The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) and the Small Business Reorganization Act of 2019 (SBRA) provide useful options for small business debtors (i.e. those whose debts are less than $7.5 million) considering Chapter 11 bankruptcy protection. However, to reap the benefits of these Acts, small business debtors may need to act quickly, as some of the key benefits of the CARES Act are scheduled to sunset on March 27, 2021.
So far in 2020, bankruptcy courts have seen numerous mega-retail bankruptcies, oil & gas cases, and continued health and healthcare industry filings. Many of these debtors were on the verge of financial insolvency despite the COVID-19 pandemic. Bankruptcy courts have not, however, seen filings by the small and mid-sized businesses that were on solid financial footing prior to the pandemic. Many of these businesses have been able to stave off bankruptcy so far, perhaps through funds received through the Paycheck Protection Program and Economic Injury Disaster Loans that have kept many mid-market companies afloat during the COVID-19 recession.
Nonetheless, most insolvency professionals, including the American Bankruptcy Institute, project a drastic increase in mid-market Chapter 11 filings beginning in Q4 of 2020. With the uncertainty of what federal aid may be available in the next round of COVID-19 relief funding, small business owners are feeling the pressure and cannot rely on their lenders to be flexible during continued economic downturn. This will undoubtedly lead to an increase in defaults, dissolutions, and insolvency proceedings.
For small businesses in particular, Chapter 11 reorganization can be expensive, time-consuming, and risky. The purpose of the SBRA, which became effective as Subchapter V of the Bankruptcy Code as of February 19, 2020, is to streamline the bankruptcy reorganization process for small business debtors by helping them resolve their outstanding debts through a condensed and cost-effective Chapter 11 proceeding. The goal is to get through the process quickly and successfully emerge from bankruptcy on better financial footing.
The SBRA offers several benefits for small business debtors and eliminates some of the more costly elements of traditional Chapter 11 relief. For example, in a Subchapter V proceeding:
- The debtor does not need to file a disclosure statement unless the bankruptcy court orders otherwise. This saves time and money.
- The debtor is exempt from paying costly United States Trustee Quarterly Fees that are required in traditional Chapter 11 cases.
- A disinterested Standing Trustee is appointed in every case to monitor its progress and facilitate the confirmation of a plan.
- The absolute priority rule does not apply in a “cramdown” case, and existing equity holders are more likely to retain their equity interests. In other words, creditors do not need to receive payment in full on their claims before equity can be retained. This is a drastic change from a traditional Chapter 11 case.
- The debtor has the exclusive right to file a Chapter 11 plan, and acceptance of the plan by an impaired class of creditors is not required.
- A committee of unsecured creditors will not be appointed unless the bankruptcy court, for cause, orders otherwise.
- The SBRA also allows an individual debtor the ability to modify a mortgage on the debtor’s principal residence if that loan was not used to acquire the residence (i.e., the funds were used primarily in the business operations of the debtor).
As originally enacted, a debtor could take advantage of the SBRA only if it had less than $2.7 million in total debt, of which at least 50% has arisen from commercial or business activities, excluding debts owed to affiliates or insiders. Importantly, the CARES Act, which became effective March 27, 2020, revised the definition of “small business debtor” in section 1182 of Subchapter V of the Bankruptcy Code such that any business with less than $7.5 million in total eligible debt can benefit from the SBRA. This increase, however, is temporary and will terminate on March 27, 2021 unless Congress takes further action, which in our current political climate, is highly speculative.
Eligible small business debtors should promptly consider whether to take advantage of Subchapter V before the CARES Act modifications expire and the eligibility debt ceiling returns to $2.7 million. Unless the March 27, 2021 deadline is extended by Congress, we expect a sharp increase of Chapter 11 filings under Subchapter V at the end of 2020 through Q1 2021.
If you have questions or would like further guidance on whether and how to take advantage of the SBRA and the CARES Act, Michael Best’s Banking and Financial Services lawyers are well-equipped to advise you on how to best proceed