Expanded Limits for Small Business Bankruptcies Set to Expire in March

On February 19, 2020, the Small Business Reorganization Act (SBRA) took effect. This law, originally passed in August 2019, created a new portion of the Chapter 11 Bankruptcy Code, known as Subchapter V. The SBRA was enacted to streamline bankruptcy processes for small businesses owing less than $2,725,625 of non-contingent, secured and unsecured debt. 

Prior to the creation of Subchapter V, businesses had the option of either filing bankruptcy under Chapter 11 (reorganization) or Chapter 7 (liquidation). However, many business owners who wished to continue operating their businesses under a Chapter 11 bankruptcy found that the expense, reporting requirements, and procedural hurdles far outweighed the benefits of reorganization. Subchapter V was able to eliminate some of the requirements and expenses incurred from a traditional Chapter 11 filing. 

To assist more small businesses impacted by the COVID-19 pandemic, the CARES Act raised the debt ceiling of $2.7 million to $7.5 million for one year—until March 27, 2021. Raising the debt limit allowed larger businesses to take advantage of SBRA, and in 2020, more than 1,300 small business debtors in the country filed bankruptcy under the new Subchapter V.  

After electing to file bankruptcy under Subchapter V, an eligible debtor only needs to provide a statement of operations, federal tax returns, and a cash flow statement. The small business debtor has sole rights to file a business reorganization plan and must do so within the first 90 days after filing the petition. This process is unlike a traditional Chapter 11 bankruptcy, where debtors must file a reorganization plan within 120 days, and creditors are able to file a competing plan after the 120 days of debtor exclusivity. If the bankruptcy court determines that the debtor’s plan is “fair and equitable,” it can confirm the plan without requiring the creditors’ approval. Thus, SBRA reduces the duration of the bankruptcy proceedings and the adversarial impact of competing plans. 

Additionally, the SBRA removes the mandatory appointment of an unsecured creditor committee, which ordinarily handles the interests of creditors in a traditional bankruptcy filing. Thus, the SBRA eliminates the expense of the committee and its counsel—another common adversarial party to the reorganization process.  

The SBRA also waives the traditional Chapter 11 requirement known as the “absolute priority rule,” which requires creditors to be paid first, and in full, once the plan is confirmed. Under Subchapter V, a debtor can pay back its creditors over a period of 3 to 5 years, based on projected disposable income. However, the SBRA requires the appointment of a trustee who is tasked with facilitating “the development of a consensual plan” for the business reorganization. A trustee is rarely appointed in traditional Chapter 11 cases but is a requirement in all Chapter 7 filings. 

At this time, additional Chapter 11 bankruptcy changes are not expected to occur. However, as the pandemic continues and more struggling small businesses file bankruptcy under Subchapter V, it may be necessary to extend the $7.5 million temporary ceiling beyond the March 27, 2021 deadline. 

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