Small Business Reorganization Act improves reorganization prospects for small business

In 2012, there was a growing consensus among bankruptcy and creditors’ rights professionals that the U.S. bankruptcy system was not working well, especially for America’s small businesses. Chapter 11 cases were too expensive, and they took too long. Additionally, the vast majority of Chapter 11 cases resulted in auctions or sales of estate assets to new owners (rather than reorganizations), thereby leaving equity interests out in the cold. Perhaps most critically for small business debtors, the absolute priority rule almost always precluded the possibility of reorganization. The absolute priority rule requires a debtor to pay senior classes of creditors in full – or get them to agree to receive less – if the debtor wants to retain the equity of a business. Fulfilling the requirements of the absolute priority rule is simply impossible for most small business debtors.

In response to some of those issues, state court remedies like receiverships and assignments for the benefit of creditors started being used more regularly in state courts as adaptive proceedings to short circuit the expense and delays in bankruptcy cases.

In 2012, the American Bankruptcy Institute appointed a Commission to Study the Reform of Chapter 11. The Commission was composed of some of the most prestigious and accomplished professionals in the field who spent the next three years studying what worked and what did not work in Chapter 11 cases. The Commission noted that there had not been any major reform of Chapter 11 for over 40 years, and it suggested that four decades is the maximum amount of time that any financially driven regulation can remain relevant as markets, financial products, and industry itself often evolve far more quickly than the regulations intended to govern them. No one could disagree with that proposition.      

The Commission’s Mission Statement stated as follows:

In light of the expansion of the use of secured credit, the growth of distressed-debt markets and other externalities that have affected the effectiveness of the current Bankruptcy Code, the Commission will study and propose reforms to Chapter 11 and related statutory provisions that will better balance the goals of effectuating the effective reorganization of business debtors – with the attendant preservation and expansion of jobs – and the maximization and realization of asset values for all creditors and stakeholders.

The Commission articulated the following goals:

1. Reduce barriers to entry into the bankruptcy system;
2. Facilitate certainty and more timely resolution of disputed matters;
3. Enhance exit strategies for debtors; and
4. Create an effective alternative restructuring scheme for small and medium-sized firms.

A new Chapter 11 option, tailored to meet these goals, would (i) enable such enterprises to utilize Chapter 11, (ii) enable the court to more efficiently oversee the enterprises through the Chapter 11 bankruptcy process, and (iii) incentivize all parties, including the enterprise founders and other equity security holders, to work collectively toward a successful restructuring. 

In October 2018, Congress passed the Small Business Reorganization Act (SBRA), which became effective on February 20, 2019. The passage of the SBRA in this contentious season in Congress was one of Congress’s most remarkable and unexpected achievements. 

The following are four highlights of the SBRA:

1. Eligibility to file a SBRA case - So how is a small business debtor defined?  Which businesses are eligible to file a subchapter v case?
   • A small business debtor must be engaged in “commercial or business activities.”
   • A small business debtor must not exceed the aggregate debt limit.
     • Aggregate debt limit ($2,725,625) in the original SBRA legislation has been temporarily increased to 7.5 million for 1 year under the CARES Act.
   • Fifty percent (or more) of the debt must arise from debtor’s commercial or business activities.
   • A small business debtor may be engaged in owning or operating real property.
   • A small business debtor whose primary activity is owning or operating single asset real estate does not qualify as a small business debtor under the SBRA.
      
2. Timeline for a SBRA case - The typical timeline for a SBRA, Subchapter V case is as follows: 
   

   EARLY IN THE PROCEEDING  Debtor's senior management must attend hearings scheduled by the court or the United States Trustee, including initial debtor interviews, scheduling conferences, and the section 341 meeting of creditors.	DAY 1 Petition is filed with subchapter V election.
   	NO LATER THAN DAY 7 Debtor must file its most recent balance sheet, cash flow statement, statement of operations, and federal tax return.
   	NO LATER THAN 14 DAYS BEFORE STATUS CONFERENCE                       The debtor must file and serve on all parties in interest "a report that details the efforts the debtor has undertaken to attain a consensual plan or reorganization."  11 U.S.C. § 1188(a).
   	NO LATER THAN DAY 60 The court will hold a status conference “to further the expeditious and economical resolutions of a case under this subchapter” 11 U.S.C. § 1188(a).
   	NO LATER THAN DAY 90 The Debtor shall file a plan.
   	28 DAYS AFTER PLAN IS FILED At least 28 days’ notice must be given for the deadline to accept or reject and filed objections to a proposed plan, and for the hearing to consider confirmation of the proposed plan.  Fed. R. Bankr. P. 2002(b).

3. Contents of a SBRA plan - The plan must contain a brief history of the operations of the debtor, a liquidation analysis, and projections regarding the ability of the debtor to make payments under the proposed plan. The plan must provide for the submission of “all or such portion of future earnings or other future income of the debtor to the supervision and control of the trustee as is necessary for the execution of the plan.” The plan can be confirmed on a consensual or nonconsensual basis, so long as the plan is deemed to be “fair and equitable” with respect to each class of claims. 

4. Role of the Subchapter V Trustee; Confirmation of a SBRA plan - Perhaps acknowledging the pervasive and successful integration of mediation processes in our state and federal civil cases, Congress chose to require appointment of a “Subchapter V Trustee” to “facilitate the development of a consensual plan of reorganization.” 11 U.S.C. § 1183 (b)(7). Subchapter V Trustees are appointed by the United States Trustee.

   Further the Subchapter V trustee must appear and “be heard” at hearings on: (i) the status conference; (ii) confirmation of a plan; (iii) modification of a plan after confirmation; (iv) the sale of property of the estate; and (v) the value of any property subject to a lien. 11 U.S.C. § 1183(b)(3).   

   If the court confirms a consensual plan, the service of the Subchapter V Trustee terminates upon “substantial consummation,” which generally occurs when distributions under the Plan commence.  The debtor must serve notice of substantial consummation on all parties in interest.  The debtor then makes the payments under the Plan, and the debtor will receive a discharge upon confirmation.

   If the court confirms a nonconsensual plan, the Subchapter V Trustee will make the payments under the Plan, unless the Plan or confirmation order provides otherwise.  The debtor will not receive a discharge until completion of the payments due within the first three years, or such longer period not to exceed five years as the court may fix.

Conclusion

While some of the high points of the SBRA are outlined above, there will be developments and more clarity on procedures and outcomes as the Subchapter V cases progress.

However, this much is clear: Congress approached this Chapter 11 reform without a lot of the conclusory judgments about the character of debtors that has characterized bankruptcy legislation in the past. Means testing, credit counseling, and other punitive requirements are nowhere to be found in the SBRA legislation. Instead, there is an implicit recognition of the fact that businesses often fail for reasons other than ineptitude and/or fraud of the owner and that the “honest but unfortunate debtor” should be permitted to reorganize and stay in business under a plan that is “fair and equitable.” This is a welcome development, particularly in this time of a COVID-19 pandemic; crippling, uninsured health care costs; record-shattering unemployment levels; and civil unrest.