aspects of bankruptcy, and will continue to monitor the development of the law and bankruptcy practice under the act.