U.S. Senate Coronavirus (COVID-19) Relief Bill Would Temporarily Increase the Small Business Reorganization Act (SBRA) Chapter 11 Debt Limit to $7,500,000

The U.S. Senate’s historic $2 trillion relief package—the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”)—would temporarily expand the number of small businesses eligible to seek bankruptcy relief under the Small Business Reorganization Act of 2019 (the “SBRA”), which became effective on February 22, 2020. Months before the arrival of COVID-19 in the United States, in response to the challenges faced by small businesses attempting to reorganize under Chapter 11 of the Bankruptcy Code, including the cost and length of bankruptcy cases, Congress passed the SBRA to increase efficiency, lower costs, and ease the plan confirmation process for small businesses. Under the SBRA as originally enacted, to qualify as a small business debtor, the debtor must be a person or entity engaged in commercial or business activity with aggregate secured and unsecured debts of $2,725,625. The CARES Act would increase that debt limit to $7,500,000 for a period of one year following the enactment of the Act. This amendment would only apply to Chapter 11 cases commenced after the enactment of the CARES Act.  Under both the current law and the proposed amendments, a single asset real estate debtor (a debtor who derives substantially all of its gross income from the operation of a single real property and is subject to other provisions of the Bankruptcy Code) is not eligible to be a debtor under SBRA.

As a result of shelter-in-place orders, lost foot traffic, and social distancing, thousands of businesses are feeling the drastic effect of COVID-19. This extraordinary and unprecedented burden on all industries will result in cash shortages and an inability to pay trade creditors, lenders and landlords. Small businesses are likely to feel the brunt of this downturn, whether as a supplier or end provider to customers. Ultimately, many small businesses will be forced to make difficult decisions regarding continued operations and may look for the breathing room provided by reorganizing under the Bankruptcy Code.  And for small businesses that would specifically benefit from the temporary increase of the Chapter 11 debt limit to $7,500,000, those decisions will have to be made soon in the coming months. 

Key provisions of the SBRA include:

• Streamlining the reorganization process by permitting only the small business debtor to file a plan of reorganization, which must be filed within 90-days of the bankruptcy petition. Further, the SBRA eliminates separate approval of a disclosure statement in support of a Plan of Reorganization. These provisions are intended to eliminate unnecessary delay in the plan approval process.
• A trustee will be appointed in every case. The trustee will not, typically, operate the business during the reorganization (as opposed to a trustee appointed in a regular chapter 11 case), but will help facilitate the reorganization and is charged with administering payments to creditors under the debtor’s confirmed plan of reorganization.
• No impaired class of creditors is required to vote in favor of the plan. In a typical Chapter 11 case, at least one class of creditors that is impaired under the plan must vote in favor of the plan in order for that plan to be confirmed over the objection of non-consenting creditors. So long as the other plan requirements are satisfied, a plan of reorganization can be confirmed by the Court under the SBRA without any creditor support.
• The absolute priority rule is eliminated. In a typical Chapter 11, unless the equity holders contribute new value to the reorganization, the debtor must pay unsecured creditors in full if the business owners wish to retain their equity interests. The SBRA removes this requirement. Under the SBRA, plan confirmation only requires that the plan does not discriminate unfairly among creditors, is fair and equitable, and provides that the debtor will contribute all of its projected disposable income to pay creditors over a three to five year period.
• The SBRA eliminates the categorical prohibition against individual small business debtors modifying their residential mortgages. Small business debtors are now permitted to modify a mortgage secured by the debtor’s residence if the underlying loan was not used to acquire the residence and was primarily used in connection with the debtor’s small business.
• The costs of Chapter 11 should be significantly reduced under SBRA, and payment of the expenses can be delayed. Unless otherwise ordered by the Bankruptcy Court, the SBRA eliminates the appointment of an unsecured creditors committee. In a typical Chapter 11 case, the cost of a committee and its counsel were borne by the debtor.  Eliminating such a committee will reduce the expense of reorganization. Additionally, a debtor under the SBRA can stretch out payment for costs incurred during its bankruptcy proceedings over a three to five year period (contrasted with a Chapter 11 case where such administrative costs are required to be paid in full upon confirmation of a plan of reorganization).

The SBRA contains several other provisions designed to help small businesses to take advantage of a Chapter 11 reorganization. The Workouts & Restructuring Group at KMK Law is here to provide you with advice and guidance in connection with SBRA, or any other business reorganization issues.