COVID-19 and Small Business Reorganization

An overview of how the coronavirus disease (COVID-19) impacts reorganization for small businesses.
 
When the Small Business Reorganization Act of 2019 (“SBRA”) came into effect in February 2020, news of a novel coronavirus disease (COVID-19) afflicting people in China seemed distant at best to most Americans. Now in March 2020, the U.S. economy has come to a near halt in the midst of a global pandemic, and the financial consequences of COVID-19 have hit small businesses especially hard, as the average small business has only 27 days of cash in reserve.

The COVID-19 pandemic may force small businesses that were stable even just a few weeks ago to explore the full range of financial options available for them, including reorganization. While filing for Chapter 11 bankruptcy can alleviate pressures a company feels when negotiating with creditors and provide the company a chance to continue its operations, it can be a complicated, lengthy, and expensive process that typically favors large companies. Various provisions of an ordinary Chapter 11 make it very difficult, if not impossible, for small business owners to retain control of their companies if they cannot pay all unsecured creditors in full. The SBRA’s aim was to increase access and the ease of reorganization for small business debtors by relaxing the requirements of an ordinary Chapter 11 and allowing business owners to retain more control over their companies.

Congress also views the SBRA as an important avenue for relief during the current health crisis. The coronavirus stimulus bill, which appears on its way to passage by Congress, has made several material temporary changes to the Bankruptcy Code, including an important change to the SBRA to open it up to a much larger universe of businesses over the next year.

Key provisions of the SBRA include the following:

• Small business debtor. To qualify as a “small business debtor” under the SBRA, the debtor must be a person or entity engaged in commercial or business activity with aggregate secured and unsecured debt of no more than $2,725,625.[1] The Coronavirus Aid, Relief and Economic Security Act (the “CARES” Act), § 1113(a)(1),  temporarily increases this limit to $7,500,000.[2] This should open the SBRA to a much broader group of distressed businesses.

• Filing the plan. Unlike a standard Chapter 11 bankruptcy case, only the debtor may file a plan of reorganization. The SBRA also consolidates the disclosure statement and plan typically required in a Chapter 11 case into a single plan document that includes, among other things: (a) a brief history of the debtor’s business, (b) a liquidation analysis, and (c) projections regarding the debtor’s ability to make plan payments.[3] Such a plan must be filed within 90 days of the commencement of the case, unless the court extends the deadline due to circumstances outside the debtor’s control.[4]

• Modification of certain residential mortgages. An individual debtor is empowered to modify any mortgage on the debtor’s principal residence, if the related loan was not used to purchase the residence and was primarily used in connection with operating the small business.

• Modified confirmation standards. The most valuable part of the SBRA for small business debtors is the modified confirmation standards. In a standard Chapter 11 plan, the debtor may not retain any equity in the business over an impaired creditor’s objection unless she either: (a) pays all unsecured creditors in full or (b) essentially wins an auction to inject new value into the business.[5] Under the SBRA, the debtor may retain ownership of the business, even without paying unsecured creditors in full, provided that the plan payments are funded by all of the business’s projected disposable income over a three to five year period.[6] Importantly, the business’s disposable income is defined as any income received by the debtor that is not reasonably necessary to be expended (x) to support the debtor, the debtor’s dependents, and any domestic support obligation of the debtor, and (y) to continue to operate the business.[7]

• Appointment of a trustee. Instead of establishing an independent creditors committee, the SBRA contemplates the appointment of a standing small business trustee within each region of the Office of the U.S. Trustee to monitor each debtor’s compliance with the requirements of the SBRA, facilitate the development of a consensual plan of reorganization for the business, and ensure the debtor commences making timely payments under the plan. If the debtor’s management is removed for cause due to fraud, dishonesty, incompetency, or gross mismanagement of the affairs of the company, then the trustee may be empowered to take control of the business.[8]

The SBRA retains all of the key benefits of a Chapter 11 bankruptcy filing. The filing of a bankruptcy petition automatically stays all creditor collection actions, providing the debtor with the breathing space it needs to reassess and restructure its business during the current crisis.[9] The debtor will have an opportunity to assess all of its leases and executory contracts and choose which contracts to assume or reject.[10] And, the debtor may also take advantage of streamlined processes to sell off under-performing assets free and clear of liens and encumbrances[11] and obtain much needed debtor-in-possession financing.[12]
 
In this time of great uncertainly, the new small business debtor reorganization subchapter of the Chapter 11 of the Bankruptcy Code is a possibility that small businesses should review as they are considering their options going forward.
 
As the COVID-19 pandemic continues, Ice Miller attorneys stand ready to assist you and your business with questions regarding reorganization, including filing under the SBRA. Contact Daniel Swetnam or Michael Ott for more information.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstances.