A New Platform for Small Businesses to Reorganize in Bankruptcy Under Chapter 11
By Creditors’ Rights & Bankruptcy and Litigation Practice Groups
News Update – On Friday, August 23, 2019, President Donald Trump signed the “Small Business Reorganization Act of 2019” into law. The law will take effect in February of 2020.
President Trump is expected to sign the “Small Business Reorganization Act of 2019” which will add a new option for small business debtors to file bankruptcy under Chapter 11. Small businesses, which are either organized entities (such as corporations or limited liability companies) or individuals operating a business, qualify as small business debtors if the business has no more than $2,725,625.00 of secured and unsecured debts combined at the time the business files bankruptcy. Currently, under Chapter 11, there are different rules for individuals, small business debtors, and regular “big-business” debtors.
Even with the existing expedited procedures for small business debtors, it is still expensive and time-consuming to file bankruptcy under Chapter 11, especially when compared with the expedited and form-driven procedures of Chapter 13, which is reserved for individual debtors, and Chapter 12, which is reserved for smaller family farmers and fishermen. With the passage of the Small Business Reorganization Act of 2019, small business debtors who elect for treatment under “Subchapter V” of Chapter 11 will now be able to expeditiously obtain confirmation of a Chapter 11 reorganization plan. They will also obtain some additional incentives for electing treatment under Subchapter V and will be subject to bankruptcy trustee oversight. Small business cases under Subchapter V of Chapter 11 will be, in many ways, very similar to cases filed under Chapter 12 or Chapter 13.
The most significant changes to Chapter 11 under the Small Business Reorganization Act of 2019 include:
- Appointment of a Bankruptcy Trustee – Currently, in a small business case under Chapter 11, a bankruptcy trustee is only appointed if the Debtor (“Debtor-in-Possession”, or DIP) is abusing the bankruptcy system and a party in interest, such as a creditor, files a motion and obtains a court order appointing a trustee to oversee the business. Under the new Small Business Reorganization Act of 2019, a bankruptcy trustee will be automatically appointed to oversee the case, ensuring the Debtor works meaningfully toward confirmation. The trustee will also receive plan payments from the Debtor which the trustee will then distribute to the bankrupt debtor’s estate creditors, similar to cases under Chapter 12 and Chapter 13.
- Deadline Changes – Many of the deadlines contained in the new Small Business Reorganization Act of 2019 are expedited to encourage an efficient plan confirmation process. After filing a case, the court will hold the first status conference no later than 60 days after filing. A small business debtor under Subchapter V must file a public report with the court outlining the debtor’s efforts to confirm a plan. The public report must be filed no later than 14 days before the first status conference. And, the debtor must file a plan no later than 90 days after filing the case. This timeframe is much shorter than the current Chapter 11 requirements, which offers 300 days to file a case. This timeframe is also shorter than it is for individual or big-business Chapter 11 debtors, which have no hard deadline within which to file a plan.
- Debtors Who May File a Plan – Under existing Chapter 11 law, for both traditional and small business cases, only Debtors may file a plan during a limited time known as the exclusivity period. Currently, small business debtors’ exclusivity period is 180 days, while traditional individual debtors’ exclusivity period is 120 days. After the Debtor’s exclusivity period expires, any party (including any of the Debtor’s creditors), may file a Chapter 11 plan for the Debtor, which, if confirmed, is binding on the Debtor and all other parties. Under the new Small Business Reorganization Act of 2019, only the Debtor may propose a plan for reorganization, period. No other party may propose a plan for the Debtor at any time.
- Ability to “Cram-Down” Creditors – Small business debtors that elect Subchapter V treatment under the Small Business Reorganization Act of 2019 will have greater ability to confirm a plan over the objection of unsecured creditors, commonly known as “cram down” or significantly modifying the rights of the debtors’ creditors. Undersecured creditors may still elect treatment under Section 1111(b). Small business debtors under Subchapter V may have a plan confirmed over the objection of unsecured creditors so long as their plan is “fair and equitable”. Under Subchapter V, a fair and equitable plan must pay all projected disposable income of the debtor for the first 3 or 5 years of the plan. This is a different definition of the term “fair and equitable” than under current law and will be easier for debtors to comply with. It is also very similar to an individual case under Chapter 13, where plans are limited to 5 years at the maximum, and unlike existing Chapter 11 law, which has no maximum plan length.
- Ability to “Cram-Down” Certain Mortgage Creditors – Under existing Chapter 11 law, individual debtors may not modify the rights of a secured creditor if the creditor’s claim is secured only by a mortgage in the individual debtor’s primary residence (under §1123(b)(5)). Under the Small Business Reorganization Act of 2019, there is a narrow exception to this general rule: A small business debtor may cramdown and/or modify a mortgage claim in Chapter 11 Plan if the mortgage loan was not used primarily to purchase the debtor’s residence, and the loan funds were used in connection with the debtor’s small business. This is a useful tool to change the terms of home equity loans and second mortgages obtained by the debtor for business purposes.
According to the House of Representatives Report No. 116-171 and the Committee on the Judiciary, the “principal features” of the Small Business Reorganization Act of 2019 are threefold: (1) the Act requires a bankruptcy trustee to oversee the case; (2) the bankruptcy trustee must monitor the debtor’s progress toward confirmation of a plan; and (3) the Act allows the court to confirm a plan over creditors’ objections if the plan does not discriminate unfairly, and is fair and equitable.
The Small Business Reorganization Act of 2019 gives small business debtors the option of reorganizing in a manner very similar to Chapter 13 and Chapter 12 debtors, which are currently limited to individuals and family farmers and fishermen, but which are in many ways more expeditious and more beneficial chapters for debtors to file under. Small business debtors will now have the option of filing under Chapter 11, reorganizing their debts, and taking advantage of many benefits in the Bankruptcy Code currently limited to debtors who are individuals or family farmers.
The Small Business Reorganization Act of 2019 is also known as House Bill 3311 (HB 3311) and was passed by the House on July 23, 2019, and passed by the Senate on August 1, 2019. The Small Business Reorganization Act of 2019 will go into effect 180 days (approx. 6 months) after the bill is signed by President Trump.
Elayna Matthews is an associate in the Litigation and Creditors’ Rights & Bankruptcy practice groups and the Financial Services Industry Group. The information in this article is not intended to provide legal advice. For professional consultation, please contact Elayna Matthews at Saalfeld Griggs PC. 503.399.1070. elayna@sglaw.com © 2019 Saalfeld Griggs PC
