On August 23, 2019, President Donald J. Trump signed into law two bills amending the Bankruptcy Code: (i) the Family Farmer Relief Act of 2019 (“FFRA”); and (ii) the Small Business Reorganization Act of 2019 (“SBRA,” and with FFRA, the “Acts”).1 Here are summaries of the Acts and important takeaways.
DEBT LIMIT INCREASE APPLICABLE TO AGRIBUSINESSES
The most significant change to the Bankruptcy Code is the increased debt eligibility limit applicable to a wide range of agribusinesses. Effective immediately, FFRA raises the debt limit for “family farmers” to $10 million from the previous limit of approximately $4.4 million. Because agribusiness is one of a few industries that actually appears to be under substantial stress, what this means is that businesspeople, consultants, and lawyers who handle distressed agribusiness deals will likely need to become more conversant with Chapter 12 of the Bankruptcy Code. Chapter 12 contains a host of provisions that are foreign to those who handle Chapter 11 cases (e.g., co-debtor stays, inapplicability of “adequate protection” under Section 361, Chapter 7 conversion limitations). It is also a virtual certainty that a greater number of family farmers will seek relief under Chapter 12, rather than seeking Chapter 11 relief.
REVISED BANKRUPTCY CODE § 547(b) REQUIREMENT TO ACCOUNT FOR AFFIRMATIVE DEFENSES
SBRA contains an amendment to Bankruptcy Code § 547(b) that is not specifically related to small business cases, but could have an impact on preference litigation. Historically, it has always been the plaintiff’s burden to prove the elements of a preference under § 547(b), and the defendant’s burden to prove affirmative defenses under § 547(c). SBRA amends Bankruptcy Code § 547(b) to provide that the trustee or debtor-in-possession “may, based on reasonable due diligence in the circumstances of the case and taking into account a party’s known or reasonably knowable affirmative defenses under subsection (c), avoid any transfer of an interest of the debtor in property,” if it otherwise meets the enumerated elements of a preferential transfer. (new language in italics).
The new language seems to have been intended to require the preference plaintiff to consider the validity and strengths of a defendant’s affirmative defenses prior to filing suit and to abandon or reduce the amount of a claim depending on that evaluation. But the placement of the language is awkward and possibly ineffectual. The substantive elements of a preference claim have not changed, and Congress did not provide any obvious mechanism for a defendant to enforce the pre-filing obligations that the new language seems to impose on the plaintiff. How a plaintiff will be required to demonstrate its due diligence, and precisely what kind and amount of due diligence will generally be required in each case, will be up to the bankruptcy courts to decide. But at the very least, the amendment may cause trustees to think twice before commencing non-meritorious preference actions with the hope of extracting nuisance settlements.
NEW CHAPTER 11 SUBCHAPTER FOR SMALL BUSINESS DEBTORS
SBRA creates a new subchapter within Chapter 11 of the Bankruptcy Code specifically for small business debtors. Provisions for small business debtors within the other subchapters of Chapter 11 remain, but a small business debtor may elect to proceed under the new subchapter instead. The debt limit for a small business debtor under either option remains the same, approximately $2.5 million, but SBRA amends the definition of a small business debtor to require that not less than 50% of the debtor’s debts arose from the debtor’s commercial or business activities.
The new subchapter includes significant changes to the structure of a small business debtor’s Chapter 11 case and eases the requirements for the plan proposal and confirmation processes.
No Committees Absent Cause and Automatic Chapter 11 Trustee
The most substantial structural changes under SBRA’s new subchapter are that: (i) no committees are to be appointed absent cause; and (ii) a trustee will be appointed in each small business debtor’s case as a matter of course, thus adopting a Chapter 13-like structure. The trustee remains in service until the debtor’s plan of reorganization has been substantially consummated, unless reappointed for cause, as discussed below.
In all cases, the trustee is to perform certain administrative and supervisory duties, such as:
- Appearing and being heard regarding the value of property subject to a lien, confirmation or modification of the plan, or sale of property of the estate;
- Facilitating the development of a consensual plan;
- Ensuring the debtor commences making timely payments required by a plan;
- Examining and potentially objecting to proofs of claim; and
- Opposing the debtor’s discharge, if advisable.
Where cause is shown, the trustee may also be called upon to closely investigate the acts, conduct, assets, liabilities and financial condition of the debtor, and if the debtor is removed as debtor-in-possession, the trustee would step in to manage the estate and operate the debtor’s business as would a traditional Chapter 11 trustee.
Plan Proposal and Confirmation Requirements
Under current Chapter 11, a small business debtor has the exclusive right to file a plan during the first 180 days of the case, and must file a plan within the first 300 days of the case to avoid dismissal. After filing the plan, the debtor has only 45 days to obtain confirmation of the plan, unless extended by court order. Under SBRA, only the debtor may file a plan, though it must be filed within the first 90 days of the case. However, there is no longer a fixed deadline to obtain confirmation, which should allow debtors more time to negotiate consensual resolutions of potential plan objections.
As to confirmation requirements, SBRA incorporates most of the conditions for consensual confirmation, but contains two key differences for cramdown plans. First, small business debtors are no longer required to have an accepting impaired class to confirm a cramdown plan. Instead, the plan need only not discriminate unfairly and be fair and equitable with respect to classes of impaired claims and interest. Second, the absolute priority rule is absent from SBRA, which means that equity holders can retain interests under the plan without paying higher-priority classes in full.
Other notable provisions related to plan proposal and confirmation include:
- To be “fair and equitable” requires the debtor to devote its disposable income or the value of its disposable income to payments over the life of the plan and includes a feasibility concept, requiring that the debtor has at least a reasonable likelihood that it will be able to make the payments under the plan;
- Debtors are not required to prepare separate disclosure statements unless the court orders otherwise;
- Administrative expenses may be paid over the life of the plan; and
- A plan may propose to modify the rights of the holder of a claim secured by the debtor’s principal residence, so long as the new value given to the debtor was not used primarily to acquire the residence and was used primarily in the debtor’s business (for example, a home equity line of credit).
Based on the foregoing, it should be easier for small business debtors to confirm plans of reorganization under the new subchapter. Additionally, the relatively less-stringent confirmation requirements may encourage individual Chapter 11 debtors who qualify to designate themselves as small business debtors, where there was little incentive for them to do so in the past.
Certain ambiguities exist in SBRA with regard to the division of duties and powers between the debtor and the trustee that may only resolve themselves through practice and case law. For example, similar to the requirements of Chapter 13, SBRA contemplates that a plan of reorganization must provide for the debtor’s future earnings to be submitted to the supervision and control of the trustee for execution of the plan. However, as stated above, under SBRA, the trustee’s services are terminated upon substantial consummation of the plan, which can be accomplished in a traditional Chapter 11 case within a matter of days following confirmation. In such instances, the debtor would then be responsible for distribution of plan payments, contrary to SBRA’s contemplated trustee-managed plan execution process. Courts may well require specific language in plans of reorganization keeping the trustee in place to make plan payments, notwithstanding that the trustee’s duties would normally terminate upon substantial consummation.2
Other, less structurally significant ambiguities exist in SBRA regarding the relative duties and powers of the trustee and debtor-in-possession, such as who will be primarily responsible for claim objections or avoidance actions during certain phases of the case. As the case law develops around SBRA, it will be interesting to see whether bankruptcy courts will apply Chapter 13-like interpretations to the subchapter, or if they instead choose to allow small business debtors more of the autonomy inherent in traditional Chapter 11 cases.
1. FFRA is effective immediately and SBRA is effective in 180 days.
2. Alternatively, courts could adopt a different interpretation of the requirements for “substantial consummation” of a small business debtor’s plan, allowing the trustee to remain in place until plan payments are complete.