A new law that took effect last year to expand the number of small businesses eligible to restructure their debts through a streamlined bankruptcy process is set to expire on March 27, 2021. While it is possible the deadline will be extended in response to the pandemic, it is important to know what the law does and which businesses are most likely to benefit from it.
Less than one month before the COVID-19 pandemic was declared a national emergency, a new federal law designed to make Chapter 11 bankruptcy reorganization more accessible to small businesses took effect. To ensure that more businesses could take advantage of the powerful tools that the Bankruptcy Code provides, Congress enacted the Small Business Bankruptcy Reorganization Act (SBRA), which became effective on February 19, 2020.
The SBRA allows small businesses to file for bankruptcy relief under the newly-created “Subchapter V” of Chapter 11 of the U.S. Bankruptcy Code. Subchapter V streamlines the Chapter 11 bankruptcy process and makes it more cost-efficient, so that more small businesses can successfully restructure their debts and stay in business.
The small business community has taken notice. As of the end of February 2021, over 1,560 Subchapter V bankruptcy cases have been filed nationwide. Arizona was among the top ten jurisdictions in the country for Subchapter V filings with 46 cases.
Subchapter V offers a powerful tool for small businesses to remain afloat in the face of serious financial distress. A business or individual that files a bankruptcy petition (the “debtor”) immediately receives the benefit of an “automatic stay” that temporarily prohibits creditors from taking collection actions like pursuing lawsuits, foreclosures, or evictions that could otherwise ruin a business. During this breathing spell, the debtor works on obtaining the bankruptcy court’s approval (or “confirmation”) of a plan for restructuring its debts. Some debts must be paid in full, like certain taxes, employee wage claims, and loans secured by property whose value exceeds the outstanding loan balance. However, these debts can be paid over time, and for most secured debts, the debtor will have flexibility to modify terms like the rate of interest. Unsecured debts can often be paid at a considerable discount, in addition to being stretched out over time.
For example, consider a popular restaurant that experienced a 50% decline in revenue in 2020 due to the pandemic. As a result, it is now three months behind on its rent payments and in default on the high-interest secured loan it took out to finance its new state of the art kitchen equipment. Filing a Subchapter V bankruptcy would enable the restaurant to avoid eviction and foreclosure of its equipment while it works on formulating a plan to “cure” the delinquency on its rent and to pay off the equipment loan over time—perhaps at a substantially lower interest rate. While every situation is different, and it is important to consult with your accountant and your lawyer, Subchapter V can give struggling businesses a chance to overcome temporary setbacks and get back on their feet.
Under the original provisions of the SBRA, only businesses and individuals whose debts totaled no more than $2,725,625 were eligible—leaving many small businesses that could otherwise benefit from a Subchapter V ineligible to take advantage of its debtor-friendly provisions. That quickly changed with the enactment of the CARES Act in March 2020.
In response to the emerging economic devastation wrought on small businesses by the COVID-19 pandemic, the CARES Act raised the debt limit for Subchapter V eligibility to $7,500,000—but only for bankruptcy cases filed within one year from March 27, 2020. Unless Congress acts to extend this timeframe, the increase in the debt ceiling will automatically revert back to the original limit of about $2.7 million on March 27, 2021. This is unwelcome news for small businesses still struggling with the lasting impact of the pandemic.
Before Subchapter V became an option for small businesses debtors had no option but to navigate a byzantine series of requirements to obtain confirmation of a reorganization plan, including complex disclosure obligations, costly fees, and other procedural hurdles. Subchapter V streamlines and lowers the expense of the reorganization process for eligible debtors by eliminating many of the costs, complexities, and procedural hurdles to confirmation of a restructuring plan. These new efficiencies offer a lifeline to viable businesses grappling with disruptions to their cash flow or unanticipated expenses.
But time may be running out for many businesses to take advantage of Subchapter V’s enactment. The March 27 sunset date for the increase in the debt limit for Subchapter V eligibility is rapidly approaching. The new coronavirus stimulus bill recently passed by the House of Representatives does not include any extension of that date.
Senators Dick Durbin and Chuck Grassley have, however, recently introduced a separate bill that would extend the increase in the debt limit by another year. It remains to be seen whether the bill can garner the bi-partisan support that is likely necessary to its passage. If it does not, financially distressed businesses whose debts exceed $2.7 million may be well advised to consult with bankruptcy counsel now to determine whether a Subchapter V bankruptcy petition is right for them.
Bradley Pack is a certified business bankruptcy specialist and a shareholder at the law firm of Engelman Berger, P.C. He represents both debtors and creditors in bankruptcy proceedings, litigation, and workout negotiations. [email protected] 602.222.4994 www.eblawyers.com