UPDATED–Relief for the Small Business: The Coronavirus Aid Relief and Economic Security Act (“CARES”) and the Small Business Reorganization Act of 2019 (“SBRA”)

The coronavirus pandemic is placing unprecedented stress on small businesses. Consequently, a key provision in the Coronavirus Aid Relief and Economic Security Act (“CARES”) provides small businesses with greater access to bankruptcy reorganization.

CARES amended the Small Business Reorganization Act of 2019 (“SBRA”) and increases the eligibility threshold for businesses filing under new subchapter V of chapter 11 from $2,725,625 of debt to $7,500,000.  The eligibility threshold will return to $2,725,625 after one year.

SBRA became effective on Feb. 19, 2020 and added a new section to chapter 11 to provide a better opportunity for small businesses to successfully restructure and save jobs.  For qualifying small businesses, the Act will ease the financial burdens of bankruptcy by streamlining the process to confirmation of a plan of reorganization.  The debtors who qualify will find the small business Chapter 11 far less expensive and less daunting than those who do not.  Significantly, SBRA has removed the “absolute priority rule” from small business Chapter 11s, thereby allowing business owners to retain their equity interests even if creditors are not paid in full.

SBRA includes the following provisions:

  • Elimination of the Absolute Priority Rule for Small Business Debtors:  Under the “absolute priority rule,” equity interest holders are not permitted to retain their equity under a plan unless all senior claims are paid in full.  This rule often dooms a company to liquidation, particularly in cases of smaller companies where continued participation by current equity holders is vital to the reorganization effort.  If a small group of owners cannot retain their ownership because all creditors cannot be paid in full, then there is no choice but to try to sell the operations of the business as a going-concern, find new investors or otherwise inject new equity into the company, or simply liquidate.  Under SBRA, the owners may retain the business if (in addition to all of the other requirements for confirmation) the plan: (i) does not discriminate unfairly, (ii) is fair and equitable, and (iii) provides that all of the debtor’s projected disposable income will 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.
  • Streamlining the Process to Confirmation. SBRA removes several procedural and financial burdens associated with a typical Chapter 11 case.  For example, no unsecured creditors committee (whose attorneys, financial advisors, and other professionals must be paid by the debtor) will be appointed unless ordered by the court.  Further, the debtor has the exclusive right to propose a plan of reorganization. Moreover, the Debtor is not required to obtain approval of a disclosure statement or solicit votes for its plan.  SBRA also provides a 90-day deadline within which to file a plan—an accelerated timetable which may reduce the administrative costs of a case.
  • Delayed Payment of Administrative Expense Claims.  Under the typical Chapter 11 reorganization, administrative claims must be paid upon the effective date of the confirmation of the plan.  Administrative claims (typically claims for postpetition goods and services provided to the debtor) can be substantial and can be a significant hurdle to confirmation.  SBRA removes this requirement and now permits a small business debtor to stretch out the payment of administrative claims over the term of the plan.
  • Appointment of a Trustee. SBRA provides for the appointment of a trustee for the small business’s bankruptcy estate.  This trustee will not have the plenary powers of a Chapter 7 trustee, but instead acts as a facilitator—watching over the process to ensure that is not abused, helping to guide the debtor to a confirmable plan, and monitoring the debtor’s progress towards consummation of its plan of reorganization.  The trustee has the authority to investigate the financial affairs of the debtor and to object to the allowance of proofs of claim, shall appear and be heard at plan confirmation, and shall attempt to facilitate the development of a consensual plan of reorganization.
  • Residential Mortgage Modification. SBRA removes the prohibition against the modification of residential mortgages. A small business debtor will now be permitted to modify a mortgage secured by a residence if the proceeds of the loan were used for the small business rather than for acquiring the residence.

Given their size and limited financial resources, small business debtors have generally been unable to benefit from the small business provision in Chapter 11.  CARES and SBRA will assist small businesses to a successful reorganization, thereby preserving jobs, maintaining business relationships, preserving economic value, and resulting in higher distributions to creditors.

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