Author: Andrew M. Thaler
The Small Business Reorganization Act of 2019 will take effect on February 22, 2020. The new law permits a small business debtor (“SBD”) to reorganize under what is known as Subchapter V of chapter 11.
A person or entity engaged in commercial or business activity with aggregate secured and unsecured debts of $2,725,625 can qualify to be a SBD (The new law does not count contingent and unliquidated debtor in calculating total debts such as unresolved tort claims and guarantees). More than 50 percent of its debts must arise from such activities. “Single Asset Real Estate” cases are excluded from eligibility.
A person or entity engaged in commercial or business activity with aggregate secured and unsecured debts of $2,725,625 can qualify to be a SBD (The new law does not count contingent and unliquidated debtor in calculating total debts such as unresolved tort claims and guarantees). More than 50 percent of its debts must arise from such activities. “Single Asset Real Estate” cases are excluded from eligibility.
As in a conventional chapter 11, a SBD is permitted to operate as a debtor-in-possession. The SBD will file Schedules and a Statement of Financial Affairs that discloses it assets, liabilities and other information regarding its financial affairs.
The SBD must file a copy of its most recent balance sheet, statement of operations, cash-flow statement and federal income tax return.
In conventional chapter 11 cases the Office of the United States Trustee selects creditors to serve on a Creditors Committee to be watchdogs over the reorganization. In reality, most creditors in small bankruptcy cases show little interest in serving on a Creditors Committee. For that reason, the new law basically eliminates the need for the Unites States Trustee to constitute a committee unless the court orders otherwise. Accordingly, Creditors Committee is expected to be the exception and not the rule in these cases.
Highlights of the new law include:
i. Professionals are not disqualified from being employed by the estate if their claim against the debtor is $10,000 or less. This avoids debtor’s pre-petition counsel from being barred from the case unless they waive their fees. It also makes it easier for the debtor to have representation, as debtors often do not have sufficient cash flow to pay a retainer to new counsel.
ii. Every SBD case will have a trustee appointed. The trustee will act as a conduit for plan payments and have authority to investigate the financial affairs of the debtor, object to claims, to appear at the hearing on plan confirmation and a general obligation to “facilitate the development of a consensual plan of reorganization.” As this early stage it is unclear how the trustee system will work in a SBD case including who will serve as trustee and how that person will be compensated given that the trustee’s rule is terminated upon “substantial consummation” of the confirmed plan.
iii. Only the debtor is allowed to propose a plan. There can be no competing plan, which is different than a conventional chapter 11.
iv. The SBD does not have to solicit plan acceptances or disseminate a Disclosure Statement. The Plan of Reorganization will now include the history of the debtor, the liquidation analysis and projections that were all previously required to be in the Disclosure Statement. Theoretically, the elimination of voting and preparation of and hearing to approve the Disclosure Statement will streamline and make the process less expensive.
v. If the SBD is an individual, he/she may be able to modify a non-purchase money mortgage on a principal residence that was used for business purposes. This is a benefit to a SBD not available in chapter 13 or 11. In Subchapter V the debtor may be able to lower interest rates, extend the maturity date of a mortgage or lower the mortgage amount to the value of the collateral or security interest, something commonly referred to as a cram down or strip down.
vi. The SBD does not have to obtain the acceptance of an impaired class of creditors as is necessary in chapter 11. However, if the plan is confirmed without the consent of all impaired classes, (i) all property acquired post-petition becomes property of the estate; (ii) the debtor must commit all of its “projected disposable income” to plan payments for a minimum of three years and a maximum of 5 years; and (iii) demonstrate a “reasonable likelihood” that it will be able to make all payment under the plan. Drawbacks to these provisions are that SBD’s are more likely to be incapable of paying expense for unforeseen events and unable to use property outside the ordinary course of business. This is because (i) a debtor cannot use property of the estate out of the ordinary course of business without obtaining court approval and (ii) “disposable income” includes income not reasonably necessary to (1) maintain and support the debtor or a dependent, (2) satisfy domestic support obligations that become due after the filing; or (2) ensure the continuation, preservation, or operation of the business.
vii. Equity holders of the SBD maybe able to retain their interests in the business even if the plan does not pay creditors in full, something not available in chapter 11, as long the plan “does not discriminate unfairly, and is fair and equitable” with respect to the impaired creditors. While this is possible it does come at a price including the fact that a discharge of debts will not issue until all payments under the plan have been made.
On its face the new law appears friendlier and more attractive to small business debtors. Whether that translates to reality remains to be seen. As an example, although a case can be confirmed without acceptance by an impaired class, it comes with the downsides mentioned above, which can significantly restrict the business owners ability to have flexibility and full autonomy in operating its business after confirmation.
The SBD must file a copy of its most recent balance sheet, statement of operations, cash-flow statement and federal income tax return.
In conventional chapter 11 cases the Office of the United States Trustee selects creditors to serve on a Creditors Committee to be watchdogs over the reorganization. In reality, most creditors in small bankruptcy cases show little interest in serving on a Creditors Committee. For that reason, the new law basically eliminates the need for the Unites States Trustee to constitute a committee unless the court orders otherwise. Accordingly, Creditors Committee is expected to be the exception and not the rule in these cases.
Highlights of the new law include:
i. Professionals are not disqualified from being employed by the estate if their claim against the debtor is $10,000 or less. This avoids debtor’s pre-petition counsel from being barred from the case unless they waive their fees. It also makes it easier for the debtor to have representation, as debtors often do not have sufficient cash flow to pay a retainer to new counsel.
ii. Every SBD case will have a trustee appointed. The trustee will act as a conduit for plan payments and have authority to investigate the financial affairs of the debtor, object to claims, to appear at the hearing on plan confirmation and a general obligation to “facilitate the development of a consensual plan of reorganization.” As this early stage it is unclear how the trustee system will work in a SBD case including who will serve as trustee and how that person will be compensated given that the trustee’s rule is terminated upon “substantial consummation” of the confirmed plan.
iii. Only the debtor is allowed to propose a plan. There can be no competing plan, which is different than a conventional chapter 11.
iv. The SBD does not have to solicit plan acceptances or disseminate a Disclosure Statement. The Plan of Reorganization will now include the history of the debtor, the liquidation analysis and projections that were all previously required to be in the Disclosure Statement. Theoretically, the elimination of voting and preparation of and hearing to approve the Disclosure Statement will streamline and make the process less expensive.
v. If the SBD is an individual, he/she may be able to modify a non-purchase money mortgage on a principal residence that was used for business purposes. This is a benefit to a SBD not available in chapter 13 or 11. In Subchapter V the debtor may be able to lower interest rates, extend the maturity date of a mortgage or lower the mortgage amount to the value of the collateral or security interest, something commonly referred to as a cram down or strip down.
vi. The SBD does not have to obtain the acceptance of an impaired class of creditors as is necessary in chapter 11. However, if the plan is confirmed without the consent of all impaired classes, (i) all property acquired post-petition becomes property of the estate; (ii) the debtor must commit all of its “projected disposable income” to plan payments for a minimum of three years and a maximum of 5 years; and (iii) demonstrate a “reasonable likelihood” that it will be able to make all payment under the plan. Drawbacks to these provisions are that SBD’s are more likely to be incapable of paying expense for unforeseen events and unable to use property outside the ordinary course of business. This is because (i) a debtor cannot use property of the estate out of the ordinary course of business without obtaining court approval and (ii) “disposable income” includes income not reasonably necessary to (1) maintain and support the debtor or a dependent, (2) satisfy domestic support obligations that become due after the filing; or (2) ensure the continuation, preservation, or operation of the business.
vii. Equity holders of the SBD maybe able to retain their interests in the business even if the plan does not pay creditors in full, something not available in chapter 11, as long the plan “does not discriminate unfairly, and is fair and equitable” with respect to the impaired creditors. While this is possible it does come at a price including the fact that a discharge of debts will not issue until all payments under the plan have been made.
On its face the new law appears friendlier and more attractive to small business debtors. Whether that translates to reality remains to be seen. As an example, although a case can be confirmed without acceptance by an impaired class, it comes with the downsides mentioned above, which can significantly restrict the business owners ability to have flexibility and full autonomy in operating its business after confirmation.
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