Time is Running Out for Small Businesses and Their Owners to Reorganize and Shed Debt

by EmergeLaw, PLC


Federal law that expanded streamlined debt restructuring sunsets March 27, 2021


There is an efficient, inexpensive method for businesses and individuals to shed or restructure millions of dollars in debt while retaining ownership of substantially all their assets. For businesses with $7,500,000 or less in debt, this means an unprecedented (and unfortunately, soon to expire) chance to deleverage and emerge leaner and stronger with the owners retaining their equity (no “absolute priority rule”). For individuals with complex financial situations, it means the ability to keep their homes and assets in a way that is unavailable in a standard Chapter 11 or small business Chapter 11.


This incredible tool is the Small Business Reorganization Act (“SBRA”). Businesses and their owners can stop lawsuits and foreclosures, jettison debt (even over the objection of creditors), keep or sell assets, and do so only with the minimal commitment of “disposable income” for three to five years. A traditional Chapter 11 is more expensive, usually has much longer repayment periods, and has limitations that are not found in the SBRA.


The SBRA is the streamlined version of Chapter 11 that companies and owners should utilize to position themselves to rise from the pandemic stronger, stabilized, and ahead of their competitors. However, the SBRA expansions found in 2020’s CARES Act are a “limited time offer” and some of the advantages will be severely curtailed on March 27, 2021.


SBRA Highlights

Eligibility

To file under the SBRA, a small business debtor must be a person or entity engaged in commercial or business activity with aggregate debts not exceeding $7,500,000[1]. For smaller and medium-sized companies, regular Chapter 11 and/or the 2005 small business amendments may be too expensive and complex. The streamlined SBRA makes reorganizing or winding down more efficient. However, on March 27, 2021, the debt limits go back to $2,725,625 thus making many businesses ineligible after that date.


Lower Costs

Subchapter V[2] is less expensive and less administratively burdensome due to its streamlined nature. Specific cost savings include: (1) no U.S. Trustee Quarterly fees; (2) no creditor’s committee (as a general rule); (3) no separate Disclosure Statement required; and (4) ability to pay administrative expenses over the life of a non-consensual plan[3]. No United States Trustee fees can be a significant savings to Chapter 11 debtors. For example, the quarterly fee is calculated by totaling the reported disbursements for the three-month calendar quarter and be anywhere between $325 to $250,000 per quarter. Further, not having an unsecured creditors committee means a business will be paying their own professionals but not the professional fees of adversaries.


Faster Relief

Subchapter V moves very quickly. Some of the changes that have increased the speed include: (1) only the debtor can file a Plan; (2) the time limits are shortened[4]; (3) no separate Disclosure Statement is required; (4) a Subchapter V Trustee is appointed to “facilitate the development of a consensual plan of reorganization;” and (5) the debtor may confirm a cramdown plan without the acceptance of any class of creditors. These new SBRA provisions are designed to lead to more successful reorganizations while reducing the number of liquidating businesses. Not only is the SBRA streamlined for cost and efficiency, it also provides advantages not otherwise available in Chapter 11.[5]


Important New Benefits

Some of the most important new benefits include: (1) elimination of the absolute priority rule; (2) certain modifications to home mortgages; (3) the allowance of post-confirmation modifications in some instances; (4) the allowance of a discharge; and (5) other more specific benefits.


(1) No Absolute Priority Rule. The most important benefit of Subchapter V is arguably the elimination of the absolute priority rule. Under the SBRA, the court may confirm a plan over the objection of unsecured creditors as long as all projected disposable income of the debtor, to be received over 3 years (or such longer period as the court may approve but not to exceed five years) will be applied to the plan. This is a major change from conventional Chapter 11 cases and makes it easier for owners to retain their equity interest in the reorganized business.


(2) Home Mortgage Modification. Another big change allows a Subchapter V debtor to modify the rights of certain holders of claims secured only by a security interest in the debtor’s principal residence when the proceeds of the relevant mortgage were used primarily in connection with the debtor’s business. This can be a very important provision for homeowners who have used equity in their home to support their business.


(3) Plan Modification. Subchapter V provides that only the debtor can modify a plan, which is not the case under 11 U.S.C. § 1127(e). Thus, after confirmation if a business does better than anticipated, there is no risk of creditors forcing the plan to be modified.


(4) Allowance of a Discharge. A Subchapter V debtor may receive a discharge on the effective date of the plan if it was a consensual confirmation. A corporate debtor may be able to obtain a discharge even if the plan is a nonconsensual liquidating plan.[6]


(5) Other Benefits. There are several other benefits including: (1) an individual Subchapter V debtor can modify car loans (relief that is unavailable for “910 cars” in chapter 13); the limitations of the automatic stay in 11 U.S.C. § 362(n)[7] are not applicable to a Subchapter V case; and (3) a preference action cannot be filed without first considering statutory defenses, and only for actions more than $25,000, and they must be filed where the creditor resides.


Most Recent Amendments

Congress further amended the SBRA in the new Consolidated Appropriations Act of 2021signed into law on Dec. 27, 2020 (H.R. 133). The importance of these newest amendments highlights the need for businesses to act quickly to take advantage of the SBRA. On March 27, 2021, the debt limits sunsets back to $2,725,625. The new provisions include:


(1) PPP Second Round Forgiveness. Only SBRA, chapter 12 or chapter 13 debtors can use 11 U.S.C. § 364 to apply for a second-round PPP loan that if not forgiven is treated as an administrative expense.


(2) Rent Deferment Provisions. Chapter 11 debtors must continue to pay rent and comply with all other obligations under a lease of commercial real estate, but the Code is amended to allow the bankruptcy court to extend the time for performance for up to 120 days for an SBRA debtor in some circumstances.


(3) Extension of Time to Assume or Reject. The period of time to assume or reject a commercial real estate lease has been extended from 120 days to 210 days, with the possibility of an additional 90 days.


(4) Preference Protections. Certain preference protections are put in place for commercial landlords and suppliers of goods and services where the parties changed terms because of COVID related issues.


Conclusion

According to the American Bankruptcy Institute, 18% of all Chapter 11 filings in 2020 were SBRA cases. The new benefits taken together with the increased efficiencies make the SBRA an excellent tool for deleveraging a business. The enactment of the SBRA was a thoughtful start to making relief more available for overleveraged businesses, but that was before the pandemic shook up certain segments of the economy in unprecedented ways. Unless the 117th Congress acts quickly to extend (and possibly raise) the debt limits, many businesses will miss out on the SBRA reorganization provisions unless they file before the March 27, 2021 sunset deadline.


Notes:

[1] The SBRA originally contained a debt limit of $2,725,625 but was raised by the CARES ACT to $7,500,000. Without Congressional action, the limit will sunset back to $2,725,625 on March 27, 2021.


[2] The Small Business Reorganization Act is referred to in the shorthand as “SBRA” or “Subchapter V.”


[3] If the plan is consensual, this provision is not available.


[4] The SBRA deadlines include: (1) a status conference within 60 days of filing the bankruptcy petition, and (2) the debtor is required to file a plan within 90 days of the order for relief (as opposed to 300 days in a regular Chapter 11).


[5] For a more in depth discussion of the SBRA, see Small Business Reorganization Act: Streamlined Chapter 11 Relief For Businesses and Individuals.


[6] The discharge provisions are not completely straightforward. Section 1192 provides for discharge when plan payments are completed, but the nondischargeability provisions of 11 U.S.C. § 523 are applicable.


[7] § 362(n) provides, among other things, that the automatic stay does not apply if the debtor was a small business debtor in a case that was dismissed for any reason in the prior 2 years.


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