A new law will help small businesses go through the bankruptcy process. Here’s what you need to know
Small businesses looking to reorganize their debt through the bankruptcy process will now get a break under federal legislation, which went into effect on February 19, 2020.
The “Small Business Reorganization Act” (SBRA) streamlines existing debt reorganization procedures for small businesses and provides new tools to improve a small business’ ability to restructure, proponents say.
“American businesses come in all shapes and sizes. It’s time that the bankruptcy code reflects this reality. Mom and pop shops shouldn’t face the same debt reorganization challenges as major companies with armies of accountants. The Small Business Reorganization Act takes into account the unique needs of small businesses and streamlines existing reorganization processes,” Sen. Chuck Grassley (R-Iowa) said about the bipartisan legislation.
“Mom and pop shops shouldn’t face the same debt reorganization challenges as major companies with armies of accountants.”
Grassley said he worked with other Senate Judiciary Committee members, including Amy Klobuchar (D-Minn.) and Richard Blumenthal (D-Conn.) to get the proposal through the legislature. He also said the SBRA was crafted in consultation with the National Bankruptcy Conference, American Bankruptcy Institute, National Conference of Bankruptcy Judges, and input from numerous stakeholders ranging from commercial lenders to the U.S. Trustee.
The SBRA was signed by President Trump on August 23, 2019.
The new law will make the process “cheaper, easier to confirm, and faster” for small businesses, Zach Shelomith, an attorney with law firm Leiderman Shelomith Alexander & Somodevilla, PLLC said in a telephone interview.
Struggling with debt
When business owners are struggling with debt, they may consider declaring bankruptcy. There are 2 choices.
1. Chapter 7 bankruptcy
This is a liquidation, which means that the assets, if any, of the business are sold. The funds obtained, if any, are distributed to creditors and the business is shut down. A Chapter 7 eliminates most or all of the debts for which the owner is liable.
2. Chapter 11 bankruptcy
This allows business owners to continue the business while negotiating the amounts owed to their creditors. Under Chapter 11, a debtor can restructure its finances through a plan of reorganization approved by the bankruptcy court.
Completing a Chapter 11 bankruptcy, however, is not easy for small businesses. Chapter 11 in the bankruptcy code was designed for administering complex business reorganizations involving multi-million-dollar companies, according to a fact sheet issued by Sen. Grassley.
Though several provisions focus on small business debtors, a “significant amount of research” shows that Chapter 11 may still create difficulties for small businesses, “including high costs, deficits, and procedural roadblocks,” Grassley noted.
Less than one-third — 27% — of the small business debtors that filed Chapter 11 bankruptcy from 2008 to 2015 successfully completed a reorganization plan.
“Small businesses can’t really reorganize well under the old laws,” Shelomith said.
In response to this problem, Congress and the president approved the SBRA, which adds a new subchapter to the bankruptcy laws called a “small business debtor reorganization,” and addresses many of the difficulties small businesses said they experienced in Chapter 11 cases.
Small businesses and individuals whose debts are primarily business-related and do not exceed $2,725,625 qualify under the new rules.
The new law creates several changes.
One of the most powerful changes is that a debtor can get a case confirmed without the need to have its creditors vote on accepting the plan, Shelomith said. Before the new law, a debtor could not confirm a plan unless at least 1 impaired class of creditors voted to accept the plan.
An impaired class of creditors are creditors who will receive less than the full value of their claim. This requirement alone made many Chapter 11 plans impossible to confirm, according to Shelomith.
Congress realized this was a big stumbling block to small businesses and that it was one of the reasons why Chapter 11 was not successful for small businesses, Shelomith said. Now, if the other requirements are met, a plan can be confirmed with no votes at all.
Shelomith added: “It takes a lot of the leverage away from the creditors.”
Absolute priority rule
Another change is the elimination of the “absolute priority rule.” The rule provides for the satisfaction in full of the claims of senior creditors before any payments can be made to junior creditors under a Chapter 11 bankruptcy plan. The new law does away with the absolute priority rule, allowing business owners a greater opportunity to retain their ownership interests.
Qualified individuals are allowed to modify a lien on a principal residence — which they could not do before — as long as the value received for the lien was not used to acquire the residence, Shelomith said.
For example, suppose you own a house “free and clear,” and you need working capital for your business so you decide to mortgage your house and all the money is used for your business. Then, you file for Chapter 11. You will be able to take advantage of the new rule on modifying liens on primary residences, he said.
Appointment of a bankruptcy trustee
Before the new law, a bankruptcy trustee in a small business case under Chapter 11 was appointed only if the debtor was discovered to be abusing the bankruptcy process and a creditor asked the court to appoint a trustee to oversee the business. Under the SBRA, a bankruptcy trustee will be automatically appointed and will receive payments from the debtor to be distributed to the creditors.
Here are some other changes:
- Disclosure statements are no longer required
- No creditors committee is needed unless certain circumstances are met
- Only the debtor can file a plan
- Many of the deadlines have been shortened. The debtor must file a plan no later than 90 days after filing the case, rather than the 300 days allowed under the old rules
Shelomith said the main concern that has been expressed to him is the appointment of a trustee. Before SBRA, a trustee was appointed only in certain circumstances. But, he pointed out, under the new rules this is a “financial monitor” type of trustee, not an operational trustee. The debtor remains in control of the business, he said.
Shelomith said he expects the new law to make a considerable impact.