Small businesses often struggle to reorganize effectively under Chapter 11 of the Bankruptcy Code. To address this issue, Congress passed the Small Business Reorganization Act of 2019, creating a new subchapter of Chapter 11 of the Bankruptcy Code. The Act takes effect in February 2020. Businesses, lenders and other creditors should understand the risks and opportunities created by this new subchapter of the Bankruptcy Code.
The Act aims to make small business bankruptcies faster and less expensive. At this time, the Act only applies to business debtors with secured and unsecured debts, subject to certain qualifications, less than $2,725,625.
Some notable provisions of the Act include:
Appointment of a Trustee. The Act provides for the appointment of a trustee who will help facilitate reorganization and may monitor payments to creditors under the debtor’s confirmed plan.
Streamlining of the Reorganization Process. Only the debtor can propose a plan of reorganization, and must submit its plan within 90 days of the bankruptcy filing. The court does not have to approve a separate disclosure statement, reducing the time and expense necessary to confirm the debtor’s plan. The Act does not provide for a committee of unsecured creditors, absent an order from the Court. Removing the creditors’ committee should further reduce costs associated with the bankruptcy.
Elimination of the Absolute Priority Rule. In a typical Chapter 11, the debtor must pay unsecured creditors in full if the business owners wish to retain their equity interests. The Act removes this requirement. This is a significant change from prior law. In most cases, particularly with closely-held businesses, the business owners want to keep their ownership interests. Under the Act, plan confirmation only requires that the plan does not discriminate unfairly, is fair and equitable, and provides that the debtor will contribute all of its projected disposable to the plan.
Modification of Certain Residential Mortgages. The Act also removes the categorical prohibition against individual small business debtors modifying their residential mortgages. A small business debtor may now modify a mortgage secured by a residence if the underlying loan was for commercial purposes.
Delayed Payment of Administrative Expense Claims. The Act removes the requirement that the debtor pay priority claims – including for goods and services provided to the debtor during bankruptcy – on the effective date of the plan. A small business debtor may now stretch payment of these claims out over the term of the plan, which will typically last about five years.
- Discharge Limitations. The scope of the small business debtor’s discharge of debts will now depend upon the terms of the plan and the consent of creditors. If the creditors contest the plan, exceptions to a discharge, such as fraud and breach of fiduciary duty, will apply to the small business debtor. This is a departure from a typical business Chapter 11 that only has very limited exceptions to discharge.
The benefits of Chapter 11 reorganization have been elusive to small business debtors given their size and limited financial resources. The Act attempts to remedy these obstacles. If the Act proves successful, there may be a legislative push to increase the debt limit and provide more businesses access to the new subchapter.
The original article, "What New Bankruptcy Law Means for Small Businesses," was published in the Birmingham Business Journal on November 25, 2019.