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The Small Business Reorganization Act of 2019

Oct. 10, 2020

Congress passed the Small Business Reorganization Act of 2019 (the “SBRA”) to create a more favorable route for small businesses to seek bankruptcy protection. The SBRA created the new Subchapter V to Chapter 11 of the Bankruptcy Code. Among various other changes, subchapter V creates a streamlined and sped up process for a business to survive Chapter 11 and receive a discharge.

Who Qualifies?

To qualify for electing treatment under subchapter V, the debtor must show that (1) 50% or more of the debt arises from commercial or business activities of the debtor, (2) the debtor is not a single asset-real estate debtor, (3) the debtor is not a publicly traded company, and (4) the aggregate non-contingent liquidated and unsecured debts as of the petition date or date of order of relief of not more than $2,725,625 (for a limited time, based on the CARES Act, until March 27, 2021 this debt limit was increased to $7,500,000).

Big Changes from the SBRA

The SBRA and subchapter V created a few “big” changes in the way the Chapter 11 process will work for debtors, including:

(1) Increased speed of cases – a plan must be filed within 90 days of the petition

(2) Increased efficiency for debtor – no creditor’s committee and no disclosure statement required for proposed plans

(3) Increased authority for debtor – only the debtor may file a plan (no competing creditor’s plans)

(4) Avoidance of the “absolute priority rule” – debtors have new rules for “cramdown” of unsecured claims. Practically speaking, this means there is a much higher likelihood of existing owners retaining their equity in the discharged entity

(5) The appointment of a trustee, other than the DIP, to assist with creating a consensual plan

(6) No quarterly US trustee fees

Biggest Benefits of SBRA Changes

A few of these changes drastically enhance the likelihood of a small business will survive bankruptcy as well as incentivizing small business owners to use the bankruptcy process.

The biggest change is doing away with the “absolute priority rule.” The absolute priority rule provided that no junior class of claims could receive anything until the prior (senior) class of claims was paid in full. Basically, the order of claims is secured claims, priority claims, unsecured claims, then equity holders. So unless a Chapter 11 debtor paid all unsecured claims in full, the debtor’s owners could not keep their equity (with a few exceptions). Now, the SBRA allows the debtor to file a plan that pays out the “projected disposable income” of the debtor, which may be less than 100% payments to unsecured creditors, yet the equity owners are able to retain their ownership interests. Obviously, the ability for owners to retain equity creates much more incentive for management/owners to utilize the Chapter 11 process.

The SBRA and subchapter V also help small businesses survive the bankruptcy process by allowing only the debtor to file a plan and creating a shortened time period for filing a plan. This means that creditors may object to a plan, but may not file a competing plan.

In addition, the subchapter V debtor may also confirm a plan without obtaining the approval of an impaired class of creditors. The plan can be confirmed even if no impaired class consents to the plan.

How Does the SBRA streamline the Chapter 11 process?

Subchapter V also does away with the committee of creditors. There are a few advantages to the debtor by removing the creditors’ committee, including reducing the overall cost since the estate will not need to pay counsel for the creditors’ committee and, because only the debtor can propose a plan, there are no competing plans filed by creditors or the creditors’ committee.

The SBRA drastically speeds up the timing on the proposal of a plan (from 300 days to 90 days) which means that the bankruptcy will be shorter. Subchapter V also removes the requirement to file a disclosure statement along with the plan.

Confirmation of a Plan Made Easier

The SBRA makes the confirmation of a plan easier in a few different ways. First, the trustee in a subchapter V case is there to help “create a consensual plan” of reorganization. What this means is that the trustee assists in obtaining consent from all classes of creditors to approve the plan.

Subchapter V also allows for confirmation even over the objection of all classes of creditors. Whereas, in a typical Chapter 11 the debtor would be required to obtain the consent of at least one class of “impaired” creditors to “cramdown” the plan. That consenting class is not required under the new SBRA rules – meaning that the debtor can confirm a plan over the objection of all classes of creditors.

The SBRA also does away with the “absolute priority rule” which means there is a much higher likelihood of existing owners retaining their equity in the discharged entity.