Until now, the utility of chapter 11 reorganizations for small businesses has been limited. One reason for this has nothing to do with the law. Small business owners often cling to a formerly profitable "business as usual" approach until their resources have been drained to the point where even the administrative cost of a bankruptcy reorganization is unrealistic. But there have been legal impediments as well, including the procedural complexity of a chapter 11 case.
On August 23, 2019 the Small Business Reorganization Act, a subchapter of chapter 11 of the Bankruptcy Code, became law. The SBRA, which becomes effective in February 2020 seems to me, at least at first glance, to be designed to address some of the basic problems which have made chapter 11s problematic or ineffective for many small businesses and business owners that could otherwise benefit. Here are some of the Act's main features:
1-) To qualify, a business must have less than $2,725,625.00 total secured and unsecured debt. The concept of a debt ceiling (although not the amount) is similar to that long used as a qualifier for chapter 13 wage earner reorganization relief. For that reason, and because of other similarities, the Act has been described as a kind of hybrid between chapters 11 and 13.
2-) A trustee will be appointed from a standing panel, with the apparently limited obligation of facilitating and monitoring the plan of reorganization. This may relieve the debtor from the strict fiduciary obligations to creditors otherwise imposed on chapter 11 debtors.
3-) There is no voting requirement to confirm a plan, and a separate disclosure statement will not be required.
4-) The Act limits the availability of preference actions. This provision is somewhat complex, but it appears to make the pursuit of certain preferential payments discretionary, not required. Although beneficial to creditors, this provision may also benefit debtors, in that it may increase the availability of credit in the time period preceding the bankruptcy filing, and while the company is reorganizing.
5-) The Act permits the modification of some residential mortgages- those incurred for a business purpose and not for acquiring the residence. This is a major departure from both existing chapter 11 and chapter 13 laws, which have long prohibited the restructuring of loans secured only by the debtor's principal residence.
6-) The Act seems to limit the rule of absolute priority. This statutory rule is somewhat complex. Heretofore, in a business chapter 11 the rule prohibits the owners of equity interests, such as stockholders, from retaining their interests if there is a class of creditors that votes against the plan and is not paid in full, including for the time value of its claim. The rule has been a practical stumbling block for many business reorganizations, particularly given the scarcity of affordable "debtor in possession financing" in recent years. The Act seems to allow business owners to retain their ownership interests without an injection of new capital.
These are some of the highlights of the new Small Business Reorganization Act. As with any legislation, its scope and meaning will be determined by court decisions for an indefinite period of time. But this seems to be an exciting development which may address some major limitations on the effectiveness of chapter 11 for small businesses. Doubtless, there are many issues that are not yet apparent. But, based on a first look, I believe that there are many small businesses that can benefit, and that the Act will be good for the economy as a whole.