Bankruptcy and Restructuring

Small Business Bankruptcy Reforms You Need to Know

Small Business Bankruptcy Reforms You Need to Know

Key changes covered here:

  • prompt deadlines
  • protection from vengeful creditors
  • class of creditors not needed to approve a plan
  • absolute priority rule eliminated
  • independent trustees to oversee process

For many years, people associated with the bankruptcy system in the United States recognized the process didn’t work well for small business owners. Corporate reorganizations through the Chapter 11 process were cumbersome and expensive. Alternatively, limited liability companies and partnerships were not eligible for the provisions of a Chapter 13 bankruptcy, which is restricted to individual debtors. Congress made an attempt to address some of these concerns in legislation passed in 2006, but those changes provided no dramatic improvements.

The Small Business Reorganization Act of 2019 (SBRA) became effective on February 19, 2020. This legislation, which grew out of the American Bankruptcy Institute’s (ABI) Chapter 11 Bankruptcy Reform Commission, makes important changes to existing law. These changes streamline the small business bankruptcy reorganization process by reducing time and costs, and, as a result, they enhance a debtor’s ability to navigate and survive bankruptcy reorganization.

Curiously, the monetary limitations to qualify as a small business under the SBRA were not modified. For eligibility, a debtor’s obligations, both secured and unsecured, cannot exceed $2,725,625, and at least 50 percent of the debtor’s debts must have come from ongoing business activities. This limitation on small business owners was not raised, but the same package of bills raised family farmers’ eligibility caps for Chapter 12 proceedings to $10 million. It remains to be seen how effective these new reforms will be or whether small business owners can avail themselves of the proposed streamlining process.

Assuming a small business can meet the eligibility criteria, important changes were made in the SBRA. First, the SBRA creates an independent trustee to oversee the process and to assist the court in enforcing the performance of the plan and making payments to creditors. Anecdotal evidence suggests that it may be difficult to identify and have these independent trustees participate in the bankruptcy system in all locations. Since relatively modest dollars are at issue, substantial uncertainty exists regarding the willingness of an individual to be compensated for services of a trustee. Accordingly, the effectiveness of the independent trustee provision remains to be seen. Moreover, how active these trustees may be in the process is uncertain, and it is likely the role will develop over time.

Second, the SBRA establishes prompt deadlines. The law requires a mandatory conference between the debtor and the court within 60 days of filing. Moreover, a status report must be on file 14 days prior to this conference. In addition, the SBRA mandates a proposed plan of reorganization be on file within 90 days of filing unless the court extends the deadline for “circumstances for which the debtor should not justly be held accountable.” These deadlines should create important structural safe grounds to ensure the bankruptcy process moves swiftly.

Another key element designed to enhance potential reorganizations is the elimination of a requirement that a class of creditors approve a bankruptcy plan. Generally, in the past at least one group of creditors was required to accept a proposed plan. Under the SBRA, a court can determine that a proposed plan is “fair and equitable” over the objections of creditors and have the case approved and confirmed. This change is designed to protect the good faith debtor from vengeful creditors.

A fourth key feature of the SBRA is the elimination of the absolute priority rule for eligible companies. This means that small business owners don’t have to pay creditors “in full” in order to retain their ownership interest. As long as the plan is fair and equitable, owners may ultimately be able to retain ownership of their assets and small business through a confirmed plan of reorganization. It is contemplated that plans under the SBRA will be for three to five years. During that time period, debtors are required to make payments that the court deems adequate to satisfy the old obligations. Whether this timetable is feasible or practical, given the uncertainties that face small businesses year to year, is yet to be seen.

The SBRA has other important and technical features. The key takeaway is that Congress tried to improve the bankruptcy process both for small businesses that face the prospect of bankruptcy and for their creditors.

The provisions of the SBRA take effect after the effective date, so cases filed earlier do not fall under the SBRA provisions. Through the leadership of the ABI, Congress has enacted important legislation that seeks to improve the ability for small businesses to reorganize. Only time will tell whether these new provisions are effective or workable, but important steps have been taken to improve the small business bankruptcy process in a system and marketplace that has become increasingly complex and costly.

The future for the SBRA is not clear and bankruptcy practitioners and small business owners face an uncertain future about the effectiveness of this legislation. Even given these questions, it seems that those who advocate for a cost-effective and streamlined system for small business bankruptcies have been heard and the results await further judgement.

This article was originally shared on Business Alabama on March 5, 2020 and is republished here with permission from the publication.