The recently enacted “Coronavirus Aid, Relief and Economic Security Act” (CARES) expands the applicability of the Small Business Reorganization Act (SBRA), passed just last year. As a result:
- Businesses with less than $7.5 million in debts may proceed under the new subchapter V of chapter 11 of the Bankruptcy Code;
- The cost of a chapter 11 reorganization for these qualifying businesses will in most cases be drastically reduced;
- Reorganizations can occur much quicker than a normal chapter 11, with a plan due within 90 days of the filing of the bankruptcy;
- Filing bankruptcy will become a viable option for more businesses; while many businesses will use these new provisions legitimately, it also provides the opportunity for abusive filers attempting to use bankruptcy as leverage with adverse parties.
The streamlined provisions created by these two pieces of legislation will likely encourage more businesses to seek bankruptcy relief in the aftermath of the Covid-19 pandemic. Given the new legislation and existing complexities of bankruptcy, for successful outcomes regardless of whether you are the debtor or creditor, it will be important to have experienced counsel knowledgeable in the intricacies of bankruptcy law and procedures.
The following are some of the significant aspects of the SBRA and CARES Act:
The SBRA makes bankruptcy reorganization feasible for more small- to mid-sized businesses, but also may lead to an increase in strategic or abusive filings.
SBRA allows small business debtors—i.e., businesses with less than $2,725,625 in debts, provided at least half of the debt is business debt— to proceed under a new subchapter V of chapter 11 of the Bankruptcy Code.
Prior to the SBRA, businesses seeking bankruptcy relief were limited to filing under chapter 7 or the prior version of chapter 11. A chapter 7 bankruptcy is generally less expensive and consists of a liquidation of the business’s assets by an independently appointed trustee. Consequently, chapter 7 is not an option for businesses looking to control and continue operations.
On the other hand, a chapter 11 allows the debtor to remain in control and restructure its debts. However, it is subject to oversight by both the bankruptcy court and the United States Trustee’s office, and can be a long and expensive process. Because of this, many struggling businesses, particularly small to mid-sized businesses, may not be able to afford (or survive) a normal chapter 11.
The SBRA provides a middle ground approach. The legislation was designed to help small businesses survive economic instability by making the reorganization process quicker and less expensive and by providing other tools to help businesses successfully reorganize. It does this by:
- Shortening deadlines;
- Eliminating U.S. Trustee fees and creditors’ committees;
- Removing certain requirements (such as disclosure statements describing how the plan will operate and impact creditors); and
- Requiring the debtor to file a plan of reorganization within 90 days.
Additionally, the SBRA provides for a private trustee to help the business and its creditors negotiate and structure a consensual plan, and has other provisions that make the process more appealing to small business owners, such as allowing business loans secured by a principal residence to be restructured in some circumstances.
While the SBRA presents many benefits to small businesses, the convenience and lowered barrier of entry make it more likely that parties dealing with a distressed business, whether through litigation or otherwise, will end up in bankruptcy court. A deep understanding of the bankruptcy rules and procedures will allow businesses and individuals to avoid the pitfalls and potential adverse consequences a bankruptcy filing may have.
The CARES Act expands the availability of the SBRA to more businesses.
Although the SBRA has only been in effect for little over a month, just last week Congress passed and President Trump signed the CARES Act. Among other things, the CARES Act expands the SBRA to make it available to more businesses in light of the current crisis the nation is facing due to the COVID-19 pandemic. The Act temporarily increases the SBRA’s debt limit from $2,725,625 to $7.5 million, and has implications on other bankruptcy provisions—for example, the treatment of certain stimulus-related income, and temporary student-loan relief.
Other aspects of the CARES Act will have direct impact on businesses with restructuring needs. Perhaps most prominently, the Act contains a $349 billion loan program to help provide businesses with capital and keep workers employed. The loan program will also be available retroactive from mid-February 2020, so employers can re-hire any laid off staff through the end of June. The program allows businesses with less than 500 employees (with some industry-specific exceptions) to apply for loans that will be fully forgiven so long as the funds are used for specific business-related costs, such as payroll; otherwise, loan payments will be deferred for 6 months, and loans have a maturity of 2 years at 1% interest. The maximum loan amount available to qualifying borrowers is determined by a formula taking aggregate payroll costs for the prior 12 months, subtracting compensation paid to an employee in excess of $100,000, dividing that number by 12 (to calculate the average monthly payroll costs), multiplying that number by 2.5, and adding the amount of any Economic Injury Disaster Loan (EIDL) and less any advances received under an EIDL COVID-19 loan. The loan amount is capped at $10 million.
At the same time the enactment of the CARES Act is making the SBRA’s tools and benefits available to many more businesses, it correspondingly expands the unique challenges the SBRA presents to creditors and other interested parties to a much wider field. Certain changes the SBRA makes to a normal chapter 11, for example allowing administrative expenses to be paid over the life of the plan instead of upfront upon plan confirmation, means that those dealing with a small business that is in bankruptcy or about to file will need to carefully assess the risks of doing so. By raising the debt limits, the SBRA also greatly increases the number of businesses that may file bankruptcy to avoid or gain leverage in litigation with adverse parties.
We’re here to help.
The CARES Act is unlikely the last piece of legislation impacting businesses and the bankruptcy system as we continue to address the economic impact of the COVID-19 outbreak.
If you have any questions or concerns, or would like to discuss your situation, please give us a call. Perhaps now more than ever, being proactive in addressing these issues will be a key to achieving long term success.