As businesses consider their options while they attempt to navigate their way through the economic crisis caused by the COVID-19 pandemic, many will find relief in the newly-enacted Small Business Reorganization Act (“SBRA”). The SBRA, which became effective on February 19, 2020, and was expanded on a temporary basis under the CARES Act to allow more businesses to take advantage of its provisions, greatly simplifies the Chapter 11 reorganization process, making it less expensive and more predictable.
This Client Alert explores the SBRA from the point of view of the business struggling to pay its debts, with a focus on how it works to help a business reorganize and how the existence of the SBRA might help a business avoid bankruptcy. A subsequent Client Alert will discuss issues raised by the SBRA from the creditor’s viewpoint, including the effect that the SBRA may have on repayment negotiations and how creditors might find the SBRA beneficial.
Who Qualifies for Small Business Treatment?
As originally enacted, the SBRA was available to any business with debts of no more than $2,725,625 other than single-asset real estate enterprises and businesses subject to reporting requirements under the Securities Exchange Act. With the CARES Act, businesses with debts up to $7,500,000 now qualify. The expanded eligibility sunsets on March 27, 2021, meaning that businesses with debts greater than $2,725,625 but no more than $7,500,000 that want to take advantage of these streamlined provisions will need to do so by March 27, 2021.
What’s So Great About the Small Business Provisions?
One of the biggest impediments for small businesses attempting to work through financial difficulties in a Chapter 11 reorganization has been the very complex nature of a Chapter 11 case and its attendant high, often prohibitive, costs. The SBRA allows a qualifying business to continue in operation while settling its debts under a procedure that is more streamlined, less costly and more predictable than a traditional Chapter 11 reorganization. The most significant differences between a traditional Chapter 11 reorganization and one under the SBRA are as follows:
- Under the SBRA, a plan of reorganization may be confirmed without getting approval from creditors as long as the plan meets certain basic requirements, the most notable of which is that it proposes to pay to creditors over a three- to five-year period all of its projected disposable income, or the present value of the projected income over a shorter period. Under a traditional Chapter 11 case, payments to creditors were subject to negotiation, with a requirement that the debtor obtain the approval of at least one class of creditors. The uncertainty of knowing what creditors will accept is eliminated under the SBRA, as well as the expense entailed in negotiating with the creditor body.
- In a traditional Chapter 11 case, a business owner risked giving up ownership and control over his or her business unless all classes of creditors approved of the plan. This is no longer the case. Under the SBRA, only the debtor may propose a plan. As long as the debtor can make the payments prescribed in the SBRA the owners need not be concerned with losing their ownership interest.
- The SBRA has eliminated the requirement that there be a disclosure statement, the document that sets forth background information about the debtor and its financial condition, and describes the plan. Much of the information contained in the disclosure statement is now included in the plan. In a traditional Chapter 11 case, the disclosure statement would need to be first approved by the court in a separate hearing. Elimination of the disclosure statement, therefore, also eliminates the need for a separate hearing, thus reducing costs of the case further.
- Creditors’ committees generally will not be appointed in a case under the SBRA. The debtor is responsible for paying the fees of the committee’s lawyer, financial advisor and other professionals, adding significantly to the burdens of the debtor in pursuing its reorganization in a traditional Chapter 11 case. And, while the trend has been for committees not to be appointed in smaller cases, the SBRA provides assurance to small businesses considering Chapter 11 that they will not have to undergo that expense.
It should be noted that while the SBRA streamlines the process it is not a free ride. Debtors must still pay taxes, wages and other priority claims in full, as well as the value of the claims of their secured creditors and rent under the leases that they want to keep. They must also pay unsecured creditors more than they would receive in a Chapter 7 liquidation. Debtors whose projected disposable income is insufficient to meet these requirements will need to come up with more money in order to reorganize.
How the SBRA Can Aid in Out-of-Court Workouts
Negotiations in out-of-court workouts invariably are conducted against a backdrop of what would occur in a bankruptcy proceeding. In an out-of-court workout, a business might argue that the creditor would receive less than it proposes to pay if the business were to close, but such a claim is often opposed by a creditor that bets that the debtor would prefer to keep the business open and would pay a premium to do so. The outcome of a traditional Chapter 11 case, with its emphasis on negotiating a settlement with the creditor body, is much more uncertain. By eliminating the requirement for creditor approval, a business can now approach its negotiations with its creditors with some certainty as to how much it needs to pay and over what period of time. The SBRA will not necessarily eliminate the need to reorganize as a small business under Chapter 11, but it will provide guidance and some incentive to the parties to reach an agreement without the intervention of the Bankruptcy Court.
We Are Here to Help
Rubin and Rudman is committed to helping our clients through these extraordinary times. If you have any questions about the SBRA, please contact any of the following attorneys at our firm: