An Analysis of the Small Business Reorganization Act of 2019
By Joshua Greene
In a rare act of bipartisanship, Congress recently enacted the Small Business Reorganization Act of 2019 (“SBRA”), which took effect on February 19, 2020. The SBRA, which is encompassed in a special Subchapter V of Chapter 11, makes substantial changes to the way small business reorganizations are treated under the Bankruptcy Code. The purpose of the SBRA is to make it easier and less costly for small businesses to reorganize under Chapter 11. This article provides an analysis of some of the most important amendments and how these amendments may impact future small business Chapter 11 filings, both good and bad.
Debtor Must Make Election
At the outset, it’s important to note that the chapter 11 debtor is not required to proceed under the new rules at all. Amended Section 103(i) provides that “Subchapter V of chapter 11 of this title applies only in a case under chapter 11 in which a small business debtor elects that subchapter V of chapter 11 shall apply.”1 Thus, the Debtor has the ability to choose whether to proceed under the small business provisions of chapter 11 which were enacted in 2005, or the new amendments. Debtor’s counsel must carefully analyze the differences between the two statutes and how they may impact the potential ability of the debtor to reorganize. While a debtor is not required to proceed under the new amendments, the potential cost savings and streamlining of the bankruptcy process may be sufficient to entice a debtor to choose to proceed under the new SBRA. In order to qualify to proceed under Subchapter V, the Debtor must have no more than $7,500,000 in total secured and unsecured debt.2 One element that may discourage a debtor from filing under the new amendments, however, is the appointment of a third party trustee.
Appointment of Trustee
One of the primary highlights of the SBRA is the appointment of a trustee.3 The trustee oversees the bankruptcy case, investigates the debtor’s assets and financial affairs, makes recommendations on the debtor’s plan of reorganization, ensures that the debtor makes timely payments under the plan of reorganization, and ensures that the debtor is complying with all appropriate applicable provisions of the Bankruptcy Code. The trustee is entitled to compensation for services rendered in a similar fashion to trustees in other types of bankruptcy cases. The role of the trustee under the SBRA appears to be similar to the role of a chapter 12 or chapter 13 trustee in that the trustee does not operate the business of the debtor or liquidate assets. Rather the trustee acts in an oversight role and ensures that the debtor performs the duties required under the Bankruptcy Code. Importantly, the SBRA requires the trustee facilitate the development of a consensual plan of reorganization.4
No Creditors’ Committee
Prior to the enactment of the SBRA, in many cases, a committee of unsecured creditors would be appointed by the court. The purpose of the creditors’ committee is to represent the body of unsecured creditors, investigate the assets of the debtor, and make recommendations to the court. Quite often, the fees of the creditors’ committee were paid by the debtor, which could prove quite expensive. The new amendments provide that a committee is not appointed in a case where the debtor elects to proceed under the SBRA.5 The chapter 11 trustee’s oversight will likely replace the role of the creditors committee.
No Quarterly Fees to the U.S. Trustee
Prior to the SBRA, the chapter 11 debtor was required to pay quarterly fees to the U.S. Trustee’s Office, a branch of the Department of Justice charged with overseeing bankruptcy cases. The fees were based on the debtor’s disbursements during each applicable quarter. The quarterly fees could be quite costly for a debtor that was required to spend a substantial amount of its revenues on supplies, outside vendors, and other costs. That is because the quarterly fees were based on the debtor’s disbursements and not the debtor’s profit. By eliminating the requirement that the debtor pay quarterly fees to the U.S. Trustee’s Office, the SBRA may save the debtor substantial amounts of money depending on the nature of the debtor’s business.
Only Debtor May File a Plan
The prior chapter 11 provisions allowed the debtor an exclusivity period of 180 days within which to file a plan of reorganization. After this point, creditors could file a plan as well. Quite often, this led to costly litigation over competing plans of reorganization. The SBRA eliminates the exclusivity period and provides that only a debtor may file a plan of reorganization.6 The Debtor must act quickly to file its plan within 90 days, however, as the SBRA allows extensions only in extremely limited circumstances, providing that the court should only extend the deadline to file a plan “if the need for the extension is attributable to circumstances for which the debtor should not justly be held accountable.”7
No Requirement of a Disclosure Statement
In addition to eliminating the exclusivity period, the SBRA further eliminates the requirement for the debtor to file a disclosure statement.8 Section 1125 of the Bankruptcy Code normally requires a disclosure statement that provides adequate information regarding the debtor’s plan of reorganization and implementation of the plan of reorganization. This section often generated substantial litigation about whether the disclosure statement provided adequate information. The potential for such litigation is reduced under the SBRA because the debtor is not required to file a separate disclosure statement. Instead, the Debtor is required to file certain information along with its plan of reorganization that would have previously been included in the disclosure statement, such as a liquidation analysis and projections.9
Attorneys Not Disqualified For Being Owed Money By the Debtor
In an effort to avoid bankruptcy, quite often, small businesses will hire attorneys to represent them in an attempt to work out their financial problems. In the event this doesn’t work, debtors were often forced to engage new counsel to file a Chapter 11 petition. Due to their pre-bankruptcy work, the original attorney often became a creditor and was therefore conflicted out of the debtor’s continued representation. The SBRA recognizes this conundrum and provides that an attorney is not disqualified from representing a debtor in a small business case if they are owed less than $10,000.10 This allows a continuity of representation for the debtor and saves the debtor money by avoiding the situation where a new attorney has to expend substantial time and energy familiarizing themselves with the facts of the case.
Elimination of Absolute Priority Rule
The Absolute Priority Rule, set forth in Section 1129 of the Bankruptcy Code, provides that in the event one class of creditors votes against a plan, creditors in a lower class could not retain property under a plan unless creditors of a higher class were paid in full.11 The practical impact of this section is that individual shareholders, being the lowest possible class of creditors, could not keep their interests in a small business unless all creditors were paid in full. In cases where all creditors were unable to be paid in full, individual shareholders were required to contribute substantial sums to repurchase their shares, called “new value.” In Section 1191(c)(1), the SBRA eliminates the absolute priority rule altogether, which may streamline confirmation of a plan and save the shareholders of a closely held business substantial sums of money.12
Administrative Expenses Paid Through Plan
The prior version of the Bankruptcy Code provided that administrative expenses must be paid in full on the effective date of the plan, which was usually at or around the date that the plan is confirmed. For a debtor with substantial administrative expenses, this made confirming a plan of reorganization very difficult due to the financial barriers to raising a substantial lump sum. The SBRA, instead allows the debtor to pay administrative expenses over the life of the plan, which would allow the debtor to pay those administrative expenses over the course of several years, rather than a lump sum.13
The Small Business Reorganization Act includes many new provisions designed to make it easier and less costly for small businesses to reorganize under the Bankruptcy Code. It remains to be seen whether the SBRA will actually have the impact intended by Congress, as courts have yet to interpret most of its provisions. A debtor that is considering filing for Chapter 11 should carefully review, with their counsel, the various provisions of the SBRA and the standard Chapter 11 provisions to determine the most appropriate course of action.
1. 11 U.S.C. §103(i).
2. 11 U.S.C. §101(51). The debt limit was recently increased in the CARES Act to $7,500,000. This increase is temporary, however, and expires in one year from the enactment of the CARES Act, in March 27, 2021, at which point the debt limit will decrease to $2,725,625.
3. 11 U.S.C. §1183
4. 11 U.S.C. §1183(b)(7)
5. 11 U.S.C. §1181(b)
6. 11 U.S.C. §1189(a)
7. 11 U.S.C. §1189(b)
8. 11 U.S.C. §1187(c)
9. 11 U.S.C. §1190
10. 11 U.S.C. §1195
11. 11 U.S.C. §1129(b)(2)(B)
12. 11 U.S.C. §1191(c)(1)
13. 11 U.S.C. § 1191(e)
Joshua D. Greene is a member of Springer Larsen Greene, LLC, in Wheaton, Illinois. The firm focuses its practice in bankruptcy law and insolvency. Mr. Greene has specialized in bankruptcy law, insolvency and bankruptcy litigation for over twelve years and represents debtors, creditors and bankruptcy trustees in chapter 7 and 11 bankruptcy proceedings.