The Small Business Reorganization Act and Its Prolonged Adoption Through June of 2024
Chapter 11 bankruptcy code generally provides businesses with avenues and protections to reorganize and restructure obligations. This form of bankruptcy is very often more favorable than Chapter 7 bankruptcy because it allows business owners to stay in the driver’s seat while attempting to negotiate a plan that complies with the bankruptcy code. In contrast, filing a Chapter 7 petition results in full relinquishment of control of the business and the appointment of a third-party trustee whose primary obligation is to liquidate estate assets for the benefit of unsecured creditors.
Historically, Chapter 11’s benefits have been far out of reach for small-to-mid-size businesses due to the costs and complexities of a typical Chapter 11 case. For example, to confirm a plan of reorganization, post-petition claims (often amounting to hundreds of thousands of dollars) must be paid in full by the date the plan or reorganization is confirmed. In addition, in a typical chapter 11, equity owners of a business will lose their interests if any non-consenting class of creditors do not receive full payment of their claims.
As a response to these costly obstacles small-to-mid-size business owners face when considering bankruptcy protection, Congress enacted the Small Business Reorganization Act (the “SBRA”). The SBRA falls under Chapter 11 as “Subchapter V.” Congress signed the SBRA in 2019 and the law went active in February 2020. When first enacted, the debt limit under the SBRA for total non-contingent, liquidated debt was $2,725,625, meaning that if a business held more debt than that amount, it could not qualify for SBRA protection. However, the onset of Covid-19 quickly caused Congress to raise the debt ceiling eligibility to $7,500,000 as part of the CARES Act.
In creating Subchapter V, Congress made clear that it intended to provide a faster, easier, and cheaper version of Chapter 11 bankruptcy to small-and mid-size businesses. The SBRA eliminates the requirement of establishing an unsecured creditors committee, eliminates the obligation to pay quarterly U.S. Trustee fees, eliminates the requirement of filing a disclosure statement, and provides a reduced period of time for a debtor to file a plan. The SBRA also permits a debtor to confirm a plan that “crams” down creditors’ claims without the approval of any impaired, consenting class of creditors. A trustee is also assigned to each estate to facilitate the development of a consensual plan.
Perhaps the most significant benefit afforded to a Subchapter V debtor is the elimination (or relaxation) of the absolute priority rule. Outside of the SBRA, a debtor’s equity holders cannot retain their ownership in the debtor unless non-consenting creditors receive full payment of their claims, or unless equity holders infuse new capital into the estate. This requirement – which provides a fundamental level of protection to creditors – can be quite difficult to meet and, as a result, equity owners lose their interests as a result of the bankruptcy. Under the SBRA, equity owners can retain their interests as long as a proposed plan commits the debtor’s projected, disposable income toward the plan, and as long as the plan “does not discriminate unfairly.”
The SBRA also allowed debtors to pay post-petition claims over the course of a 3–5-year plan. Outside of the SBRA, a debtor is required to pay such claims (which include administrative expense claims like legal fees, rent, utilities, and other necessary goods and services supplied to a debtor) in full as of the date of plan confirmation. By permitting such claims to be paid over time, a debtor can infuse more estate funds into the early phase of a plan, theoretically increasing the likelihood of plan confirmation (while also, inversely, increasing the risk that post-petition creditors will be paid in full).
Since enactment, SBRA filings account for the vast majority of bankruptcy filings in the United States. More than 3,000 debtors have elected to file under Subchapter V. Proponents of the law point to higher plan confirmation rates, speedier plan confirmation, more consensual plans, and improved cost-effectiveness than if those cases had been filed as a traditional Chapter 11.
As mentioned above, Congress quickly increased the SBRA’s debt ceiling to $7,500,000 at the onset of Covid-19 in 2020. On June 21, 2022, President Biden signed the Bankruptcy Threshold Adjustment and Technical Corrections Act, which freezes the debt limit of the SBRA at $7,500,000 through June 21, 2024. Given mounting concerns over near-term economic woes, the prolonged adoption of the SBRA’s debt ceiling could provide necessary relief for small-to-mid-sized businesses
ABOUT THE AUTHOR
Mike Richardson joined Milgrom & Daskam as a Partner in May 2022. His practice focuses on litigation and bankruptcy matters. He has represented parties on either side of real estate disputes, breach of contract actions, oil and gas disputes, fraudulent transfer claims, and breach of fiduciary duty claims. Mike has also represented debtors, chapter 7 bankruptcy trustees, and other matters involving financially distressed parties reorganizing under chapter 11 of the U.S. Bankruptcy Code.
Chapter 11 bankruptcy code generally provides businesses with avenues and protections to reorganize and restructure obligations. This form of bankruptcy is very often more favorable than chapter 7 bankruptcy because it allows business owners to stay in the driver’s seat while attempting to negotiate a plan that complies with the bankruptcy code. In contrast, filing a chapter 7 petition results in full relinquishment of control of the business and the appointment of a third-party trustee whose primary obligation to is to liquidate estate assets for the benefit of unsecured creditors.
On September 30, 2022, the U.S. Treasury’s Financial Crimes Enforcement Network (FinCEN) issued its highly anticipated Final Rule establishing a beneficial ownership information (BOI) reporting requirement under the Corporate Transparency Act (CTA) of 2019. These rules significantly change the obligations of business entities to disclose previously private information regarding the ownership and control of these entities. The primary purpose of the CTA, enacted as part of the Anti-Money Laundering Act of 2020 is to protect the US financial system from being used for illicit purposes, including preventing corrupt actors, terrorists, and criminals from hiding assets in anonymous shell companies. Background for this rule was addressed in prior blog posts including The Corporate Transparency Act (1/31/22) and FinCEN and Real Estate (8/2/22).
As attorneys representing startups, Milgrom & Daskam knows that early-stage businesses often have many needs and not much capital to meet them. This often results in startups bartering for services using whatever currency they have. Sometimes this results in interesting exchanges (two hundred pounds of Valencia oranges in exchange for a logo design being our personal benchmark); more often it results in founders giving away the most freely available form of credit they have—equity in their company.