Client Alert: Small Business Rescue: A Quick Guide to the Small Business Reorganization Act
Date: June 9, 2020
Recent changes in the bankruptcy code have made restructuring in bankruptcy a much more attractive option for smaller businesses than in the past. While bankruptcy is generally a remedy of last resort, small businesses needing to file for bankruptcy now have significant additional protections, and an increased chance of survival, under the provisions of the Small Business Reorganization Act.
When Is It Time for Bankruptcy?
Almost never a first option, bankruptcy is usually a remedy of last resort. Companies will almost always try and solve financial problems through an out-of-court workout. There are several reasons for this, including:
- It will be less costly. Out-of-court workouts are typically less expensive than a bankruptcy filing.
- It avoids the stigma of bankruptcy.
- By staying out of court, a company can run its business without the distraction of a court proceeding and legal paperwork.
There are potential benefits to a company that may be available only through a bankruptcy filing. These include getting out of “out of market” leases and forcing creditors to the table to discuss a resolution. Every situation is unique, and benefits that are available to some companies in bankruptcy are not necessarily available to all. But the fact is that bankruptcy can be a necessary step, and in the past it was not an easy path for small businesses to follow.
In order to understand why the Small Business Reorganization Act (SBRA) is a potential breakthrough for small businesses that need to file for bankruptcy, it is necessary to understand some of the challenges small businesses routinely faced under traditional Chapter 11 bankruptcies. (Note that we are discussing only Chapter 11 bankruptcies, which involve reorganizations of a company, and not Chapter 7, which involves liquidations.)
In any bankruptcy, including in a Chapter 11 filing, all collection efforts against the party filing bankruptcy, i.e., the “debtor,” are automatically stayed. The debtor can maintain its business operations while negotiating a plan of reorganization with creditors. That sounds good in theory, but the reality for small businesses has been that the process is often extremely cumbersome and expensive.
- In Chapter 11, Court approval is required at many points along the way, significantly increasing legal fees.
- Extensive financial reporting requirements can mean substantial payments to accountants and financial advisors.
- Creditors can form a committee, hire lawyers and accountants and bill the company for their fees.
- Equity holders can lose ownership interests.
The SBRA is a new and potentially powerful corrective to what have been intractable issues for small businesses.
How SBRA Changed the Landscape
The SBRA became effective February 19, 2020, making it quicker and less expensive for small businesses to go through a Chapter 11 reorganization. In addition to providing a more streamlined process, the SBRA has also made it easier for business owners to retain equity interests, even without creditor support.
For a business to be eligible to file for bankruptcy under the SBRA, its debt can be no greater than $7.5 million, and at least 50% of that debt must be business-related. Both individuals and entities may file under the SBRA, and both for profit and nonprofit entities may file. One key exclusion: a single asset real estate entity may not file.
Under the SBRA, compared to traditional Chapter 11 filings, the process moves quickly once a party files. A reorganization plan is required within 90 days of filing. In order to ensure this happens, there is a mandatory status conference with the Court within 60 days of filing. At least 14 days in advance of the status hearing, a status report is required that outlines efforts to negotiate a repayment deal with creditors. The upshot of these requirements and deadlines is that a debtor gets in front of a judge and the case moves along quickly
In addition, throughout the process, the debtor is required to work with a court-appointed Trustee. The Trustee’s main role is to work with the debtor in negotiating a deal with creditors. The Trustee is required to appear at the status conference and key hearings. The Trustee may also be charged with handling payments to creditors under the reorganization plan. The Trustee’s role in the case ends when the plan is substantially consummated, and, unless there are extenuating circumstances, he or she will not get involved in running the debtor’s business.
Why File under the SBRA?
When compared to the potentially very high costs of a traditional Chapter 11 bankruptcy, the newly enacted provisions of the SBRA offer small businesses a number of clearly identifiable advantages.
- Plan of reorganization not as complex as in a typical Chapter 11 case.
- No separate disclosure requirement required to be prepared and filed.
- Fewer filing requirements.
- Official forms for certain filing requirements are available, which can keep legal costs down.
- No creditors’ committee and no committee professionals to pay for.
- No U.S. Trustee fees.
It is also much easier for a business owner to maintain equity interests even if no creditors agree with the reorganization plan. There can be both Consensual and Non-Consensual Plans. In a Consensual Plan, all creditors would agree to repayment terms offered in plan. In a Non-Consensual Plan – also known as a “cram-down” – all creditors DO NOT have to agree to the repayment terms offered in the plan. In the event of a non-consensual plan, the repayment terms must be “fair and equitable.” For unsecured creditors’ claims, this means using disposable income to pay off these debts over a 3-to-5-year period. Disposable income is primarily that income from the business that is not necessary to continue operations.
Not surprisingly, complications and concerns may arise in a bankruptcy under SBRA. For example, the debtor’s business will become an “open book,” giving rise to possible trade secret concerns. There may also be complex landlord/tenant issues to resolve, as landlords have certain rights in bankruptcy.
Despite the potential need to solve for unique legal and business issues, the fact remains that the SBRA is a giant step in the right direction for a small business facing the prospect of bankruptcy. When there is literally no other option to save the business, the SBRA offers immediate relief in stopping collection efforts, as well as for time needed for negotiations with creditors, and a reorganization plan can be put before the Court immediately upon bankruptcy filing and possibly confirmed within 45 days.
The information contained here is not intended to provide legal advice or opinion and should not be acted upon without consulting an attorney. Counsel should not be selected based on advertising materials, and we recommend that you conduct further investigation when seeking legal representation.