New Law Has Big Changes for Small Businesses Filing for Chapter 11

The Small Business Reorganization Act of 2019 (“SBRA”) (H.R. 3311) is one of three bills, which made significant changes to the bankruptcy code in February 2020. The other two bills include The Honoring American Veterans in Extreme Need Act of 2019 (the HAVEN Act) and the Family Farmer Relief Act of 2019. The HAVEN Act provides disabled veterans greater protections in bankruptcy proceedings and excludes Department of Defense disability payments from calculations of a debtor’s disposable income. It is expected to impact up to 25 percent of the veteran population. The Family Farmer Relief Act of 2019 makes important changes impacting the farming and fishing industries, including raising the debt limit for farming and fishing operations seeking to reorganize from $4.3m to $10m. Of the three bills, the SBRA is expected to have the broadest impact on bankruptcy practice and the business community in particular.

The SBRA was based on recommendations from the National Bankruptcy Conference, a voluntary, non-partisan, not-for-profit organization composed of about sixty of the nation’s leading bankruptcy judges, professors and legal practitioners. They proposed that Congress enact a new subchapter of Chapter 11, Subchapter V, designed exclusively for small businesses. The SBRA was the result, and should have a major impact, with nearly half of all Chapter 11 filings projected to qualify under Subchapter V.

To qualify for reorganization under the SBRA a business must have an aggregate total of all noncontingent, liquefied, secured or unsecured debt of not more than about $2.74 million dollars. For those that do qualify, benefits to the new Subchapter include a streamlined reorganization process whereby filers can expect to have a scheduled status conference within sixty days, and have ninety days to file a reorganization plan. Filers also benefit from changes designed to make reorganization more palatable to small business owners.

Most significantly under Subchapter V a debtor can have a reorganization plan approved without an approving class of creditors as long as they devote all of their “disposable income” to the payment of creditors. In fact, there is a presumption against even the formation of a creditor’s committee without cause, and only the debtor business may file under the subchapter. This prevents reorganizations that amount to hostile takeovers by creditors and prevents priority creditors from insisting upon liquidation of the business.

New Section 1191(d) also defines “disposable income” very generously as income received by the debtor that is “not reasonably necessary to be expended” in operating the business. These two changes effectively write out the “absolute priority rule” for small businesses trying to reorganize, making liquidation much less likely. Shareholders in the debtor corporation would not be prevented from keeping their stock until creditors are paid in full, and the hope is that more small businesses will be able to survive a reorganization and remain in operation during the process.

It should go without saying, the SBRA also changes the landscape of Chapter 11 for creditors. Creditors facing a reorganization under the new subchapter should consider options outside of the bankruptcy process. However, most commentators predict better results for creditors as well as debtors if the debtor stays in control of the process and the business is able to reorganize successfully.