Small Business Reorganization Act Provides a Smoother Path to Chapter 11 Reorganization

On February 19, 2020, small businesses became eligible to file a streamlined chapter 11 bankruptcy under the newly enacted “Subchapter V.” The Small Business Reorganization Act (“SBRE”) arose from Congressional recognition of both the importance and vulnerability of America’s small businesses.

Small businesses—typically family-owned businesses, startups, and other entrepreneurial ventures—“form the backbone of the American economy.” By their very nature, however, the longevity of these businesses is limited. According to the Small Business Administration Office of Advocacy, approximately 20 percent of small businesses do not survive the first year, but by the five-year mark only 50 percent are still in business and by the ten-year mark only one-third survive. Notwithstanding the 2005 Amendments, small business chapter 11 cases continue to encounter difficulty in successfully reorganizing…the legislation allows these debtors “to file bankruptcy in a timely, cost-effective manner, and hopefully allows them to remain in business” which “not only benefits the owners, but employees, suppliers, customers, and others who rely on that business.”

In re Ventura, 2020 WL 1867898 (Bankr. E.D.N.Y. Apr. 10, 2020) (quoting the Unofficial Transcript of Oversight of Bankruptcy Law and Legislative Proposals: Hearing Before the Subcomm. on Antitrust, Commercial, & Admin. Law of the H. Comm. on the Judiciary, 116th Cong. 27 (2019)) (Emphasis Added). The risks faced by such businesses, which employ over 47 percent of the U.S. workforce, increased exponentially with the spread of COVID-19 just weeks after the enactment of the SBRE.

In response, Congress widened the path to eligibility for Subchapter V relief, currently available to individuals or entities who meet the following qualifications:

• Engaged in commercial business activities.
• Aggregate liquidated (sum certain) noncontingent (liability is not contingent on some future event, such as guaranty where guarantied obligation is not in default) debt of no more than $7,500,000 owed to non-affiliates/insiders (this increased liability amount is due to sunset March 27, 2021 unless extended again).
• $7,500,000 applies to total of affiliated entities.
• At least half of the debt must be related to commercial or business activities.

However, if the business is comprised only of owning and/or operating a single real property or project (known as “single asset real estate” and defined in Bankruptcy Code section 101(51B)), or if the business or its affiliates are SEC reporting entities, Subchapter V relief is not available.

Information is provided to creditors in the form of the schedules of assets and liabilities and statement of financial affairs required in all bankruptcies. In addition, the debtor attaches to the petition copies of its most recent balance sheet, cash flow statement, and tax return. A monthly operating report must be filed, but it is a highly abbreviated form of the report required in traditional Chapter 11 cases. Like other cases, the SBRE debtor appears at a meeting of creditors and answers questions.

Oversight is provided by a Subchapter V trustee, who does not (absent misconduct or other cause) take possession of assets. Instead, the trustee acts as a resource to assist the debtor and the creditors in formulating a consensual plan and reviews the financial and operating information provided by the debtor. The bankruptcy court also schedules status hearings (with a status report to be filed by the debtor) in order to monitor the progression of a small business case.

A Subchapter V is similar to a Chapter 13 for individuals with regular income. The debtor is required to devote three years of net operating income to plan payments, and creditors must receive no less than they would if the company were liquidated. While a plan is required, the basics of the plan are presented by completing official form 425A. Unlike traditional Chapter 11 cases, no disclosure statement is required to be prepared and approved by the court for circulation in connection with voting on the plan. Instead, the plan attaches a liquidation analysis and a cash flow projection.

Many of the confirmation requirements of Chapter 11 apply to Subchapter V plans. The plan separates obligations into classes, makes payments to professionals, taxes, secured claims (limited to the amount due of the value of the collateral, whichever is less, with interest at the fair market rate, often prime plus one to two percent plus one to two percent), payments needed to cure leases or other contracts, with the balance (if any) divided among unsecured creditors. However, SBRE includes provisions which increase the ability to confirm a plan. First, the plan can be confirmed even if all classes vote no on the plan. Second, the ownership in the company may be retained even if unsecured creditors vote no on the plan, and no payment (or “new value”) is required. Third, in a Subchapter V, the attorneys’ fees and other expenses of the bankruptcy may be paid over time through the plan, whereas in a standard Chapter 11 matter those expenses must be paid when the plan becomes effective. In a Subchapter V case, no official committee of unsecured creditors is appointed. Creditor committees are the source of a large portion of the costs of a normal Chapter 11 since the Bankruptcy Code allows the committee to have its own counsel and financial advisors, and requires payments of those fees by the debtor. Another advantage of Subchapter V is that no fees have to be paid to the Office of the United States Trustee. U.S. Trustee fees in a traditional Chapter 11 range from $250 to $250,000 per quarter based on the distributions made by the debtor.

The Consolidated Appropriations Act of 2021 also extends certain benefits to bankruptcy debtors. The Act makes individuals in bankruptcy eligible for CARES Act assistance and opens the door to PPP funding eligibility for small businesses in bankruptcy. (Such eligibility will require SBA regulations, which have not yet been enacted.) The Act also gives small business debtors up to 120 days to cure lease defaults, and up to 210 days to decide whether to retain or reject leases. Landlords who accept late payments from insolvent tenants are also afforded protection from having to repay those amounts if the tenant subsequently files for bankruptcy protection.

The SBRE was one year old on February 18, 2021. Statistics gathered during that period indicate that 1,675 cases took advantage of the act, almost a quarter of the Chapter 11 filings during that year.

About the author

Candace Carlyon, Esq. has been a certified Commercial Bankruptcy Specialist since 1994, has been recognized in Best Lawyers in America since 1996, and has held an A-V rating since 1989.