New federal legislation proposed for small businesses in bankruptcy

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Chapter 11 has historically created debilitating hurdles for the small business debtor, which in many cases prevents meaningful rehabilitation. As a result, in late November 2018, the Small Business Reorganization Act (S. 3689 and H.R. 7190, the “SBRA”) was introduced. This bipartisan, bicarmeral legislation would add a new subchapter to Chapter 11 of the Bankruptcy Code to address many of the difficulties experienced by small business debtors. The SBRA would apply to cases where a debtor has aggregate liabilities that do not exceed $2,566,050 (excluding debt owed to one or more affiliates or insiders). 

Chapter 11 for small businesses

Chapter 11 in its current form contains few provisions designed specifically with small businesses in mind. Instead, while Chapter 11 can be effective for administering complex business reorganizations involving multi-million dollar companies, it is seldom effective for smaller businesses due to  extensive reporting requirements, complicated procedures, broad participation from groups of creditors at a debtor’s expense, and high costs. As such, many small businesses do not consider Chapter 11 a viable option due to the costs imposed by these requirements. 

The SBRA streamlines existing bankruptcy procedures and provides new tools to increase a small business’s ability to achieve a successful restructuring, reduce the number of liquidations, and increase recoveries to creditors. 

Key provisions of the SBRA include: 

  • Increasing the debtors’ ability to negotiate a successful reorganization and retain control of the business. 
    • Compared to Chapter 11, the SBRA provides that only the small business debtor may propose a plan of reorganization, thus removing some creditor pressures. 
    • The owner of the small business debtor may retain a stake in the company so long as the plan does not discriminate unfairly, and is fair and equitable, with respect to each class of claims or interests. This distinction cannot be overlooked. In a traditional Chapter 11, a debtor must comply with the “absolute priority rule”, which requires that any equity holder seeking to reorganize under Chapter 11 must also contribute to the plan to maintain their equity interest. The SBRA removes this constraint, giving small business debtors more flexibility to propose a plan with continuity of ownership. 
    • The SBRA adds a new requirement for proposed plans. A small business debtor must contribute its “disposable income” for the length of the plan. Disposable income in this context means income that is not reasonably necessary for the continuation, preservation, or operation of the business debtor. Moreover, small business plans cannot exceed five years. Both of these additional requirements mimic burdens imposed on Chapter 13 consumer debtors and Chapter 12 farming debtors. 
  • Reducing unnecessary procedural burdens and costs. 
    • The SBRA eliminates the automatic appointment of an official committee of unsecured creditors (when requested by creditors). Instead, a committee will only be appointed upon a showing of cause. Because appointed creditors’ committees are funded by a debtor, this elimination will dramatically reduce the costs associated with a reorganization. Additionally, this may avoid bankruptcy sales resulting from pressure to fund creditors and instead give the debtor breathing room to propose a successful reorganization. 
  • Increasing oversight and ensuring quick reorganization. 
    • A standing trustee would be appointed in every small business debtor case to perform duties similar to those performed by a Chapter 12 or Chapter 13 trustee. A small business debtor may be wary of this addition, as it has the potential to reduce debtor control of the proceedings.  
    • The SBRA requires that a small business debtor file a plan of reorganization within 90 days of commencement, which may be extended under limited circumstances. The new timing restrictions will reduce bankruptcy overhead and streamline the process, which may result in reduced costs for the small business debtor.

The U.S. Senate Judiciary is currently reviewing the SBRA and it has been referred to the House Judiciary committee for consideration. McDonald Hopkins understands the importance of this upcoming legislation and is available to discuss its implications on future bankruptcy filings for both debtors and creditors. 

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