As businesses of all sizes brace for the impact of COVID-19 over the next several months, and possibly years, the rise of bankruptcy filings is inevitable.
The impact on small businesses in particular is likely to be devastating. While you may be familiar with traditional filings under Chapter 11 of the Bankruptcy Code, you may be less familiar with the recently enacted Small Business Bankruptcy Reorganization Act (SBRA), which was expanded in light of the COVID-19 pandemic.
On February 19, 2020, the SBRA added a new subchapter to the Bankruptcy Code. Commonly referred to as “Subchapter V,” the SBRA was enacted to encourage small businesses to more frequently use Chapter 11 by making the process more efficient and cost-effective. Although just over two months old, Subchapter V has already been amended as a result of the COVID-19 pandemic—the CARES Act includes the first amendment to Subchapter V and makes it available to more small businesses.
What makes Subchapter V different from other avenues of relief under the Bankruptcy Code, and what do you need to know?
1. Who is eligible for relief under Subchapter V?
The original version of Subchapter V provided that a debtor with debt not exceeding $2,725,625 was eligible, but the CARES act increased the debt limit to $7,500,000. At least 50% of the debt must come from “commercial or business activities” to qualify for SBRA relief. The increased debt limit is available only for a limited time, as businesses with noncontingent, liquidated debts between $2,725,625 and $7.5 million will only be eligible for SBRA relief until March 27, 2021.
Eligibility under the SBRA continues to evolve. On April 27, a bankruptcy judge in the District of South Carolina held that a business may still qualify as a small business debtor under the new Subchapter V of Chapter 11 even if the business is defunct or not currently operating. Emphasizing that the bankruptcy code provides “relief from debtor in various forms including reorganization of a business, sale of assets, valuation of property, the adjustment of debt, and combination of those and other remedies,” Judge Helen B. Burris ruled that the SBRA was sufficiently broad to cover debtors who are not currently engaged in commercial activities. Even a business that is dealing with residual business debt after closing is eligible under the SBRA. This may provide significant relief at a time when many businesses are not generating any income due to the COVID-19 pandemic.
2. What makes Subchapter V different from a regular Chapter 11 case?
- Faster process with more debtor controls.
- In a traditional Chapter 11 case, the debtor has the exclusive right to file a plan of reorganization within the first 120 days, but this “exclusivity period” is frequently extended, and after the 120 days it is possible that a creditor can file a plan instead of the debtor. The plan must have a disclosure statement containing detailed information about the debtor’s operations and the key terms of the plan. Because of the plan and disclosure statement requirements, it can often be a year or more before a plan is confirmed in a traditional Chapter 11 case.
- In an SBRA case, no disclosure statement is required, and the debtor has to file the plan within 90 days of filing for bankruptcy. This means that from filing to confirmation, the bankruptcy process can be completed in a few months.
- No creditor support needed for plan confirmation.
- A traditional Chapter 11 plan requires at least one class of creditors who are “impaired,” (meaning the creditor is not being paid in full, or its rights are otherwise altered), vote to accept the plan. There is no such requirement under the SBRA. As long as the plan otherwise meets the confirmation requirements under 11 USC §1129, then the plan can be confirmed without any creditor support.
- Rights in primary residences can be altered.
- The SBRA allows for a Chapter 11 plan to modify the rights of a creditor secured by a security interest in the debtor’s principal residence if the loan secured was not used to acquire the residence, but was related to the debtor’s business.
- Administrative claims can be paid over time.
- In a traditional Chapter 11 case, all administrative claims must be paid in full at once in order to confirm a plan. The SBRA allows administrative claims to be paid over time.
- A debtor can keep its equity.
- Under the SBRA, even if a debtor is not proposing to pay its general unsecured creditors in full, a debtor’s owner can keep its equity in the business if the debtor commits all of its “projected disposable income” to paying creditors for a minimum of 3 and a maximum of 5 years.
- A standing trustee is in place.
- Ordinarily, a trustee will only be appointed in a Chapter 11 case under certain circumstances (upon motion of a creditor or the US Trustee). However, under the SBRA, standing trustees (similar to those in Chapter 13 cases) monitor every case.
There are other provisions on the SBRA that differ from a traditional Chapter 11 case, but the above are the main highlights and give you a glimpse into how a Subchapter V case might look very different from what you have seen before. Although we cannot predict the future, particularly in these uncertain times, we expect that Subchapter V, especially with the expansion of its eligibility due to the CARES Act, will become a common tool for small businesses to recover from COVID-19.
However, some of the traditional rules you are used to are the same, including the automatic stay. As soon as you receive notice of a bankruptcy, you should both immediately cease communications with the debtor and cease all attempts to collect any amounts due before the debtor filed bankruptcy. You may have special rights if you are a landlord or a tenant, or certain obligations if you are the party to a contract or lease, but those obligations depend on the facts of each case, no matter what chapter the case is filed under. Our Bankruptcy and Recovery Team is here to help answer any questions you might have.