Small Business Reorganization Act provides a new tool to restructure small franchisees

The franchisee world is populated primarily by small businesses. Until recently, when those franchisees experienced financial difficulty, addressing the challenges and finding a way to restructure those businesses generally involved limited legal tools – often leading to a shutdown or liquidation. Indeed, Chapter 11 was once a favored way to reorganize a small business, but high costs and complicated procedural hurdles made Chapter 11 undesirable or unsustainable for most small businesses – until now.

In an effort to make Chapter 11 relevant again, on August 23, 2019, the president signed into law the Small Business Reorganization Act of 2019 (SBRA), which adds a new subchapter to Chapter 11 of the Bankruptcy Code intended to streamline the Chapter 11 bankruptcy process for companies that might not otherwise be able to afford the Chapter 11. The provisions of SBRA are scheduled to become effective in February 2020.

The SBRA may provide a new lease on life for struggling small franchisees. Although working with the franchisor will remain paramount to the ongoing business viability, the SBRA will allow an owner to retain equity in the franchised business, restructure debt, and designate a payment plan through a more efficient bankruptcy process – all at a lower cost than what had been previously available for a small business in Chapter 11. Since most small franchisees are closely held and/or family-owned, the SBRA provides business owners with a greater incentive to work with the franchisor, the landlord, and other creditors in an attempt to reorganize using Chapter 11 since there is no a real opportunity to maintain control of the business at the conclusion of the reorganization process. This possibility should likewise be viewed favorably by franchisors who now know that franchisees can work to avoid liquidation thus doing less damage to the overall franchised brand.

At this time, SBRA applies only to business debtors with secured and unsecured debts, subject to certain qualifications, less than $2,725,625. Highlights of the SBRA are as follows:

• Appointment of a standing trustee. Upon filing, a standing trustee will be appointed to serve as the trustee to oversee the small business’s bankruptcy estate. The role of the trustee will be to review the financial conditions and operations of the business, report any fraud or misconduct, facilitate the small business debtor’s reorganization, and monitor the distributions in accordance with the plan of reorganization.
• Faster and simpler process. Only the debtor can propose a plan of reorganization with the goal that confirmation would occur within 90 days of the filing of the bankruptcy. The plan must provide the history of the business, financial projections, and a liquidation analysis. However, small business debtors will not have to obtain approval of a separate disclosure statement or solicit votes to confirm a plan. Unless the court orders otherwise, there are no unsecured creditors’ committees appointed to oversee the case.
• Easier reorganization requirements. The SBRA removes the requirement that equity holders of the small business put new money into the business in order to retain their equity interest without paying creditors in full. For plan confirmation, the SBRA instead only requires that the plan does not discriminate unfairly, is fair and equitable, and provides that all of the company’s projected disposable income be applied to payments under the plan or the value of property to be distributed under the plan is not less than the projected disposable income of the debtor.
• Longer creditor payment streams. The SBRA removes the requirement that the debtor pay administrative expense claims (including those claims incurred by the debtor for post-petition goods and services) on the effective date of the plan. Unlike a typical chapter 11, a small business debtor may now stretch payment of administrative expense claims out over the term of the plan.
• Discharge of debts. Subject to certain exceptions, the bankruptcy court must grant the debtor a discharge after completion of all payments due within the first three years of the plan, or such longer period as the court may fix (not to exceed five years).

Finally, there is a law on the books that can truly help distressed small business franchisees take advantage of the benefits of chapter 11 to right-size the balance sheet, reduce liabilities, reject or restructure burdensome leases and executory contracts, renegotiate debts, and sell assets.