SMALL BUSINESS REORGANIZATION ACT
HELLER, DRAPER, PATRICK, HORN & MANTHEY, LLC
650 POYDRAS STREET, SUITE 2500
NEW ORLEANS, LOUISIANA
A. Financial Challenges to Small Businesses Due to Covid-19
The social distancing/shutdown protocol/declaration of emergency (and the impending recession) because of the coronavirus has led (and will continue to lead) to extraordinary financial impact on small businesses. For small businesses that are unable to successfully negotiate with their creditors, lenders, and/or landlords, an alternative option to consider is to file for chapter 11 bankruptcy relief under the Small Business Reorganization Act (the “SBRA”) which went into effect on February 20, 2020.
Prior to the implementation of the SBRA, many small businesses were reluctant to file for chapter 11 due to high costs and delays. In 2019, Congress passed the SBRA to provide a new streamlined version of chapter 11 reorganization for small businesses. The intent of the SBRA is to promote simplicity and efficiency by eliminating some of the more costly elements of a traditional chapter 11 case and incorporating certain expedited procedures.
B. What Relief Does Filing Under the SBRA Provide to Small Businesses?
Filing for bankruptcy relief will automatically stop foreclosures, evictions and litigation, as well as give the “small business” an opportunity to restructure its debts (including taxes) and cure defaults under any lease under a plan of reorganization.
The ultimate goal of a case under the SBRA is to obtain confirmation (judicial approval) of a plan of reorganization, which legally binds the creditors to a new repayment schedule for debts of the company and prohibits the creditors from taking action against the debtor because of prior defaults in the payment of those obligations. The plan becomes the new legal arrangement between the company on the one hand and the creditors on the other.
Plans usually provide for the payment over time, often on a re-amortized basis, of debt which is secured by collateral which the debtor needs to operate its business (i.e. equipment, inventory, automobiles, fixtures, etc.), to pay tax obligations and other priority claims over a number of years, and the reasonably prompt cure of defaults in any leases which the company wants to keep in place on a go-forward basis. With respect to all other unsecured debts of the company, the plan can provide for the payment of the “disposable income” of the company for three years in full satisfaction of the unsecured creditors, even if that only pays a fraction of the total unsecured debt. And, under the SBRA, the plan can provide that the owners can still continue to own the business.
C. Who Can File for Relief Under the SBRA?
An individual person, partnership, limited liability company, corporation or other legal business entity may file for relief under the SBRA; however, in order to take advantage of the SBRA, that person or entity must fall under the definition of “small business debtor”. Under the Bankruptcy Code, a “small business debtor” is defined as a person or entity engaged in commercial or business activity with aggregate non-contingent and liquidated secured and unsecured debts of no more than $7,500,0001 and with at least 50 percent of its pre-petition debts arising from commercial or business activities.
D. What are the Advantages of Filing for Relief under the SBRA Compared to a Traditional Chapter 11 Case?
If you fall under the definition of a “small business debtor”, the SBRA has many improvements compared to a traditional chapter 11. First, it is less expensive. Small business debtors do not have to prepare and file a lengthy disclosure statement in order to confirm a plan of reorganization, a requirement which is costly and builds in delay. Furthermore, unsecured creditors committees may not be appointed unless ordered by the court for cause. This is important because creditor committees increase administrative costs and those costs are paid by the debtor. Under the SBRA, the debtor must file its plan of reorganization within 90 days of filing and that deadline can be extended only if circumstances exist for which the debtor should not be held accountable. And as a matter of strategy, there is no reason not to file a plan of reorganization almost immediately upon filing the case so the restructuring process can be concluded as soon as possible. Thus, the plan process is quicker than in a traditional chapter 11, which decreases administrative costs. Finally, in a traditional chapter 11, administrative expenses must be paid on the effective date of the plan. Under the SBRA, however, administrative expenses can be paid over time.
1 Under the Keeping Americans Workers Paid and Employed Act likely to be signed into law this week, the debt threshold limit has been increased from $2,725,625 to $7,500,000 for one year from that and then the eligibility threshold limit will revert back to $2,725,625. Therefore, if you have debts over $2,725,625 but less than $7,500,000 and you are interested in filing bankruptcy utilizing the new Act, it would be prudent to file this year.
There are also major changes that alter the leverage over the restructuring process in favor of the small business. First, unlike in a traditional chapter 11, the SBRA permits equity owners to retain their ownership in the company under a restructuring plan without requiring that either (1) unsecured creditors are to be paid in full, or (2) unsecured creditors vote to accept less than full payment, or (3) the owners infuse significant “new value” (cash) into the company. Instead, in order for equity owners to retain their ownership, the SBRA requires that the plan commit the debtor’s disposable income to pay creditors over a three to five-year period. This commitment of disposable income may not be a significant “go forward” obligation of the business because “disposable income” consists only of income of the debtor that is not reasonably necessary for (A) the maintenance or support of the debtor or a dependent of the debtor; or (B) a domestic support obligation that first becomes payable after the date of the filing of the petition, or, (C) the payment of expenditures necessary for the continuation, preservation, or operation of the business of the debtor.
Many small businesses will not have significant projected disposable income for the first three years. Therefore, many small businesses will be able to reorganize, and the owners continue to own the business, yet pay only a fraction of their unsecured debts. And there is nothing that prevents the amount of the projected disposable income from being paid early or up front if resources are available.
Second, normally in a chapter 11 case, the debtor must obtain consent for confirmation of its plan from at least one impaired class of non-insider creditors. This requirement has been eliminated for small business debtors under the SBRA, which likewise tilts the leverage over the restructuring process in favor of the small business.
To file a plan, a debtor must attach to its plan a liquidation analysis (which shows creditors are being paid as much under the plan as they would receive if the business was liquidated) and feasibility projections (i.e. projections of cash flow which demonstrate that the business should be able to make the projected payments under the plan). The debtor must demonstrate that there is a “reasonable likelihood” that it will be able to make the payments under the plan.
The SBRA provides for the appointment of a non-operating trustee who monitors the case, ensures it is moving in the right direction and is supposed to facilitate the confirmation of a plan. Unfortunately, this is a cost that a small business debtor will incur during the case; however, there are no US trustee fees which must be paid, the trustee’s role is limited, and the trustee will likely help the debtor in moving the case forward.
E. Heller Draper
Heller Draper is at the forefront of this new simplified small business bankruptcy process and is happy to answer any questions you may have during this difficult and daunting time. You can reach Heller Draper at 504-299-3300.