The global COVID-19 pandemic continues to wreak havoc on the U.S. economy. Stay at Home orders issued by governors in all but a handful of states required, with certain exceptions, closure of all but those businesses deemed to be “essential.” While Congress has passed a series of measures meant to stem and mitigate financial impacts, a very large percentage of American small businesses will struggle to survive as states, counties and cities slowly lift restrictions and permit businesses to reopen. As this occurs, many small businesses will experience revenue contraction, waning liquidity and a lack of access to capital resources. Such businesses will find it exceedingly difficult to successfully resume and continue operations without an infusion of cash and significant restructuring of debt.
Enter the Small Business Reorganization Act of 2019 (SBRA). SBRA took effect on Feb. 19, 2020, under Subchapter 5 to Chapter 11 of the Bankruptcy Code. The SBRA was enacted in response to criticisms that the Chapter 11 reorganization process had become very expensive and Chapter 11’s protections were thus often unavailable to small businesses. As originally enacted, SBRA relief was limited to a “small business debtor” with no more than $2,725,625 of non-contingent debt. On March 27, 2020, however, Congress passed the Coronavirus Aid, Relief and Economic Security Act (CARES Act) and expanded SBRA’s definition of “small business debtor” to include businesses with debts of $7.5 million or less. At least 50 percent of a small business debtor’s debt must arise from business or commercial activity. The enhanced $7.5 million debt ceiling under CARES will sunset (unless renewed) one year from the date of its enactment.
The SBRA contains a number of key provisions intended to streamline the reorganization process and decrease costs, including:
- A debtor must elect to be a “small business debtor” under Subchapter 5.
- Subchapter 5 Trustees. The US Trustee’s Office will appoint a trustee in each case from among a standing panel of trustees established within the jurisdiction. Although the small business owner will retain authority to operate the business as a debtor in possession, the trustee will perform certain oversight functions, including the administration of payments under a confirmed plan.
- No Creditor Committees. Creditor committees will not be appointed in Subchapter 5 cases unless ordered by the Bankruptcy Court for cause.
- No Competing Plans. The debtor has the exclusive right to file a plan, which must be filed within 90 days from the date of the bankruptcy petition unless extended for cause.
- No Disclosure Statements. Disclosure statements are not required, although the plan must include information typically found in a disclosure statement, including a summary of historical operations, liquidation analysis and projections demonstrating an ability to make payments under the plan.
- No Absolute Priority. The debtor need not comply with the “absolute priority rule,” which generally prohibits the owners from retaining equity unless all creditors are paid in full. A plan may be confirmed over the objection of one or more impaired classes of creditors. In order to obtain confirmation through a “cramdown,” a debtor need only demonstrate that the plan is fair and equitable, does not unfairly discriminate and provides for the debtor’s contribution of all of its projected disposable income.
- Deferral of Administrative Expense Payments. Administrative expenses that typically must be paid upon the effective date of the plan may be deferred over the life of the plan for up to five years.
- Discharge Provisions. If the plan is confirmed with the consent of all affected creditors, the debtor will receive a discharge of its debts upon plan confirmation. For plans confirmed through “cramdown”, the discharge will take effect when all of the payments called for under the plan are made.
- Residential Mortgage Modification. The SBRA authorizes a small business debtor to modify a residential real estate mortgage to the extent that proceeds from the loan were used to fund the business, a form of relief previously unavailable under the Bankruptcy Code.
Even before the CARES Act legislation increased the small business debtor cap to $7.5 million, some estimated that approximately one-half of all Chapter 11 debtors would meet the SBRA definition of a small business debtor. We, therefore, anticipate that Subchapter 5 cases will become widespread – especially as lingering effects of the COVID-19 pandemic further strain available resources.
Taft lawyers are among the first in the country to successfully guide clients through a Subchapter 5 case. Earlier this month, Karl Johnson of Taft’s Minneapolis office secured confirmation of what is believed to be the first approved Subchapter 5 plan in Minnesota and the states comprising the Eighth Circuit. If you, like so many of our nation’s small business owners, are reeling from the effects of the coronavirus, we at Taft are eager to help you to explore in-court and out-of-court restructuring, recapitalization or related opportunities.
Please visit our COVID-19 Toolkit for all of Taft’s updates on the coronavirus, and feel free to contact any member of our Distressed Business Task Force with questions.