CARES Act Temporarily Increases Debt Limit for Small Business Debtors, Creating Potential for Wave of Reorganization Cases
The measures adopted across the United States to stop the spread of COVID-19 have substantially impacted small businesses, with even thriving businesses facing a temporary but steep decline in, or in many instances loss of all, revenue while social distancing and stay at home orders are in place. Small businesses have limited access to capital and, therefore, limited ability to weather the current crisis.
Recognizing the immediate and potentially irreparable harm even the temporary reduction or elimination of revenue will cause small businesses, the Coronavirus Aid, Relief and Economic Security Act (the CARES Act) enacted last week provides over $360 billion for small business loan programs and contains important temporary amendments to the Small Business Reorganization Act (the SBRA), which itself just became effective on February 19, 2020, and remains largely untested. While the small business loan programs will save some small businesses, it is reasonable to anticipate the first wave of bankruptcy filings resulting from the current economic crisis will be cases filed by small business debtors seeking to reorganize under the SBRA.
Overview & Eligibility
The SBRA is designed to provide an efficient and streamlined reorganization process for individuals operating sole proprietorships and small business entities with obligations that exceed the debt limits for chapter 13 (or are ineligible for chapter 13 because they are not individuals) but for which the expense of a full chapter 11 case and the requirements for plan confirmation make reorganization under chapter 11 almost impossible. As originally enacted, to qualify to file under the SBRA, at least 50% of the debtor’s debt must have risen from commercial or business activity, and the debtor could not have more than $2,725,625 in debt. The CARES Act temporarily increases the debt limit to $7.5 million for cases filed on or before March 27, 2021. Single asset real estate debtors are not eligible to file under the SBRA.
While cases filed under the SBRA will be designated chapter 11 cases, there will be no committees of unsecured creditors (unless the court orders otherwise) and debtors will not be required to pay quarterly U.S. Trustee fees. These revisions alone remove significant financial burdens to maintaining a chapter 11 case for a sole proprietor or small business.
Borrowing concepts from chapter 13 of the Bankruptcy Code, the SBRA provides that the small business debtor will remain in possession of its assets and be permitted to operate its business, but the United States Trustee will appoint a case trustee to oversee and monitor small business debtor cases. A small business debtor may be displaced from serving as a debtor in possession “for cause,” which includes fraud, dishonesty, incompetence, or gross mismanagement of the affairs of the debtor, either before or after the commencement of the case, or a failure of the debtor to perform the obligations of the debtor under a confirmed plan. The inclusion of bad acts prior to the commencement of the case is a meaningful change from existing chapter 11 practice, which primarily focuses on bad acts occurring after the commencement of a case as a basis for appointment of a trustee. If a debtor in possession is removed for cause, the case trustee will take over possession of the debtor’s assets and operation and management of the debtor’s business.
Modified Standards for Plan Confirmation
The SBRA modifies many of the requirements for plan confirmation and precludes creditors from proposing competing plans. The absolute priority rule does not apply in SBRA cases, which will permit owners of small business debtors to retain their equity interest without making a new value capital contribution or undertaking the burdensome and sometimes expensive process of demonstrating the value (or lack thereof) of their ownership interests. Small business debtors also will not be required to obtain an impaired accepting class to confirm a plan so long as the plan does not discriminate unfairly and the plan is fair and equitable as to each impaired nonconsenting class.
In a small business case, a plan is fair and equitable if: (a) the treatment of secured claims satisfies the existing requirements of section 1129(b)(2)(A); (b) the plan provides for application of all debtor’s projected disposable income for three years beginning on the date the first payment is due under the plan (or five years, if ordered by the court); and (c) the debtor demonstrates that it will be able to make all plan payments or that there is a reasonable likelihood that the debtor will be able to make all plan payments. Disposable income for a small business debtor is defined as income received by the debtor that is not reasonably necessary to be expended for: (a) the maintenance or support of the debtor or a dependent of the debtor; (b) a domestic support obligation that first becomes payable after the date of the filing of the petition; and (c) the payment of expenditures necessary for the continuation, preservation, or operation of the debtor’s business.
Small business debtors also will not be required to file a disclosure statement (unless the court orders otherwise), thereby avoiding the expense of having counsel prepare that document and avoiding costly fights over the adequacy of information contained in a disclosure statement. However, a plan filed in a small business case must include certain disclosures typically included in a disclosure statement, including a brief history of the business operations of the debtor, a liquidation analysis, and projections with respect to the ability of the debtor to make payments under the proposed plan.
Secured creditors will still be able to make an election under 1111(b) of the Bankruptcy Code; however, the deadline for doing so will no longer be tied to the approval of a disclosure statement and, instead, courts will establish a deadline by separate order or local rule.
A plan proposed by a small business debtor must also provide “appropriate remedies, which may include the liquidation of nonexempt assets” to protect creditors if the debtor fails to make plan payments.
Each of these revisions removes significant legal impediments that previously caused many small business chapter 11 cases to fail and should reduce the expense to the debtor of seeking plan confirmation. These revisions also make it substantially more likely that small business debtors will be able to confirm plans and remove many of the obstacles to plan confirmation that creditors previously used to prevent plan confirmation and obtain dismissal or conversion of small business cases.
Role of the Case Trustee
The case trustee is required to appear at the initial case conference (which must be conducted within 60 days of the commencement of the case) and any hearing that concerns the value of property subject to a lien, plan confirmation, post-confirmation modification of a plan, or sale of property of the estate. The case trustee is to facilitate the development of a consensual plan of reorganization, generally perform the duties of a chapter 13 trustee, and be accountable for assets of the estate. The case trustee is also responsible for certain reporting for which the debtor in possession previously had responsibility.
The case trustee has standing to be heard at all hearings during the case and is accountable for all property received by the small business debtor during the case. The case trustee is also required to respond to requests for information about the case from creditors and parties in interest. The case trustee will also make adequate protection payments to secured creditors prior to confirmation of a plan. If a consensual plan is confirmed, the case trustee’s role will terminate upon substantial consummation of the plan. If the plan is not consensual, the trustee will be responsible for making distributions under the plan.
The case trustee in small business cases will be compensated in the same manner as chapter 13 trustees.
Modification of Claims Secured by a Debtor’s Principal Residence
An important new power granted to small business debtors is the ability to modify claims secured by a debtor’s prinicipal residence if the debt was not used primarily to acquire the real property but rather was used primarily in connection with the debtor’s business.
Timeline & Discharge
SBRA cases are required to proceed quickly. Within 60 days of the petition date, the court must hold a status conference. The small business debtor must file a report 14 days prior to the status conference detailing the small business debtor’s efforts to achieve a consensual plan of reorganization. The small business debtor must file its plan of reorganization within 90 days of the order for relief. The deadline for filing a plan of reorganization may be extended by the bankruptcy court only if an extension is necessary because of “circumstances for which the debtor should not justly be held accountable.”
Small business debtors will receive a discharge of debts upon confirmation of a consensual plan. If the plan is not consensual, small business debtors will receive a discharge upon completion of plan payments over the time fixed by the court, from three to five years.
Attorneys in Ballard Spahr’s Bankruptcy, Reorganization & Capital Recovery Group are well-prepared to assist creditors and small businesses in navigating the unchartered territory of small business debtor cases under the SBRA and are currently assisting lenders and small businesses in navigating the process of applying for and documenting emergency small business loans available under the CARES Act.
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