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How the SBRA's Raised Debt Cap Can Help Those Facing Bankruptcy with Personal Guarantees

October 20, 2020

One question often asked of bankruptcy lawyers is, “what happens to my personal guarantee of business debt if my business files for bankruptcy?” Generally, the response has been that the guarantor is personally liable for a guarantee of the business debt. The creditor will seek repayment of the guarantee from the individual if the business files for bankruptcy or closes its doors.

Without another way to restructure the personal guarantee, the harsh reality is that many small business owners have been forced to file personal Chapter 7 bankruptcy or face potential foreclosure. But now, thanks to the Small Business Reorganization Act of 2019 (SBRA), also called “Subchapter V,” individuals can seek Subchapter V bankruptcy relief to restructure personal guarantees of bankrupt or otherwise defunct business debt.

The SBRA introduces a more efficient path to reorganization and gives small businesses (and individuals) some advantages not previously available under Chapter 11. These include:

  • Removal of the absolute priority rule, which allows equity holders to retain their ownership interests without paying all creditors in full
  • The exclusive right to file a plan of reorganization
  • The ability to confirm a plan without getting consent of an impaired class of creditors, which allows a debtor to restructure payment of a debt over the objection of a class of creditors

An individual who qualifies as a “small business debtor” can use Subchapter V to restructure personal guarantees of non-operating company debt through an individual plan of reorganization. This spreads payments of “disposable income” over a three- to five-year period.

Some have challenged an individual’s eligibility to file a Subchapter V case to address residual business debt incurred from a non-operating business. Challengers suggest that such an individual does not meet the SBRA definition of a debtor, because they are not currently engaged in a business activity if the business is no longer operating. The SBRA defines a debtor as a business or individual:

  • That must be “engaged in commercial or business activities”
  • With “aggregate noncontingent liquidated secured and unsecured debts…in an amount not more than $7,500,000” and “not less than 50% of which arose from the commercial or business activities of the debtor”

In several recent opinions, bankruptcy courts have held that nothing in the SBRA requires a debtor to be currently engaged in commercial or business activities. The courts have reasoned that an individual is “engaged in commercial or business activities” by addressing residual business debt. As such, the individual must meet three requirements to seek Subchapter V bankruptcy relief:

  • Aggregate noncontingent liquidated secured and unsecured debts less than $7,500,000
  • More than 50% of the aggregate debt arising from the personal guarantee
  • No coexistent bankruptcy case for the individual and non-operating business

The primary purpose of the SBRA is to promote successful reorganizations. Subchapter V is a useful tool for those facing potential liability on personal guarantees during this critical time. When enacted, a debtor could take advantage of the SBRA only if the debtor had less than $2,725,625 in total debt. The CARES Act revised the definition of “small business debtor” such that businesses and individuals with less than $7,500,000 in total eligible debt can benefit from the SBRA. This increase, however, is temporary. It will end on March 27, 2021, unless Congress takes further action. Small businesses and individuals that are currently eligible for Subchapter V should talk with a bankruptcy lawyer before the eligibility cap lowers again.

Please contact Rick Shelby or any other member of Phelps’ Bankruptcy team if you have questions or need compliance advice and guidance. For more information related to COVID-19, visit Phelps’ COVID-19: Client Resource Portal.