There have been some changes with Chapter 11 that directly impact small businesses. On August 23, 2019, Congress enacted the Small Business Reorganization Act of 2019 (“SBRA”). The SBRA became effective as of February 19, 2020, prior to the President’s declaration of a national emergency resulting from the Covid 19 pandemic. However, the SBRA was modified (in a business-friendly manner) when Congress enacted the Coronavirus Aid, Relief and Economic Security Act of 2020 (“CARES”).
The SBRA is designed to make the reorganization process more streamlined and more cost effective for a “small business”. The key provisions of the SBRA that will help fulfil these objectives include:
- Qualification. To qualify under the SBRA, the small business, which can be either an individual or an entity (“Debtor”), may not have debts greater than $2,775,625. However, CARES increased this debt cap to $7,500,000, but this increase will only last for one year.
- Exclusivity. Under the SBRA, only the Debtor may file the Chapter 11 Plan of Reorganization (“Plan”).
- Timing. The Plan must be filed within 90 days of the date that the Debtor commenced its bankruptcy case, unless the Court orders otherwise.
- No Disclosure Statement. The Debtor is not required to file a disclosure statement (the equivalent of a proxy statement), unless the Court orders otherwise. And this alone will save considerable time, and money arguing about what is “adequate information”.
- No creditors committee. There will be no creditors committee. However, a Chapter 11 trustee will be appointed similar to Chapter 13.
- Modification of secured claim. The Plan can modify the rights of a creditor with a security interest in the Debtor’s home if the loan was not used for the purchase of the home, and the money was used in the Debtor’s business.
- No absolute priority rule. Without getting overly technical, if the Plan is fair and equitable, and does not discriminate unfairly, then the Plan can be confirmed without creditor consent (cramdown) and the “absolute priority rule” does not apply. This rule normally requires that the shareholders of the Debtor may not retain their equity interest in the business unless the unsecured creditors consent or are paid in full.
The SBRA also adjusted certain rules to protect creditors that may have received preferential transfers from the Debtor before bankruptcy. These changes include:
- Unless the potential transfer was more than $25,000 the lawsuit must be filed in the District Court where the defendant resides. By way of example, if the bankruptcy case is pending in New York and the creditor/defendant lives in Los Angeles, the lawsuit must be filed in Los Angeles.
- Before the plaintiff may file a preference complaint, it must first calculate the creditor/defendant’s potential defenses (such as ordinary course of business, new value, etc.). Again, this should help creditors in that it imposes a higher burden on the plaintiff (debtor or trustee) to conduct more reasonable diligence before asserting the complaint and should reduce the number of complaints that are filed for smaller dollar amounts.
My view remains that bankruptcy is a powerful tool but should only be used as a last option. As my clients over the years know very well, there are often other options available to resolve creditor disputes and financial difficulties.