The Small Business Reorganization Act: An Unintended Lifeline For Small Businesses Considering Restructuring Due to COVID-19

Nelson Mullins Riley & Scarborough LLP

For years, small business debtors have struggled with the intricacies of Chapter 11, the debt limitations of Chapter 13 and Chapter 7 bankruptcy liquidations. Stringent requirements and procedural hurdles often made restructuring a prohibitively expensive option for many small business debtors. Congress attempted to address these issues with H.R. 3311, the Small Business Reorganization Act (the “SBRA”). The SBRA, which was signed into law on August 23, 2019, creates a new subchapter, Subchapter V, of Chapter 11 of the Bankruptcy Code. Subchapter V is intended to give small businesses a more viable, less expensive route to reorganization, relaxing Chapter 11 requirements while keeping the small business debtor in control of operations. While COVID-19 would not have been on the mind of the legislators at the time of passage back in August of 2019, the SBRA’s February 2020 effective date certainly gives small businesses an unintended lifeline in the wake of COVID-19. In fact, the SBRA’s scope has already been expanded under the CARES Act to give more businesses an opportunity to utilize Subchapter V.

To be eligible, Subchapter V requires that at least half the debt of an individual or business debtor must arise from commercial or business activity. Additionally, the debtor’s principal activity must not be a single asset real estate operation, the debtor cannot be publicly traded, and the debtor cannot be an affiliated issuer. While the debt threshold to restructure under the SBRA is $2,725,625 or lower, the CARES Act has temporarily increased that threshold to $7.5 million until March of 2021 due to COVID-19.

Once deemed qualified, a debtor can expect to see the following differences in a Subchapter V restructuring versus the traditional Chapter 11 bankruptcy proceeding:

  1. Only the debtor can submit a reorganization plan. In a traditional Chapter 11 proceeding, if the debtor fails to file a reorganization plan within a set amount of time, other creditors can file their own competing plans. Under the Subchapter V, only the debtor is permitted to submit a plan, but the tradeoff is plans must be filed quicker. This gives debtors an advantage in deciding their own reorganization and prevents contested hearings that prolong the reorganization process. The debtor must submit a plan within 90 days of filing for bankruptcy. The trustee is expected to participate in plan confirmation issues.
  2. The debtor is not required to submit a disclosure statement. Traditional Chapter 11 proceedings require a debtor to submit a disclosure statement, providing creditors with information regarding the debtor’s financial affairs. The court must first accept the debtor’s disclosure statement before making any determinations on the reorganization plan. The SBRA removes this requirement so long as the reorganization plan includes a history of business operations, a liquidation analysis, and a feasibility analysis.
  3. Creditor’s Committees are not required unless ordered by the court for cause. Traditional Chapter 11 proceedings include a creditor’s committee appointed by the U.S. Trustee, and payment for the committee typically comes from the debtor’s assets. The SBRA does away with creditor’s committees such that the debtor will not have to incur these costs. As a practical matter, cases this small rarely had creditor committees.
  4. The court can confirm the reorganization plan without the vote of any impaired class. A Chapter 11 reorganization plan must garner majority support from impaired creditors in order to reach confirmation; reaching this consensus can take months. The SBRA allows the court to unilaterally confirm the debtor’s reorganization plan.

While the changes above are the more substantial changes under the SBRA, Subchapter V reorganizations will differ from more traditional processes in other ways as well. A trustee is assigned to each debtor to facilitate reorganization and monitor the debtor’s progress. Equity holders can retain their ownership interest in the small business without having to make a substantial contribution to creditors—normally required under the New Value Rule—so long as the reorganization plan is “fair and equitable” and “does not discriminate unfairly.” 11 U.S.C. § 1191(b). Additionally, the debtor may delay payment of Administrative Expense Claims over the term of the plan.

While the SBRA will undoubtedly simplify the restructuring process for many small businesses, there are still many unanswered questions regarding Subchapter V restructuring. For instance, Subchapter V restructuring adopts requirements from Chapter 11, Chapter 12, and Chapter 13 bankruptcy proceedings. As such, courts may elect to use Chapter 12 or 13 precedent when interpreting Subchapter V, the extent to which will not be known for some time. The concept of a standby trustee is similar to a Chapter 12 trustee. A particular area of possible contention will be with regards to the determination of interest rates for secured loans under confirmed plans, as this question has been answered differently depending on the jurisdiction and whether Chapter 11, 12, or 13 is at issue in the given action.

When contemplating restructuring during these difficult times, small businesses should consider taking a hard look at both the benefits and requirements for utilizing the streamlined bankruptcy process created by the SBRA. As the economy continues to recover, creditors will need to be aware of the intricacies of the SBRA, and the expansions of the SBRA due to COVID-19, when participating in these proceedings. It is important for debtors and creditors alike to consult experienced legal counsel when navigating Subchapter V proceedings as this area of law grows over time.

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Nelson Mullins Riley & Scarborough LLP
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