The Small Business Reorganization Act of 2019
The Small Business Reorganization Act of 2019, effective February 22, 2020, should make bankruptcy reorganization for small businesses and professionals easier. While businesses may wish to take advantage of the new law, lenders need to understand that it changes the workout environment. For example, in certain circumstances, under the new law, debtors will be able to alter debts secured solely by their residence.
Under current bankruptcy law, filing for relief under the Bankruptcy Code as a small business or a small business owner with debts in excess $419,275 for unsecured debt and $1,257,850 for secured debt is very difficult. This is because business entities themselves are not eligible for Chapter 13 protection and business owners who own businesses with debts in excess of these limits must file Chapter 11 cases if they want to reorganize.
Being within Chapter 11 brings all kinds of additional administrative and legal hurdles that are not present in a Chapter 13 case. One of the biggest is the absolute priority rule. This rule provides, in essence, that if a class of creditors objects to confirmation of the plan, the debtors cannot confirm a plan unless they pay all creditors in full if they retain any property. As a practical matter, if you were a professional or small business owner, you often had to pay 100% to unsecured creditors to keep your practice or business.
Being in a Chapter 11 also brings significant administrative burdens that do not exist in a Chapter 13 case. For example, in a Chapter 11 there is usually a creditors committee. This committee often retains professionals like lawyers and accountants. These professionals must usually be paid as an administrative expense in the case. This adds greatly to the cost of case administration.
Under the new law there are certain relatively significant changes:
A new Subchapter V is created underneath Chapter 11.
Both individuals and businesses are eligible for relief under this new Subchapter.
A debtor must elect Chapter V treatment
More than half of the debt must be from business or commercial activities and there still is a $ $2,725,625 debt limit (excluding debts owed to one or more affiliates or insiders).
Single asset real estate cases are not eligible.
Debtors can modify loans secured by a mortgage solely on a debtor’s principal residence if the loan was used not primarily to acquire the residence and was used primarily in the business.
There is also no Chapter 11 trustee in a Subchapter V case. In Subchapter V there will be likely a standing trustee who will be paid based upon disbursements under the Plan, but they will have a high incentive to make sure a plan is confirmed. If a plan is not confirmed, the trustee does not get paid.
There is no creditors committee unless the judge orders one to be formed for cause.
Debtors can owe their counsel up to $10,000 pre-petition without it being an automatic disqualification.
Creditors cannot propose plans, but the Debtor only has 90 days to get their plan on file.
The absolute priority rule is gone. In its stead, a plan can be confirmed generally if the debtor devotes all of their projected disposable income (or property of equivalent value) for a three to five year period.
There are other confirmation requirements as well.
Post-petition earnings will be included in estate property and must be devoted to the plan.
A discharge is not entered until the end of the case after all payments are made.