Long before COVID-19 (Coronavirus) was even known to most Americans, Congress acted to address a recognized deficiency in the Bankruptcy Code. The expansive provisions for business reorganization under Chapter 11 were too cumbersome, expensive and complex for many smaller businesses, while the options for “mom and pop” enterprises under Chapter 13 were too limited.
To address this “gap,” Congress enacted the Small Business Reorganization Act of 2019 (the SBRA), which expanded the options for small businesses, providing a simplified alternative to Chapter 11. The SBRA became effective on February 19 of this year. The potential relief it offers to small businesses with sound business plans facing temporary difficulties has become both more widely available and more relevant in the face of COVID–19.
The Small Business Reorganization Act of 2019
The SBRA was designed to retain many of the key benefits previously available only through a Chapter 11 bankruptcy filing. For example, the filing of a bankruptcy petition automatically stays all creditor collection actions, providing the debtor with the breathing space it needs to reassess and restructure its business. The debtor has an opportunity to evaluate its leases and executory contracts and to choose which contracts to assume (retain) or reject (terminate). The debtor may also take advantage of a bankruptcy-specific process to sell assets free and clear of liens and encumbrances, as a means to generate cash, reduce debt, or even to liquidate a business, while achieving the maximum return to creditors. Chapter 11 also provides a procedure to obtain financing. Ultimately, the Bankruptcy Code permits the debtor to submit a plan for creditor consideration that provides for the restructuring of its finances and the “reorganization” of its business.
These key reorganization tools were retained in the SBRA, under what is sometimes referred to as “Subchapter V.” In comparison to Chapter 11, Subchapter V is simpler, faster and cheaper for reorganizing a business. It eliminates the appointment of a creditors’ committee, as well as the requirement of filing a disclosure statement with a plan of reorganization. Further, a Subchapter V plan need not comply with the “absolute priority rule,” so that a debtor can retain an ownership interest in its assets even when all creditor claims are not paid in full. Moreover, under Subchapter V, only the debtor can file a bankruptcy plan, giving the debtor greater leverage in negotiations with its creditors.
How the CARES Act Modifies the SBRA
The SBRA is relatively new, and barely had a chance to get off the ground before the country found itself a victim of the current pandemic and the resultant economic fallout. The SBRA suddenly has new relevance for business owners, and in the recently enacted Coronavirus Aid, Relief, and Economic Security (CARES) Act, Congress acted to expand the SBRA in response to the current crisis. The Cares Act contains significant, but temporary, revisions to the Bankruptcy Code intended to open the SBRA to a much larger universe of businesses over the next year.
Under the CARES Act, the definition of a “Small Business Debtor” has been modified to make Subchapter V available to more businesses. To qualify as a Small Business Debtor under the SBRA, the debtor must be a person or entity engaged in commercial or business activity with aggregate secured and unsecured debt of no more than $2,725,625. The CARES Act temporarily increases this limit to $7,500,000. This opens the SBRA to a much broader group of distressed “small” businesses.
The CARES Act also allows debtors to exclude from their income any payments made under Federal law relating to the national emergency declared by the President under the National Emergencies Act with respect to COVID–19. This permits a debtor to pursue reorganization and not be penalized for having received benefits in response to the Coronavirus emergency.
The expanded availability of the SBRA will last for only one year. Therefore, only a temporary opportunity exists for small businesses facing a greater debt load to reorganize under Subchapter V.
In addition to new cases under Subchapter V, pending cases under Chapter 11 (filed due to previous limitations on debt) may be converted to cases under Subchapter V, in appropriate circumstances. The CARES Act amendments also allow for the modification of plans confirmed prior to the Act’s enactment.
In short, when other remedial measures adopted in response to COVID-19 prove inadequate, the expanded Subchapter V may provide necessary relief to a business damaged by this crisis. FLB’s attorneys have extensive experience in financial reorganizations and can provide guidance to businesses and business owners faced with debt and related issues brought about by the COVID-19 pandemic. Please contact us using the form below, or give us a call at 610-797-9000. We wish you well during these extraordinary times.