CARES Act Increases The Limits For Small Business Bankruptcy Cases, But How Does A Small Business Bankruptcy Case Work?

April 22, 2020

By Steven R. Kinsella

Emergency AidFaced with the unprecedented challenge of responding to the COVID-19 crisis and its impact on the nation’s economy, Congress passed the Coronavirus Aid, Relief and Economic Security Act, commonly referred to as the CARES Act. The CARES Act includes several provisions designed to assist individuals and businesses dealing with this emerging economic catastrophe. Many of these provisions are focused on assisting small businesses, such as the Economic Injury Disaster Loans and Paycheck Protection Program Loans. In a further effort to help small businesses that require financial reorganization, the CARES Act modified a pre-existing section of the Bankruptcy Code designed for small business reorganizations.

In August of 2019, Congress passed the Small Business Reorganization Act, amending the Bankruptcy Code to add a new Subchapter V to Chapter 11. The purpose of the new Subchapter V was to streamline the bankruptcy process for small businesses, with the goal of creating faster and less expensive reorganization cases. Congress initially set a debt limit of $2,725,625 for small businesses electing to reorganize under Subchapter V, which limited the number of small businesses eligible to utilize the small business reorganization provisions. The CARES Act raises the debt limit to $7.5 million in an effort to make small business reorganizations more accessible. With this increase in the debt limit, we know that more small businesses will qualify to use Subchapter V, but what does a small business reorganization actually look like?

When a small business reorganization case is filed, the small business debtor will remain in possession of all its assets and will have the rights and powers afforded to a Chapter 11 trustee. 11 U.S.C. §§ 1182, 1184. Just as in a normal Chapter 11 case, the debtor will need to seek court approval for the normal first day motions, such as use of cash collateral, continued use of the debtor’s bank accounts and authorization to pay employees. However, no unsecured creditors committee will be appointed. 11 U.S.C. § 1181(b). Instead, the United States Trustee’s Office is authorized to appoint a standing trustee that will serve as a supervisory role similar to the role held by Chapter 12 and Chapter 13 trustees. 11 U.S.C. § 1183. The standing trustee is compensated through payments under the reorganization plan–the trustee is entitled to receive 5 percent of all distributions made under the plan. 28 U.S.C. § 586(e)(2)(A). After the case is filed, the debtor will continue normal business operations during the pendency of the case and the general operation of the case will resemble that of a Chapter 11 case, with the debtor requiring court approval for actions taken outside of the ordinary course of business.

While all reorganization cases are focused on reaching a plan of reorganization, small business bankruptcy cases place an even more significant focus on the goal of reorganized and is designed to move quickly to the plan. The bankruptcy court must set a conference within the first 60 days after the bankruptcy case is filed and the debtor is required to provide a report to the court 14 days before the conference updating the court on the debtor’s efforts to reach a consensual plan of reorganization. 11 U.S.C. § 1188. The debtor then must file its plan within 90 days after the case is commenced. 11 U.S.C. § 1189(b).

The plan process is further streamlined. There is no requirement for a disclosure statement; instead, the plan must include a brief history of the debtor’s operations, a liquidation analysis and plan projections. 11 U.S.C. §§ 1181(b), 1190. No party is permitted to file a competing plan. 11 U.S.C. § 1181. If the plan does not discriminate unfairly and is fair and equitable, an impaired class does not need to accept the plan. 11 U.S.C. § 1191(b).

The fair and equitable requirement is modified to require:

  • the plan satisfied the cramdown requirements for secured claims under 11 U.S.C. § 1129(b)(2)(A);
  • the plan provides for all projected disposable income to be received in a three-year period (or a longer period as established by the court, but not greater than five years) will be paid under the plan;
  • the debtor is reasonably likely to be able to make all the payments under the plan; and
  • the plan provides for remedies if payments are not made.

11 U.S.C. § 1191(c). Importantly, the requirement to pay all projected disposable income does not require that the plan actually last three to five years; rather, the plan may provide for payments over a shorter period of time as long as those payments equal the amount of projected disposable income over the applicable time period. The disposable income definition is also modified and means an income received by the debtor that is not reasonably necessary for the payment of expenses for the continuation, preservation or operation of the business. 11 U.S.C. § 1191(d).

One of the most important aspects of Subchapter V is the abrogation of the absolute priority rule. 11 U.S.C. § 1181(a). In a normal Chapter 11 case, the absolute priority rule prevents current equity holders from retaining their equity in the debtor unless the plan pays all creditors in full. 11 U.S.C. § 1129(b)(2)(B). With the elimination of the absolute priority rule for Subchapter V cases, small business owners will have the ability to retain their ownership interests in their businesses even if their plans do not pay all creditors in full. 11 U.S.C. § 1181(a). After the plan payments are made, the small business debtor is eligible to receive a discharge of all outstanding debts remaining. 11 U.S.C. § 1192.

While it is always impossible to know what the future holds, it is even more difficult to guess what the full economic impact of COVID-19 will have on small businesses and our economy as we work through this difficult time. In this ever-changing economic climate, it will be more important than ever for small businesses to understand and use the tools provided by the CARES Act, including small business reorganizations under the Bankruptcy Code.

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