Chapter 11—CARES Act Expands Reach of the Small Business Debtor Reorganization Act of 2019

COVID-19 Update

Smaller Chapter 11 Cases Will Impact Many and Move Swiftly

One provision of the recently passed Coronavirus Aid, Relief, and Economic Security (CARES) Act makes available to a greatly expanded group of small businesses what is viewed as a cost-effective and time-saving bankruptcy reorganization process.

Clients—lenders, borrowers, investors, shareholders, intellectual property (IP) licensees/licensors, content providers—that have faced the economic realities and uncertainties of Chapter 11 in dealing with tenants, vendors, suppliers, and various other providers of goods and services are now substantially more likely to have to deal with Chapter 11 cases as a result of the almost threefold increase in the debt ceiling eligibility that is provided for in the CARES Act. These newly created Chapter 11 opportunities for small businesses will move swiftly through the bankruptcy courts and require quicker reaction by clients. Clients that have often times viewed Chapter 11 cases as a years-long process will be surprised at the speed of small business debtor reorganization Chapter 11 cases.

For opportunistic lenders and investors, the likely increase in the number of small business debtor reorganization cases may present some opportunities. Lenders and investors will greatly benefit by making bankruptcy court-approved loans and investments. Protections for lenders and investors can be built into such transactions accomplished through the bankruptcy process.

For opportunistic buyers of assets, whether they be hard assets such as equipment or personal property or IP such as media content, there will be opportunities related to such assets in small business debtor reorganization cases under the new Subchapter V of Chapter 11.

Since small business debtor reorganization cases will move more swiftly than traditional Chapter 11 cases, there will be opportunities for clients in such cases.

Here is what that is all about.

By way of background, on February 22, 2020, the Small Business Debtor Reorganization Act (SBDRA) became effective, and bankruptcy courts across the country have begun to implement its procedures and processes. The SBDRA was intended to make the business bankruptcy process more available to small businesses and reduce the cost and time involved in traditional Chapter 11 business reorganization procedures and processes by giving small businesses a streamlined reorganization process. It is available only to businesses with a limited amount of debt. Rather than the unlimited secured and unsecured debt ceilings of a traditional Chapter 11, the SBDRA originally provided for a maximum of secured and unsecured debt totaling $2,725,625. The CARES Act substantially raises that amount to $7,500,000 of combined secured and unsecured debt, although the CARES Act, as it relates to bankruptcy, has a one-year sunset on this expansion of debt limits.

Some key elements of the SBDRA are as follows:

The SBDRA is a subset of Chapter 11, identified at Subchapter V of Chapter 11.

A “small business debtor” must be a person or entity engaged in commercial or business activity, with the debt ceilings discussed above.

Single asset real estate businesses are excluded from the SBDRA.

Once the small business debtor files under the SBDRA, there is no requirement that the business continue to operate.

After filing under the SBDRA, the business must file all schedules and statements with the bankruptcy court as required of any other Chapter 11 debtor.

Upon the filing under the SBDRA, the business initially operates as a debtor-in-possession however, a debtor-in-possession may be removed if the bankruptcy court determines that the debtor is engaged in fraud, dishonesty, misconduct or gross negligence. If the debtor-in-possession is removed, a Small Business Trustee is appointed to operate the business.

Upon filing under the SBDRA, the debtor must file a copy of the business’s most-recent balance sheet, statement of operations, cash-flow statement, and federal income tax return or a sworn statement that such documents do not exist.

Creditors’ committees may be appointed and serve under the SBDRA, but they will be more the exception than the rule.

There is a streamlined and expedited procedure for proposing and confirming a plan of reorganization, with relatively short time frames, as compared to a traditional Chapter 11.

Every case filed under the SBDRA will have a Small Business Trustee appointed by the U.S. Trustee. The Small Business Trustee has a role similar to the Chapter 13 trustee in a consumer bankruptcy case, and will act as a conduit for plan payments, and will have the authority to investigate the financial affairs of the small business debtor and object to the allowance of proofs of claim. The Small Business Trustee will also attempt to facilitate consensual plans.

Within 60 days of filing under the SBDRA, the bankruptcy court is expected to hold a status conference “to further the expeditious and economical resolution” of the case. At least 14 days prior to the status conference, the small business debtor is required to file a report detailing its efforts to attain a consensual plan of reorganization. The small business debtor must file a plan of reorganization 90 days after the order for relief. Only the small business debtor may file a plan of reorganization. The plan of reorganization may serve as both the plan and the disclosure statement, and no separate disclosure statement is required.

Unlike a traditional Chapter 11 plan of reorganization, a plan under the SBDRA need not obtain the consent of an impaired class of creditors to obtain confirmation.

With respect to confirmation, the “absolute priority rule” does not apply. This means that equity holders can retain their interests in the business even if the plan does not pay unsecured claims in full. As long as the plan “does not discriminate unfairly, and is fair and equitable” with respect to impaired unsecured creditors, the court shall confirm the plan.

Small business debtors may have seven years within which to make plan payments; the seven years represents an increase under the stimulus package from the previously mandated three-to-five-year time frame.

 A small business debtor will receive a discharge of debt upon the completion of all the plan payments as required under the confirmed plan.

Should you have questions regarding the SBDRA or the impact of the stimulus package on the SBDRA, please contact Ivan Kallick at ikallick@manatt.com or 310.312.4152, or Carl Grumer at cgrumer@manatt.com or 310.312.4149.

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