Jan. 15, 2020 – Effective next month, a new federal law called the Small Business Restructuring Act will simplify the Chapter 11 bankruptcy process for small businesses to help keep operations going while enabling creditors to recover debts owed.

The U.S. Bankruptcy Code, Chapter 11, is supposed to keep businesses operating and keep workers employed while enabling creditors to get the greatest possible recovery.

This form of reorganization has worked well for many large businesses, such as Chrysler, General Motors, Owens Corning, Kmart, and a number of airlines. It does not always work, of course, as we have seen with Circuit City and Toys’R’Us.

The Chapter 11 has also not worked very well for many small businesses.¹ The bureaucratic demands as well as the extensive and expensive disclosure requirements are difficult for many small businesses to meet. 

These requisites add greatly to the expense of reorganization, and the law itself often makes it impossible for small business owners to continue.² The Small Business Restructuring Act of 2019 is designed to rectify these problems for small businesses.

Absolute Priority Rule

Too often, debtors are unable to eliminate debt while retaining their businesses, due to what is known as the “absolute priority rule,” which requires payment in full to a senior class of creditors before any payments can be made to a junior interest.³

Because ownership is the very lowest of junior interests, all creditors must be paid in full unless they consent to other treatment. 

Payment in full is usually impossible. The debtor would not be in Chapter 11 in most instances if he or she could pay creditors in full.

Chapter 11 also has substantial administrative fees. The filing fee alone is $1,717.00.⁴ The debtor must also pay quarterly fees to the U.S. Trustee. These fees are tied to the debtor’s expenses/disbursements but can be very substantial.

The debtor also has additional Chapter 11 burdens not required in other chapters.  For instance, there is an initial debtor interview with the U.S. Trustee. 

More importantly, there is a disclosure statement which can sometimes be extremely lengthy and detailed, and very costly to prepare. 

The Small Business Restructuring Act

Now, Congress has made an effort to fix these problems.⁵ The Small Business Restructuring Act of 2019 (SBRA) takes effect February 19, 2020.⁶ SBRA is designed to make Chapter 11 cases much more like Chapter 12 or Chapter 13 cases.

Eligibility

Only a “small business debtor”⁷ may elect to proceed under the SBRA (also referred to as Subchapter V⁸). A small business debtor may be an individual, partnership, or corporation.⁹ In addition, the definition includes the following:

1. The debtor must be engaged in commercial or business activities;

2. The debtor must have no more than $2,725,625 of total debt;

3. At least 50 percent of that debt must be from the business or commercial activities; and

4. The debtor’s principal activity cannot be a single-asset real estate operation.¹⁰

Subchapter V will only apply if the debtor elects its application.¹¹ If not, normal Chapter 11 procedures will apply.¹²

New Filing Requirements

If the debtor elects to proceed under Subchapter V, the debtor must, at the outset, file the following:

1. A balance sheet;

2. A statement of operations;

3. Cash flow statements;

4. Federal tax returns.¹³

If any of these items do not exist, the debtor may file a signed and sworn statement to that effect.¹⁴

The debtor must also comply with the present debtor reporting requirements under Section 108 for a small business case. These include periodic financial and other reports, including:

1. The debtor’s profitability;

2. Projected cash receipts and disbursements;

3. Comparisons of actual cash receipts and disbursements with projections in prior reports;

4. Reports that the debtor is current on all post-petition tax returns and other required government filings.¹⁵

Trustee

The debtor acts as the debtor-in-possession in Chapter 11. There is no trustee appointed, barring fraud, dishonesty, or incompetence. The debtor-in-possession has nearly all the powers of a typical Chapter 7 trustee. 

In Subchapter V, though, the U.S. Trustee will appoint a trustee for the case.¹⁶ The duties of the trustee will be much like those of a Chapter 12 trustee.¹⁷

A major difference, though, is that the Subchapter V trustee shall “facilitate the development of a consensual plan of reorganization.”¹⁸ This particular duty varies from any other type of trustee under the U.S. Bankruptcy Code. 

While no trustee has yet been appointed in any case, since the law is not yet in effect, this provision implies that the trustee will assist the debtor in developing and promoting the plan of reorganization.

The trustee will also appear and be heard at status conferences and at hearings involving the value of the debtor’s assets, confirmation, plan modification, or sale of assets.¹⁹ If a plan is confirmed, the trustee must ensure that timely payments are made as required by the plan.²⁰

The trustee shall serve until a consensual plan has been substantially consummated.²¹ If there is no consensual plan, the trustee is required to distribute plan payments over the life of the plan.²² In any event, the trustee’s services terminate upon dismissal or conversion.²³

The U.S. Trustee will still have its required oversight functions, as in present Chapter 11 cases.²⁴ Exactly how much oversight the U.S. Trustee will exert in new Subchapter V cases is unclear.

The Process

A status conference is to be held by the court within 60 days from the date of the case filing.²⁵ At least 14 days prior to that conference, the debtor must file and serve on all parties and interests a report. The report must detail the efforts made by the debtor, and to be made by the debtor, to get a consensual plan.²⁶

The trustee must appear at and be heard at the status conference. The debtor must file its plan of reorganization within 90 days from the date of filing.²⁷ Only the debtor may file a plan.²⁸

No disclosure statement is required,²⁹ eliminating a regular Chapter 11 requirement which often proves costly to debtors.

The debtor’s plan is required to include certain disclosures, however, including a brief history of the business operations, a liquidation analysis, and projections demonstrating the ability of the debtor to make the proposed plan payments.³⁰

In some circumstances, the plan may modify the rights of a creditor secured only by the personal residence of the debtor.³¹ This differs from both Chapter 11 and Chapter 13, and may prove beneficial to some Subchapter V debtors, as many small business debtors operate out of their home. 

There typically will be no creditors’ committee.³² In a number of cases, this will result in substantial savings. Creditors’ committees often add substantially to the costs of reorganization.³³

New Costs

The Subchapter V trustee must be compensated. SBRA does not expressly provide for the method of that compensation. However, the cost will need to be borne by the debtor’s estate.³⁴

Many Chapter 11 practitioners have commented already that this additional trustee cost could be substantial and could put the debtor’s success at risk. 

On the other hand, there are no quarterly fees to be paid to the U.S. Trustee under Subchapter V.³⁵ Having no creditor committees should further reduce expenses in many cases.

The fast track upon which Subchapter V cases will travel³⁶ should also reduce overall costs. The elimination of the disclosure statement³⁷ alone will in many cases save a good deal of money.

Contested litigation might also decrease, due to the elimination of the absolute priority rule³⁸ and the ability of the debtor to force a plan confirmation by utilizing cram-down provisions of Section 1129(b). 

The Plan

The plan must be filed no later than 90 days after the filing of the case.³⁹ The court may extend this time, but only for “circumstances for which the debtor should not justly be held accountable.”⁴⁰ The plan must contain the following:

1. Brief history of the debtor;

2. Liquidation analysis;

3. Projections of future performance;

4. Submission of future earnings to fund the plan⁴¹

The plan may modify the rights of secured creditors.⁴²

Plan Confirmation

Chapter 11 requires balloting by creditors.⁴³ Presumably, Subchapter V debtors must also engage in balloting in order to have a consensual plan accepted.

The real benefit to debtors comes from being able to have a plan confirmed even without acceptance by creditors.⁴⁴ To do so, the plan must not discriminate unfairly and must be fair and equitable.⁴⁵

The fair and equitable standard is changed. Creditors must still receive as much under the plan as they would if the debtor were liquidated in Chapter 7.⁴⁶

But Subchapter V now includes an option for the debtor to contribute all of the debtor’s “projected disposable income” to making plan payments for three to five years.⁴⁷

Projected disposable income is income not reasonably necessary to be expended for maintenance or support of the debtor or a dependent (including any post-petition domestic support obligation), or for the payment of expenditures necessary for the continuation, preservation, or operation of a business.⁴⁸

In effect, then, if the business is not making enough money to pay unsecured creditors, these creditors need not be paid. This provision is very similar to the present standards under Chapters 12 and 13.

To confirm the plan, the court must find:

1. That the debtor will be able to make all payments under the plan; or

2. There is reasonable likelihood that the debtor will be able to make all payments under the plan and the plan contains appropriate remedies to protect creditors if payments are not made as proposed.⁴⁹

The statute states that appropriate remedies include the liquidation of non-exempt assets.⁵⁰ If the debtor keeps property that serves as collateral for a creditor, the plan may have to call for the surrender or liquidation of that collateral in the event of the debtor’s default. 

Because the requirement for appropriate remedies is described simply as “including liquidation,” there may be other alternatives.

These might be very similar to the various means by which a debtor provides adequate protection to secured creditors. 

Administrative Expenses

Chapter 11 administrative claims are required to be paid in cash upon the effective date of the plan, unless the holder of such a claim consents to other treatment. Under Subchapter V, post-petition administrative claims may be paid over the life of the plan. This would include taxes and professional fees, including those of the debtor’s counsel. 

Discharge

With a consensual plan, the debtor will receive a discharge at confirmation.⁵¹ Without a consensual plan, the debtor will receive a discharge after completion of all payments due within the 3-5 year term of the plan.

Long-term debt that is amortized and paid beyond the term of the plan will not be discharged.⁵² Again, this is very similar to Chapter 12 and Chapter 13.   

Disinterestedness Standard

Chapter 11 requires professionals employed by the state to be disinterested.  This has often precluded professionals from employment unless they are willing to waive any monies they may be owed by the debtor. 

For example, if the debtor’s accountant is owed $6,000 at the time of filing, the accountant will either have to waive that claim or will not be disinterested and cannot provide services to the debtor. This, in turn, can create a hardship for the debtor and substantial expense in having to retain new accounting professionals.

Sub V provides an exception. A professional will not be ruled disinterested simply because the professional is owed an amount less than $10,000.⁵³

Preferences

The SBRA also amends Section 547, dealing with preferences.  A preference is:

1. A payment or transfer of an interest in the debtor’s property;

2. To or for the benefit of a creditor;

3. For or on account of an antecedent debt;

4. Made while the debtor is insolvent;

5. Made on or within 90 days before the bankruptcy filing (one year if the transfer was for an insider);

6. That enables the creditor to receive more than if the payment had not been made and the claim was paid through a Chapter 7 bankruptcy liquidation.⁵⁴

Preferences are also used by trustees and debtors in possession as clawbacks, taking money back from creditors who had received it prior to the bankruptcy filing.

Under SBRA, the trustee or debtor in possession is required to exercise reasonable due diligence under the circumstances, “taking into account a party’s known or reasonably knowable affirmative defenses.” 

While this provision will not eliminate preference claims, nor should it, it may help deter the assertion of such claims when they should not be made.⁵⁵

Perhaps more importantly, SBRA raises the limit from $13,650 to $25,000 for preference suits to be filed in the district that has bankruptcy jurisdiction. 

If the preference claim is less than $25,000, the preference suit will have to be brought in the federal district where the defendant resides.⁵⁶ These provisions may be of great benefit to Wisconsin creditors in Delaware bankruptcy cases.

Endnotes

¹ H.R. Rep. No. 116-171, at 3 (2019).

² Id.; see also Chad Itar, What Percentage of Small Businesses Fail--And How Can You Avoid Being One of Them, Forbes: Community Voice (Oct. 25, 2018).

³ The absolute-priority rule is provided in 11 U.S.C. § 1129(b). The new requirements are codified in 11 U.S.C. § 1191(c).

⁴ See 28 U.S.C. § 1930(a)(1)(A).

⁵ H.R. Rep. No. 116-171, at 5 (2019). Both the American Bankruptcy Institute and the National Bankruptcy Conference submitted proposals and recommendations to Congress as it drafted the SBRA. See, e.g., Am. Bankr. Inst., Final Report and Recommendations of the Commission to Study the Reform of Chapter 11, 272-304 (2014) [“ABI Report”].

⁶ The SBRA “shall take effect 180 days after the date of enactment (August 23, 2019).” SBRA § 5.

⁷ See 11 U.S.C. § 1183(1). From here on, unless otherwise denoted, all code references are to title 11 of the U.S.C. as amended by the SBRA.

⁸ See SBRA § 2 (declaring that the act shall add another subchapter to Chapter 11 of title 11 of the U.S. Codes).  Subchapter V will contain § 1181 – 1195 of the Bankruptcy Code.

⁹ See § 101(51D).

¹⁰ Id. (for all). 

¹¹ See § 103(i).

¹² See, e.g., § 1116 (mandatory nature of duties in a small business case); see also § 1121(e) (requirements pertaining to a plan, disclosure statement and confirmation in small business case).

¹³ See § 1116(1)(A) (for all).

¹⁴ See § 1116(1)(B).

¹⁵ See 11 U.S.C. 308.

¹⁶ See § 1183(a).

¹⁷ See § 1183(b)(1)-(6).

¹⁸ See § 1183(c)(7).

¹⁹ See § 1183(b)(3).

²⁰ See Id.

²¹ See § 1183(c)(7).

²² See § 1191(b).

²³ See 28 U.S.C. § 586(e)(5).

²⁴ See Adam D. Herring and Walter W. Theus, “New Laws, New Duties: USTP’s Implementation of the HAVEN Act and the SBRA,” XXXVIII ABI Journal 10, 12-13, 68, October 2019.

²⁵ See § 1188(b).

²⁶ See § 1188(c).

²⁷ See § 1189(b).

²⁸ See § 1189(a).

²⁹ See § 1187(c) (stating that 1125(f)—providing that the disclosure statement is either not necessary, may be submitted on standard forms, or may be conditionally approved subject to final notice and a hearing—will apply).

³⁰ See § 1190 (detailing what a plan filed under Subchapter V shall include).

³¹ See § 1190(3) (provided that (A) the security interest was not used to acquire the residence, and (B) the security interest was used primarily in connection with the small business).

³² See § 1181(b).

³³ See ABI Report at 293.

³⁴ Trustees will either compensated as standing trustees, provided for by 28 U.S.C. § 568(e)(5), or as case trustees. The SBRA does not explicitly provide for compensating case trustees. However, such would presumably be entitled to compensation under § 330(a)(1).

³⁵ See 28 U.S.C. § 1930(a)(6)(A).

³⁶ See § 1189(b) (if not extended, a debtor must file a plan within 90 days of the case commencing).

³⁷ See § 1181(b).

³⁸ See § 1191(c).

³⁹ See § 1189(b).

⁴⁰ See Id.

⁴¹ See § 1190(1).

⁴² See § 1190(3) (provided that (A) the security interest was not used to acquire the residence, and (B) the security interest was used primarily in connection with the small business).

⁴³ See § 1129.

⁴⁴ See § 1191(b).

⁴⁵ See Id.

⁴⁶ See § 1191(c)(3)(B).

⁴⁷ See § 1191(c)(2)(A).

⁴⁸ See § 1191(d).

⁴⁹ See § 1191(c)(3)(A) (for both).

⁵⁰ See § 1191(c)(3)(B).

⁵¹ See § 1192.

⁵² See Id.

⁵³ See § 1195.

⁵⁴ See SBRA § 3.

⁵⁵ Id.

⁵⁶ See Id.