Congress Expands Small Business Bankruptcy Relief in Historic Coronavirus Aid Bill

Bankruptcy & Creditors’ Rights Alert

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Small businesses often struggle to reorganize in bankruptcy.  To address this issue, Congress passed the Small Business Reorganization Act of 2019.  The act took effect in February 2020 and makes small business bankruptcies faster and less expensive. At the time of enactment, the act only applied to business debtors with secured and unsecured debts less than $2,725,625.

On March 27, 2020, Congress passed historic legislation in response to the COVID-19 pandemic and resulting economic crisis, including substantial federal spending and loan commitments that will benefit individuals and businesses. 

But that is not all. Congress has expanded small business eligibility to take advantage of the recent amendments to the Bankruptcy Code. Now small businesses with up to $7.5 million in debt (with some qualifications) may seek relief under these new provisions. 

Notable provisions of the Bankruptcy Code available to more small businesses include:

  • Appointment of a Trustee - The new small business subchapter 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 Reorganization - Only the small business in bankruptcy can propose a plan of reorganization, which must be submitted 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. Absent an order from the court, the new small business bankruptcies will not have committees of unsecured creditors. This will further reduce costs of bankruptcy for small businesses.
  • Elimination of the Absolute Priority Rule - In a typical reorganization, the small business must pay unsecured creditors in full if the owners wish to retain their equity interests. This requirement is no longer applicable to eligible small businesses. Rather than paying all creditors in full, owners can keep their interests by confirming a plan that does not discriminate unfairly among creditors, is fair and equitable, and provides that the small business will contribute its projected disposable income to the plan.
  • Modification of Certain Residential Mortgages - An individual who operates as an eligible small business may modify a mortgage secured by a residence if the underlying loan was for commercial purposes. This is a change from prior law that generally prohibited modification of mortgages secured by a principal residence.
  • Delayed Payment of Administrative Expense Claims - The new subchapter for small businesses does not require payment in full of priority claims – including for goods and services provided to the small business 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 last three to five years.
  • Discharge Limitations - The scope of the discharge of debts for the small business will depend upon the terms of the plan and the consent of creditors. If 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 reorganization that has very limited exceptions to discharge.

Congress has attempted to remedy obstacles to small business reorganization by expanding access to the new subchapter of the Bankruptcy Code. But all small businesses will not enjoy this relief for long. There is a one-year deadline for small businesses with debts up to $7.5 million to file cases under the new subchapter of the Bankruptcy Code. Small businesses in financial distress — along with their creditors — must be prepared for these new and unique bankruptcy cases.