What you need to know about the Small Business Reorganization Act Of 2019
Understanding the bankruptcy process is critical for a creditor in bankruptcy
Because of the coronavirus pandemic, many Colorado businesses are (or soon will be) dealing with bankruptcy cases filed by other businesses that owe them money.
When a business files bankruptcy, that business is the “debtor” and those to whom they owe money are the “creditors.” Bankruptcy filings are on the rise, and many eligible debtors are opting to file under the Small Business Reorganization Act of 2019 (SBRA), a new fast-track bankruptcy option that alters creditors’ rights in certain Chapter 11 bankruptcy cases. The SBRA became effective in February 2020 and is quickly becoming an important tool for debtors in bankruptcy as the effects of COVID-19 are felt across the country.
Understanding the bankruptcy process is critical for a creditor in bankruptcy.
Shortly after the SBRA became effective, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) expanded the SBRA, making it available to more small businesses. Under the original provisions of the SBRA, a small business debtor could not have more than $2,725,625 in non-contingent, liquidated, secured and unsecured debts, excluding debts owed to affiliates or insiders. The CARES Act, signed into law by President Trump on March 27, 2020, temporarily (effective for only one year) expands the debt cap to $7,500,000, increasing the number of debtors who will utilize the debtor-friendly SBRA. The CARES Act only applies to bankruptcy cases filed on or after March 27, 2020.
The SBRA modifies traditional Chapter 11 practices and procedures with the intention of creating a faster, more efficient Chapter 11 process for small business debtors. For example, the SBRA requires debtors to attend a case status conference within 60 days and file a plan within 90 days. Fourteen days before the status conference, debtors are required to file a case status report detailing the debtor’s efforts to obtain a consensual plan of reorganization.
Thus, creditors should act quickly to begin negotiations with a debtor after a case is filed to explore potential terms for a consensual plan.
Under the SBRA, debtors are not required to file a separate disclosure statement, but the plan must include a brief history of the debtor, a liquidation analysis, and financial projections relating to the debtor’s ability to make payments under the proposed plan of reorganization. Creditors should closely examine a debtor’s liquidation analysis, valuation evidence, and financial projections and, when appropriate, challenge the analysis, evidence, and projections. Oftentimes, creditors operating within the same industry as the debtor are in a better position than attorneys or judges to understand and criticize the debtor’s analysis, evidence, and projections.
Before the SBRA, a trustee was appointed in a Chapter 11 case only if the court entered an order appointing a trustee, usually because of the debtor’s fraud, dishonesty, incompetence or gross mismanagement.
In SBRA cases, however, a standing bankruptcy trustee is automatically appointed. The trustee’s duties can include, among other things: (1) facilitating the development of a consensual plan of reorganization; (2) ensuring the debtor makes the payments required by the plan until the plan has been substantially consummated; (3) receiving plan payments or other property from the debtor and making distributions to creditors (similar to cases under Chapter 12 and Chapter 13); (4) examining and objecting to proofs of claim; (5) investigating the acts, conduct, assets, liabilities, and financial condition of the debtor, the operation of the debtor’s business, and the desirability of the continuance of such business; (6) investigating and reporting on fraud, dishonesty, incompetence, misconduct, mismanagement, or irregularity in the management of the debtor’s affairs.
Creditors should aspire to work with trustees to address issues that arise in the course of a bankruptcy case.
Perhaps the most notable characteristic of the SBRA is that it allows, under certain circumstances, a debtor to “cram down” a non-consensual plan of reorganization; in other words, it allows the debtor to confirm a reorganization plan over creditors’ objections. Under the SBRA, only the debtor can file a reorganization plan, and the court can confirm a debtor’s plan without the support of any class of claims as long as the plan is deemed to be fair and equitable with respect to each class of claims and does not discriminate unfairly.
To be fair and equitable, the Chapter 11 plan must provide that all the debtor’s projected disposable income will be applied to payments under the plan for a commitment period of three to five years. Alternatively, the plan may provide that the value of property to be distributed under the plan is equal to the debtor’s disposable income during the plan’s commitment period. When dealing with a non-consensual plan, creditors should be proactive about checking the debtor’s calculations to make sure creditors are getting paid the amounts to which they are entitled under the law.
In addition to the disposable income requirement, the SBRA requires a finding that the debtor will be able to make, or there is a reasonable likelihood that the debtor will be able to make, all payments under the plan. Moreover, the plan must provide appropriate remedies to protect the holders of claims or interests in the event the debtor does not make plan payments. This presents another opportunity for creditors to protect their rights by scrutinizing the remedies provided by the plan and, if possible, proposing additional or alternative remedies designed to provide more protection to creditors if the debtor does not perform under the plan.
Furthermore, the “absolute priority rule” does not apply to SBRA cases.
Typically, when a Chapter 11 plan does not propose to pay creditors in full, the debtor’s owners lose their equity interest unless they reinvest a sufficient amount to buy back their interest in the business. The SBRA, however, allows for confirmation of a Chapter 11 plan that maintains pre-bankruptcy ownership while discharging the reorganized debtor’s unpaid debts, as long as the debtor’s plan meets the SBRA’s plan confirmation requirements.
Because plans of reorganization under the SBRA may only be filed by the debtor, can be confirmed without any classes of creditors voting in favor of the plan, and are not subject to the absolute priority rule, prepared debtors with valuation evidence and financial forecasts may be able to quickly confirm a “cram down” plan. Therefore, creditors confronted with SBRA cases must be prepared to act quickly to engage in negotiations with the debtor, the trustee and other creditors to explore the terms of a consensual plan; to establish and/or defend the creditors’ claims and liens; to challenge a debtor’s liquidation analysis, valuation evidence, and financial projections; and to propose additional protections for creditors if the debtor does not perform.
The SBRA has the potential to alter the dynamic of negotiations between businesses who file bankruptcy and their creditors. Accordingly, creditors should be proactive in identifying experienced counsel that can protect their rights in the coming wave of small business bankruptcies.
Jacob Sparks and Nicole Detweiler are attorneys for Spencer Fane LLP. Sparks focuses on litigation, bankruptcy, and creditors’ rights, primarily representing clients in negotiations or litigation related to bankruptcy proceedings. Detweiler represents public, private, and corporate clients with all of their litigation needs at both the state and federal level.