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How Small Business Reorganization Act May Provide a Respite for Those Impacted by COVID-19

Posted by  Michael Crotty

Commentary on current events by Monique Hayes, a partner with G&M in our Miami office.


How The Small Business Reorganization Act May Provide a Much Needed Respite for Many Affected by Economic Impact of the Novel Coronavirus.

By Monique D. Hayes, Esq.

With much of the global economy grinding to a halt, most economists acknowledging that we are in the midst of a recession (perhaps on the verge of unemployment rivaling the Great Depression), and much of the congressional relief efforts centered on major corporations, many Americans are concerned about the fate of small businesses, and indeed their employees, impacted by the COVID-I9 (“Coronavirus”) pandemic. The number of confirmed Coronavirus cases now exceeds 551,246 (with more than 85,000 cases in the United States). And one in four Americans is under some form of travel or work restriction. Goldman Sachs recently estimated more than 2.5 million people filed for unemployment relief last week. Under the circumstances, it is difficult to predict when the curve will flatten or how long it will take for the economy to stabilize. It is clear however, that the small businesses that drive the American economy will be hit hardest. This is because liquidity is key to weathering any economic storm. Absent access to credit, or adequate cash reserves, many small businesses will be faced with the prospect of shuttering.


Yet, there is hope. Resiliency is engrained in the DNA of the American people. What’s more, our founding fathers, had the foresight to authorize Congress to enact uniform bankruptcy laws under the auspices of the Constitution. During the Great Depression, Congress enacted the Corporate Bankruptcy Act—which for the first time allowed corporate debtors to reorganize. The Corporate Bankruptcy Act is the predecessor to chapter 11 of the United States Bankruptcy Code which today is used by distressed corporations to restructure and return to business as a going concern or liquidate in an orderly fashion. However, chapter 11 bankruptcy proceedings are often criticized as too costly and complicated for small business owners to take advantage of.


Perhaps fortuitously, Congress enacted and the President signed, the Small Business Reorganization Act of 2019 (the “Act”) last fall. The Act went into effect February 19, 2020 and streamlines the chapter 11 bankruptcy process to make it more affordable and accessible to small businesses. To be sure, the Act created a new subchapter (“Subchapter 5”) of chapter 11 of the United States Bankruptcy Code. Relief under Subchapter 5 is limited to small business debtors with non-contingent debts of $2,725,625 or less (if the CARES Act stimulus packet is signed into law the limit will be increased to $7.5 million for one year). Other key provisions of the Act include, but are not limited to, the following:


·       Small Business Election. Debtors must elect to be treated as a “small business” under Subchapter 5.


·       Trustee Appointment. The United States Trustee must appoint a trustee in each Subchapter 5 small business case. Standing Trustees have been appointed across the country to manage such cases. Small business debtors will ordinarily retain control of their business operations, subject to restrictions, as a debtors-in-possession. However, the appointed trustees have some oversight authority, can assist with plan formulation, and are charged with disbursing plan payments to creditors.


·       No Unsecured Creditors’ Committees.  Absent a Bankruptcy Court order, issued for cause, no unsecured creditors’ committee will be appointed in a Subchapter 5 small business case.


·       Plan Protections. Only the debtor may propose a plan of reorganization in a Subchapter 5 small business case. Moreover, the plan to be proposed by the debtor need not adhere to the “Absolute Priority Rule” which otherwise prohibits the owners from retaining equity unless creditors are paid in full. In order to reach confirmation, the debtor need only demonstrate that the plan does not discriminate unfairly, is fair and equitable, and provides for the debtor’s contribution of its total projected disposable income.


·       Streamlined Plan Structure. A status conference is mandated within sixty (60) days of the petition date. No separate disclosure statement must be filed. Instead, information otherwise required to be submitted in a disclosure statement (i.e. business history, liquidation analysis, and financial projections) and approved by the court before distribution, must be included in the plan. The debtor must file its plan within ninety (90) days of the petition date, unless the period is extended by the Bankruptcy Court. The plan must cover a period of not less than three (3) years and no more than five (5) years. The usual plan solicitation and voting process is eliminated, although creditors may lodge objections to the plan.


·       Post-Effective Date Payment of Administrative Claims. Rather than satisfy all administrative claims immediately upon the effective date of the plan, the Subchapter 5 small business debtor may provide for the payment of certain administrative claims over the course (3-5 years) of the plan.  


·       Exception to Prohibition of Residential Mortgage Modification. Whereas otherwise prohibited by the Bankruptcy Code, Subchapter 5 small business debtors may modify a mortgage secured by a lien on a residential property, to the extent the related loan was not obtained to purchase the property and the proceeds were used in connection with the business.  This will provide tremendous relief to many small business owners who fund their business with a second mortgage or home equity line of credit.


·       Discharge Limitations. If the plan is confirmed with the consent of all necessary creditors, then the debtor will receive a discharge of its debts upon confirmation. If however the debtor achieves confirmation through the Bankruptcy Code’s cramdown provisions, the discharge will be granted in measure after the debtor completes all necessary payments during the prescribed period.


The Small Business Reorganization Act is not a cure-all. Even with the streamlined process, many small businesses may find that reorganization is outside of their reach. Still, many more may find the law to be a much-needed respite. Small businesses, creditors, and their respective counsel should take time to understand the opportunities for relief, as well as the consequences and risks, resulting from enactment of the Act.

Link to the article is below:

How Small Business Reorganization Act May Provide a Respite for Those Impacted by COVID-19