The New Small Business Reorganization Act: A Look at Courts’ Interpretation of New Issues in the Act’s First Few Months, Part I

As the world has reeled from the impact of COVID-19 this spring, bankruptcy courts across the country  have also been adjusting to a new type of bankruptcy case – the first bankruptcy cases filed under the new subchapter 5 of the Bankruptcy Code (“subchapter 5”). This new bankruptcy process provides for a streamlined, hopefully more cost-effective process for small businesses to file for bankruptcy and reorganize. The Small Business Reorganization Act (the “SBRA”) outlines the subchapter 5 process, and The Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) temporarily increased the debt limit for small businesses to be eligible to file for bankruptcy pursuant to subchapter 5 from $2,725,625 to $7,500,000; this increased limit stays in effect until late March 2021. While ambiguities in the SBRA and the new process will be worked out through case law over the next few months and years, the limited SBRA precedent that has already been established by courts in the last four months may be helpful for small businesses currently evaluating their finances and options in the coming months – especially as the future is uncertain due to COVID-19. Courts have primarily focused on three primary questions; part one of this two-part blog series will address the issue of a debtor’s election to proceed as a subchapter 5 debtor. Part two will examine the definition of a “small business debtor,” and the role and powers of a subchapter 5 trustee.

If a bankruptcy case was pending when the SBRA became effective, can the company or individual amend the petition to proceed under subchapter 5 of the Bankruptcy Code? Can a debtor file a chapter 11 case and then elect to proceed under subchapter 5?  

A number of bankruptcy debtors with cases pending when the SBRA became effective as of February 19, 2020 elected to modify their petitions to proceed under the new subchapter 5 after the effective date. Other debtors may initially file cases under chapter 11 of the Bankruptcy Code, but later elect to proceed under subchapter 5. The courts that have reviewed the issue have found that amendments to proceed under subchapter 5 should be allowed freely, because “[s]ubchapter 5 incorporates most of existing chapter 11, and . . . does not alter the rubric under which debtors may affect pre-petition contractual rights of creditors, much less vested property rights.” In re Moore Properties of Pers. Cty., LLC, Case No. 20-80081, 2020 WL 995544, *4 (Bankr. M.D.N.C. Feb. 28, 2020). Courts are generally required to apply the law in effect at the time it renders its decision, and the SBRA was silent as to its applicability to currently pending cases. Id., citing Landgraf v. USI Film Products, 511 U.S. 244 (1994). Because there is no substantial impairment of property rights in the SBRA, courts are not obligated to apply rules disfavoring the retroactive application of new laws in this situation. See In re Body Transit, 613 B.R. 400, 408 (Bankr. E.D. Pa. 2020).

Rule 1009(a) of the Federal Rule of Bankruptcy Procedure gives a debtor a general right to amend its petition at any time before the case is closed. Fed. R. Bankr. P. 1009(a). The interim bankruptcy rules regarding the SBRA also state that a company’s election to proceed as a small business debtor, as indicated on its original or amended bankruptcy petition, will govern “unless and until the court enters an order finding the debtor’s statement is incorrect.” Interim Rule of Bankruptcy Procedure 1020(a). If a debtor elects to proceed as a small business debtor under subchapter 5, the United States trustee and other parties in interest have 30 days after the amendment or 30 days after the meeting of creditors to object to such an election. Id.

If a party objects to a debtor’s election to proceed under subchapter 5, a court may consider “the extent to which parties in interest have invested in the case,” and whether applying the new subchapter 5 concepts would offend fundamental principles of fairness. In re Body Transit, 613 B.R. 400, 408 (Bankr. E.D. Pa. 2020). If an amendment to a petition is made in bad faith or would unduly prejudice a party, the amendment will not likely be allowed; courts usually refused to allow amendments made in bad faith in all types of bankruptcy cases. Id., citing In re Cudeyro, 213 B.R. 910, 918 (Bankr. E.D. Pa. 1997). The court also has discretion to reschedule certain procedural matters required by the SBRA (i.e., the deadlines to hold a status conference or file a plan); the passage of these deadlines alone should not impair a debtor’s election to proceed as a subchapter 5 debtor. In re Ventura, Case No. 8-18-77193, 2020 WL 1867898, *8 (Bankr. E.D.N.Y. 2020). If a debtor makes an election to proceed under subchapter 5 and no party objects, the designation will stand for the remainder of the case.  A debtor with a currently pending case should feel free to amend its petition to proceed under subchapter 5, or to make such an amendment later, if it otherwise meets the eligibility requirements under the SBRA.