April 27, 2020
The shutdowns imposed by governments in response to the coronavirus have financially devastated many small and mid-size businesses, making it difficult for them to continue operations and fulfill obligations to creditors. How a company reacts to the devastation may be the difference between whether the business survives or fails. Fortunately, there is now a quicker and more cost-effective restructuring solution, namely, the Small Business Reorganization Act (SBRA). SBRA creates a new subchapter under chapter 11 of the Bankruptcy Code that is specifically focused on assisting small businesses in reorganizing their operations in a fast and efficient manner. This relief is currently available to all businesses of all types and sizes that have less than $7.5 million of debt.
GOAL OF RESTRUCTURING
The goal of business restructuring under SBRA is to modify the amount and timing of obligations to allow the business to continue operating on a path toward profitability. This goal is accomplished through what amounts to a court-supervised negotiation between the business and its creditors, with the goal of having a formal payment plan approved by the Court. The business will receive a discharge upon confirmation of the plan, in the case of a consensual plan, and upon completion of all payments under the plan, in the case of a plan to which not all classes of creditors consent. Restructuring is not liquidation—it is the opposite of liquidation. The purpose of restructuring is to reorganize your debts to avoid a complete shutdown of the business and liquidation of its assets.
BENEFITS OF THE SMALL BUSINESS REORGANIZATION ACT
SBRA has simplified the existing chapter 11 process and makes it easier for a small-business debtor to reorganize. A few key benefits for business debtors are:
- Applies to all Businesses Whether Incorporated or Not: All businesses, whether organized as sole proprietorships or entities, are permitted to file under SBRA. There is no requirement that the business be incorporated—only that the debtor be engaged in “commercial or business activities” and have debts that do not exceed the temporary limit of $7.5 million. (The debt limit will be lowered to $2,725,625 in April 2021.)
- Immediate Stay from Creditor Action: Once a case under SBRA is filed, an automatic stay immediately goes into effect, meaning that creditors must stand down from taking any action to collect debts owed by the business. This stay of action allows a business some time to assess operations and develop a plan to reorganize its affairs.
- You Have Enhanced Control Over the Process: Debtors are allowed greater control over the reorganization, because unlike in a current chapter 11 case, only a business debtor has authority to file a plan of reorganization. Generally speaking, creditors of the business are not permitted to submit a plan.
- The Process is Less Costly Than Existing Chapter 11 Cases: SBRA eliminates many of the costly elements of a case under chapter 11. There is no unsecured creditors committee appointed, allowing the business to avoid having to pay for a committee’s professionals and costs. Likewise, the quarterly fees normally owed to the US Trustee have been eliminated. SBRA has also eliminated the requirement that a disclosure statement be filed, which further reduces expense.
- SBRA Cases Move Fast: SBRA cases will also proceed with greater speed, as well, because the debtor must file a plan within 90 days after the initial filing with the Court. In basic terms, the plan will set forth the timing and amount of the required payments. For many debtors this means that that within a three to four-month period of time, a highly leveraged business can have the financial certainty and organization needed to emerge financially stronger and more viable.
- Elimination Of “Absolute Priority Rule:” Under existing law, equity owners of a bankrupt debtor generally cannot retain their interests unless unsecured creditors receive full payment on their claims. This is known as the “Absolute Priority Rule.” SBRA, however, eliminates the absolute priority rule if the plan: (1) does not discriminate against creditors unfairly; and (2) is fair and equitable. The elimination of the absolute priority rule, therefore, allows owners and equity interest holders to retain their interests if the debtor proposes a plan in which all of a debtor’s projected disposable income will be applied to make payments under the plan. Disposable income is determined after taking into account regular operating expenses, such as wages to employees, rent expense, etc.
- Greater Ability to Modify Rights of Secured Creditors: SBRA also provides that the rights of secured creditors may be modified: (1) if the claim is secured only by a security interest in real property that is the principal residence of the debtor; and (2) the loan was not incurred to purchase the residence. As such, under SBRA, individual business debtors may be able to modify a mortgage on their residence that was given to secure a guaranty or a line of credit that was used to provide the business liquidity.
For many years the bankruptcy system has been largely accessible only to individual consumers through chapters 7 and 13 and large corporations, which file bankruptcy cases in the hopes of shedding millions (and sometimes billions) of dollars of debt. Now, for the first time there is a solution that focuses solely on small to mid-size businesses and allows those businesses to quickly and cost-effectively restructure their debts in anticipation of long-term success. It is an option that all financially distressed businesses should consider.
If you have any questions about this alert, or what relief may be available to assist you, please contact the Financial Services and Incentives members of our COVID-19 Response Team indentified below.
Contact information for the complete McGrath North’s COVID-19 Response Team can be found here.
For information regarding additional business-related concerns centered around COVID-19, please visit our COVID-19 Resource Guide here.
 Debts means “aggregate noncontingent liquidated secured and unsecured debts” as of the petition date. Notwithstanding this definition, there is likely some ambiguity regarding what obligations will be included to determine whether the threshold is met.