Client Alert
CARES Act Temporarily Expands Certain Bankruptcy Relief Available to Small Businesses
Client Alert
CARES Act Temporarily Expands Certain Bankruptcy Relief Available to Small Businesses
April 1, 2020
As American individuals, employers, and governments are implementing various restrictions from social distancing to quarantines to reduce the rate of new COVID-19 infections, each of these decisions results in an increasingly negative impact on the American economy. Even with the recent financial aid package passed by Congress, with greater credit constraints and a heightened sensitivity to weak consumer demand, small businesses are among those hit the hardest by COVID-19 restrictions.
On March 27, 2020, in response to the strain on the American economy, Congress enacted the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”). An integral part of the CARES Act is a modification to the Small Business Reorganization Act (“SBRA”) that increases access to bankruptcy relief for small businesses.
LIQUIDATION AND REORGANIZATION UNDER THE BANKRUPTCY CODE
There are two primary tracks for seeking relief under the Bankruptcy Code: liquidation and reorganization. In a liquidation under chapter 7 of the Bankruptcy Code, a company’s assets (including physical assets, rights, claims, and operations) are sold and the funds marshalled to pay the company’s creditors. In a reorganization under chapter 11 of the Bankruptcy Code, a company reorganizes its debts pursuant to a plan of reorganization, enabling the rehabilitated company to re-emerge from bankruptcy as a financially viable operation.
Prior to the enactment of the SBRA, struggling small businesses’ options were, in practice, more limited. Chapter 11 reorganization was designed to address the administration of complex (sometimes lengthy) multi-million dollar reorganizations. For small businesses, the complexities of chapter 11 lead most to liquidate without the prospect of reorganization because small businesses lacked the resources required to proceed under chapter 11.
THE SMALL BUSINESS REORGANIZATION ACT
SBRA, signed into law on August 23, 2019, created subchapter V of chapter 11 of the United States Bankruptcy Code to streamline the reorganization of small businesses. Subchapter V is a powerful and efficient tool to reorganize the financial affairs of eligible small businesses. Not only does subchapter V expedite the chapter 11 process, it also reduces costs and allows small businesses to take advantage of the reorganization process despite having limited financial resources.
Among other things—including, ultimately, discharge of debts—subchapter V includes the following benefits for small businesses:
- Expedited Timeline. The timeline of a subchapter V reorganization is truncated compared to the traditional chapter 11 reorganization. A status conference must be held within 60 days of the petition date and the company must file a plan within 90 days of the petition date. This shortened timeframe will ensure savings to the company and, by extension, preserve value of the company for the benefit of creditors.
- Efficient Plan Confirmation. Unlike in a complex chapter 11 case, where other parties can submit competing plans in certain circumstances, thereby prolonging the process, only the company itself can propose a plan of reorganization. Further, the company is not required to incur the expense of preparing a separate disclosure statement or soliciting votes to confirm a plan.
- Elimination of Creditors Committee. In contrast to many chapter 11 cases, in a subchapter V case, a creditors committee cannot be appointed unless the court finds “cause.” Because a showing of “cause” is a heightened standard, it is certainly less likely that a committee would be appointed, which results in significant cost savings to the small business and, in particular, preserves value of the company for its creditors.
- Trustee to Guide Small Business Through Process. The United States Trustee must appoint a trustee to assist the company in the reorganization process. The trustee, however, is not an operational trustee – current management of the small business remains in place (as what is called a debtor-in-possession), aided through the subchapter V process by the trustee.
- Extended Payments of Administrative Expenses. Administrative expense claims are those claims that are incurred after the bankruptcy case is commenced, and typically include professionals’ fees (including those of the trustee) and other actual and necessary expenses in operating the business through the bankruptcy case. Unlike traditional chapter 11, the small business is not required to pay administrative expense claims on the effective date of the plan, but rather is permitted to pay those claims over the life of the plan. This adjustment serves to provide even further runway for a small business to get back on its feet.
- Owners Can Retain Their Interests. Unlike traditional chapter 11, the small business equity owners are not required to give “new value”—or “buy” their equity—to retain their equity interest without paying creditors in full. In addition to certain familiar fairness requirements, subchapter V cases require a commitment in the plan of all projected disposable income for distribution to creditors (or that property is liquidated in an amount equivalent to that disposable income for distribution to creditors).
In short, a small business chapter 11 case under subchapter V should move more quickly and less expensively through the court process, while providing for a plan of repayment to creditors.
THE CARES ACT BROADENS THE REACH FOR THE SBRA
To qualify for subchapter V reorganization, a small business must meet or be below a debt threshold of $2,725,625.
The CARES Act broadens the pool of subchapter V eligible businesses, increasing the existing limit for SBRA-eligible cases to those at or under $7.5 million in liquidated claims (i.e., debt), thereby permitting substantially more small businesses to utilize subchapter V.
The CARES changes to SBRA are targeted to the effects of COVID-19: the increase in the debt limit to qualify to file under subchapter V applies for one year and thereafter will return to $2,725,625. This modification to SBRA will give more small businesses access to a tool that is tailored to the successful reorganization of small businesses and pave a critical path forward toward their long term survival in the wake of the COVID-19 pandemic.
View all of our COVID-19 perspectives here. Contact a member of our COVID-19 Legal Task Force here.