Breaking Down the 2019 Small Business Reorganization Act

April 02, 2020

The federal government made bankruptcy a viable option for small businesses with the passage of the Small Business Reorganization Act of 2019 (SBRA). The act, which became effective Feb. 19, is designed for smaller businesses that cannot afford the high administrative fees and costs associated with traditional Chapter 11 reorganizations.

Chapter 11 bankruptcy was developed with the publicly traded manufacturer in mind, not your local café or mechanic shop. Many provisions of Chapter 11 are, therefore, geared to corporations with complex capital structures and operations instead of small, family-run businesses that are dependent on the talent and labor of a single owner-manager and family members. This design has resulted in many distressed small businesses being forced to wind down piecemeal, rather than preserving value and long-term viability by successfully reorganizing through bankruptcy. The goal of the SBRA is to make Chapter 11 reorganization viable for small businesses by speeding up the proposal and implementation of a plan, reducing costs to debtors, and providing quicker returns to creditors.

The general framework is that a small business debtor files a Chapter 11 petition, elects SBRA protection and a standing trustee is appointed. Facilitated by the trustee, the debtor remains in control of its business and assets and negotiates and proposes a plan of reorganization within 90 days. If a consensual plan is confirmed by the bankruptcy court, the debtor receives a discharge at confirmation and the trustee is dismissed. The debtor will then make plan payments, typically over three to five years.

If a consensual plan cannot be reached, secured creditors must still be paid in full over the life of the plan. However, owners can retain their interests in the business even if unsecured creditors are not repaid in full. To do this, the debtor and trustee will calculate the debtor’s disposable income (revenues minus expenses necessary to operate the business), and the debtor will pay the disposable income to creditors for pro rata distribution over three to five years. After three to five years, if all plan payments have been made, unsecured debts will be discharged even if not repaid in full, and owners retain their interest in the business. The SBRA also allows a debtor to modify a residential mortgage if the underlying loan was not used to acquire the residence and was used primarily in connection with a small business.

Who is eligible for protection under the SBRA?

An individual or business with “aggregate, noncontingent, liquidated secured and unsecured debts as of the filing date of the petition or the date of the order for relief in an amount no more than $2,725,625 (excluding debts owed to one or more affiliates or insiders).” The CARES Act, recently passed by Congress to address the economic impact of the COVID-19 pandemic, temporarily increases the debt limit to $7,500,000 for cases filed after CARES becomes effective and is applicable for one year thereafter. After one year, the debt limit will return to $2,725,625 unless Congress extends the increase.

How does the SBRA reduce costs for debtors?

In most cases:

  • No unsecured creditors committee is formed
  • No disclosure statement is prepared and served
  • No U.S. trustee quarterly fees are paid
  • No dilly-dallying: the debtor must file a plan within 90 days

Other benefits for debtors?

  • Only the debtor may file a plan, so an angry creditor cannot file its own plan.
  • A standing trustee is appointed to, among other things, facilitate the development of a consensual plan or reorganization, but the debtor remains in charge of business and in possession of assets.
  • If the confirmed plan is consensual, the debtor receives a discharge at confirmation and the trustee is terminated upon substantial consummation, typically when the debtor starts making plan payments.
  • The plan may modify the rights of a claim secured only by a security interest in real property that is the debtor’s principal residence, if the new value received in connection with the granting of the mortgage was not used primarily to purchase the property, but in connection with the operation of the business.

Things the SBRA does not do:

  • Provide a codebtor stay, so if the small business owner personally guaranteed one or more debts of the business, a creditor holding that personal guarantee can seek remedies directly against the owner and her personal assets even though the automatic stay protects the business’s assets
  • If the plan is nonconsensual, the debtor does not receive a discharge until after payments have been made (between three and five years from confirmation)

As businesses continue to adjust to new American and global business environments, bankruptcy is just one option for a business that needs to make short- or long-term adjustments to its debt structure to weather the storm.

Phelps’s bankruptcy team is available to advise clients on both offensive and defensive strategies in play with the new SBRA. Also, Phelps has set up a COVID-19 Client Resource Portal to assist individuals and businesses through the economic uncertainty and myriad legal concerns that have arisen and will continue to arise in the coming months.