January 12, 2006Client Alert

New Small Business Bankruptcy Provisions

On April 20, 2005, President Bush signed into law the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA"), creating the most sweeping overhaul to the Bankruptcy Code since it was adopted in 1978. Most provisions of BAPCPA became effective on October 17, 2005. Although there was substantial press regarding the effect of BAPCPA on individuals filing bankruptcy, considerably less publicity attended the changes to business bankruptcies. The law makes significant changes to business bankruptcies and to Chapter 11 reorganization proceedings.

For example, new "small business case" provisions have been adopted to move small business bankruptcies through the system more expeditiously and with what are intended to be more and more useful disclosures. A "small business debtor" is essentially a person or organization engaged in non-real estate commercial or business activities with aggregate secured and unsecured debts of not more than $2,000,000.

BAPCPA imposes new duties on small business debtors and on the U.S. Trustee in small business cases. Small business debtors have more filing and reporting requirements than other business debtors. Those requirements include filing financial statements, federal income tax returns, profitability information, projected cash receipts and disbursements as well as a comparison of those projections to actual results, and certification of compliance (or lack thereof) with tax filings and payments. Small business debtors are now required by federal law to maintain insurance customary and appropriate to the debtor's industry. The debtor must allow the U.S. Trustee or his/her designated representative to inspect the debtor's business premises, books and records.

The U.S. Trustee is also required to perform additional duties in a small business case. The U.S. Trustee must conduct an initial debtor interview early in the case to begin to investigate the debtor's viability, inquire about the debtor's business plan, inform the debtor of its obligations, and attempt to develop an agreed scheduling order. The U.S. Trustee may inspect the debtor's business, books and records, and is expected to "monitor diligently" the debtor's activities to identify as soon as possible if the debtor appears unable to confirm a plan. If confirmation of a plan appears unlikely, the U.S. Trustee must apply promptly to the Bankruptcy Court for conversion or dismissal of the case.

The goal of any Chapter 11 bankruptcy reorganization case is to confirm a plan and complete the bankruptcy process. BAPCPA simplifies the disclosure statement and plan process in a small business case, by permitting the small business debtor to make its required disclosures regarding the plan (a) in the plan itself, (b) in a prescribed form, or (c) in a separate disclosure statement. The hearing on the disclosure statement can be combined with the plan.

In keeping with a theme of BAPCPA to expedite the bankruptcy process, the small business case plan must be filed no later than 300 days after the date of the order for relief. The Bankruptcy Court must confirm a timely filed confirmable plan no later than 45 days after a plan is filed. BAPCPA provisions are written to make it difficult to obtain extensions for any of these deadlines.

Conversion to a Chapter 7 liquidating case or dismissal of a small business debtor case has gotten easier under BAPCPA. The changes to the Bankruptcy Code removed some of the discretion previously given to Bankruptcy Judges to determine whether a case should be converted or dismissed. Now, under an extensive enumeration of circumstances that constitute "cause" for conversion or dismissal, the debtor's ability to reorganize can be terminated. Those reasons include (among other things) substantial or continuing loss to or diminution of the estate and the absence of a reasonable likelihood of rehabilitation; gross mismanagement of the estate; failure to maintain appropriate insurance that poses a risk to the estate or to the public; unauthorized use of cash collateral substantially harmful to one or more creditors; failure to comply with an order of the court; unexcused failure to satisfy timely any filing or reporting requirement; failure timely to file or pay taxes owed after the date of the order for relief; failure to file a disclosure statement, or to file or confirm a plan within the time fixed by the Bankruptcy Code or court order. Once the factual basis for any of these (and other enumerated) "causes" exists, the Court has limited discretion to refuse to convert or dismiss a case. The court may, however, be able to appoint a trustee or examiner instead, which may increase the use of that tool as an alternative to conversion or dismissal. The Court is also required to reach a decision quickly, with BAPCPA requiring a hearing on a motion to dismiss not later than 30 days after the motion is filed, and to render a decision no later than 15 days after commencement of the hearing.

Multiple, sequential filings of small business cases by the same small business debtor is difficult under BAPCPA. A significant benefit to filing a bankruptcy is the immediate and automatic imposition of an "automatic stay" which halts most pre-bankruptcy collection activity and other acts impacting the debtor and the debtor's assets. However, if a debtor files within 2 years of an order dismissing a prior small business case, or within 2 years of the order confirming a plan in a prior small business case, then the automatic stay will not apply to the new case. Debtors will not be able to frustrate this provision with a "switch and flush," since an entity that has acquired
substantially all of the assets or business of a small business debtor who otherwise would be denied the benefit of the automatic stay is similarly deprived of the benefit, unless that buying entity can establish that it made the acquisition in in good faith and not for the purpose of evading this provision of the Bankruptcy Code.

For more information, contact Ann Ustad Smith at 608.283.2251, or or Paul A. Lucey at 414.270.2719, or

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