As we wade through the tumultuous fallout and turmoil from the coronavirus, small businesses face seemingly insurmountable economic burdens. Commercial bankruptcy attorney, David Ritter, explains what the Small Business Reorganization Act of 2019 entails and how it can benefit small businesses in this time of crisis.
The Small Business Reorganization Act of 2019 became effective on February 19, 2020. It amends Chapter 11 of the Bankruptcy Code by adding Subchapter V, which applies only to small business debtors. As a result of the passage of the Coronavirus Aid, Relief and Economic Security Act (CARES Act), for the next year, a small business debtor is a business or individual business owner that owes less than $7.5 million in debts, not counting debts owed to insiders, most of which arose from business or commercial activities. Subchapter V is designed to lower costs and expedite a business’s reorganization under Chapter 11.
REORGANIZATION UNDER SUBCHAPTER V
Subchapter V of Chapter 11 provides for the removal of certain, excessively costly procedures, which allows for a more affordable reorganization for small business debtors. Most importantly, under Subchapter V, small business debtors no longer need to spend time and money negotiating with creditors or conceding to their demands. Instead, small business debtors can propose a disclosure statement and plan of reorganization and approve it without their creditors’ consent.
Further, under Subchapter V, only the debtor can propose a plan. In a normal Chapter 11 case, the creditors or third parties are able to submit plans, which can drive up the costs. Subchapter V ensures that the small business debtor will not see a takeover of its business by an opportunistic creditor or other entity.
Additionally, debtors under Subchapter V are no longer responsible for immediately paying administrative expense claims, which can often take a significant amount of cash out of a business when it is needed most. Instead, these claims can now be paid over the plan’s timespan, which can last up to 5 years.
APPOINTMENT OF A SUBCHAPTER V TRUSTEE
Because a business does not need to ask creditors to support its reorganization plan, Congress required a trustee to provide limited assistance in the reorganization. As in Chapter 11, the business debtor is a debtor-in-possession, meaning it controls its assets and income and can continue to run its business and operations. The trustee’s role in subchapter V is designed to prevent fraud, waste, or abuse of the system. In a Chapter 11 case, a creditors committee or the United States Trustee take on that role, and those entities can have onerous and expensive requirements. In Subchapter V, a good faith business owner will benefit from the role a trustee plays, and the cost will be significantly lower than in a regular Chapter 11 proceeding.
BROADER DISCHARGE OF DEBTS
For small business debtors, Subchapter V of Chapter 11 allows a business debtor a slightly broader discharge than a regular Chapter 11 case. This change relieves small business debtors of liability for all debts in their Chapter 11 plan, with very few exceptions, such as fraud, or a debt for which the payment terms are for a longer period than the time fixed by the plan. Even certain tax debts can be discharged under Subchapter V that cannot be discharged under typical Chapter 11 bankruptcy filings. These provisions in Subchapter V allow a good faith debtor more flexibility in paying his creditors and a better chance of successfully exiting bankruptcy.
NO NEW VALUE NEEDED
In Chapter 11, business owners are at risk of losing their equity if the plan does not pay creditors in full. Supreme Court case law requires that an owner’s equity be subject to a market test where the owners must pay new value that is substantial and essential to maintain their ownership. This is a significant hurdle for many business owners in Chapter 11 cases. These requirements are often strictly applied by bankruptcy courts, making a business debtor put its assets and/or business on an auction block, or making an otherwise-confirmable Chapter 11 plan fail.
Subchapter V dispenses with the requirement that debtors pay creditors’ claims in full to retain equity. Accordingly, equity interest holders no longer have to provide substantial and essential “new value.” Instead, Subchapter V allows a debtor to pay a portion of the creditors’ claims over time, based on the projected income of the business. And there is a limitation on the amount of projected income that can be applied to payments to creditors, thus assisting the debtor in maintaining its successful business.
CHANGES REGARDING RESIDENTIAL MORTGAGES
Another change for the benefit of individual small business owners is the ability to modify certain home mortgages. Many small business owners financed their business with a mortgage loan. Home mortgages are notoriously difficult to amend under federal law. Subchapter V of Chapter 11 allows a debtor to modify a home mortgage loan if the loan funds were primarily used in connection with the small business. Many people have refinanced their mortgages and put the money into their business. In times of falling property values, this provision can allow a debtor with a high loan to value ratio on their home loan to modify their home loan for their benefit.
Businesses in Texas that are preparing for or have experienced an economic downturn can rely on Dallas business lawyer, David Ritter. With over 25 years of experience helping companies reorganize, restructure, and file for bankruptcy effectively, David Ritter can help your business make a plan to survive an economic downturn. Contact the experienced team of attorneys at Dallas law firm, Ritter Spencer PLLC, to learn more about how to get your business through these unprecedented times.