According to the Small Business Administration, there are 27.9 million small businesses, which account for:

  • 99.7 % of U.S. employer firms,
  • 64 % of net new private-sector jobs,
  • 49.2 % of private-sector employment,
  • 42.9 % of private-sector payroll,
  • 46 % of private-sector output,
  • 43 % of high-tech employment,
  • 98 percent of firms exporting goods, and
  • 33 % of exporting value.

Is your small business incorporated?

If you are a sole proprietor running your business in your name or under a “Doing Business As” name, you can reorganize your business debts under Chapter 13 of the Bankruptcy Code, or you can liquidate your business under Chapter 7.

Liquidate or reorganize?

If you incorporated your small business, but for any number of reasons, you do not wish to continue operations, bankruptcy may or may not be right for individual owners or the corporation.

There are several issues to consider, but by far, the most critical question is whether the corporate shareholders have personally guaranteed any of the business debt.

If so, the shareholders must each assess their financial situation and determine whether to file a personal bankruptcy under Chapter 7 or Chapter 13 of the Code.

In most cases, a small incorporated business ceasing operations does not need to file a bankruptcy.

The typical small business can usually liquidate its assets on its own, paying priority creditors first ~ usually taxes and wages ~ then, with any remaining proceeds, paying pro-rata distributions to general unsecured creditors.

An unpaid creditor can, of course, sue the corporation, and the small business owner may have to appear on the lawsuit as the corporate custodian.

If the owner wishes to avoid going to court on behalf of the failed business, the corporation can file a Chapter 7, triggering the automatic stay, which typically stops all litigation.

Reorganizing the Incorporated Small Business

Despite being the backbone of our economy, small businesses have historically received little assistance from the U.S. Bankruptcy Code.

Big companies of every industry have utilized Chapter 11 of the Bankruptcy Code to reorganize their cash flow, so that monthly business income matches monthly business.

However, small business bankruptcy debtors have traditionally struggled to reorganize effectively under Chapter 11 because the process is too cumbersome and expensive.

All too often, small business owners give up rather than fight the uphill battle of Chapter 11.

In 2020, the prospects for small businesses bankruptcy improved tremendously because the Federal government enacted two significant pieces of federal legislation February and March of 2020, New federal laws make filing a small business bankruptcy the easiest it has ever been.

The Small Business Reorganization Act of 2019 (SBRA), which became effective in February of 2020, is technically known as Subchapter V of Chapter 11 of the Bankruptcy Code and is specific to small businesses. Congress designed the SBRA to:

  • streamline business reorganizations,
  • reduce the cost,
  • speed the process, and
  • increase the chances of success.

Compared to Chapter 11, the SBRA is efficient and straightforward.

It eliminates many costly elements of Chapter 11, such as disclosure statements.

Subchapter V takes aspects from the expedited procedures used in Chapter 12 and 13 cases.

How do you know if your small business bankruptcy qualifies for the Small Business Reorganization Act of 2019?

At the time of enactment, if your business has total debts (both secured and unsecured), subject to specific qualifications, of less than $2,725,625, it can reorganize under SBRA.

However, The Coronavirus Aid, Relief, and Economic Security Act (CARES Act), created in response to the financial catastrophe caused by the COVID-19 pandemic, was enacted on March 27, 2020.

The CARES Act raises the small business debt limit to $7,500,000 until March 27, 2021.

Highlights of the SBRA’s “mini” Chapter 11

Eligibility: The SBRA has a debt limit of $7.5M until March 27, 2021. After that, unless Congress extends this provision of the CARES Act, the debt limit will drop to $2,725,625.

A trustee is appointed: Unlike Chapter 11, the SBRA requires the United States Trustee to appoint a standing trustee (known as a “pool trustee”) in every case.

Their duties are much like a Chapter 13 trustee.

Debtors pay SBRA Plan payments to the trustee, who then disburses proceeds per the Plan of Reorganization, once confirmed by the judge.

No unsecured creditors committee: The appointment of an unsecured creditors committee adds a lot of expense to a traditional Chapter 11 case. Subchapter V cases do away with this expense unless there is a show of cause to the Court that such a committee is necessary to accomplish an effective reorganization.

The Court holds a case management conference: Within 60 days of filing the petition, the Court holds a case management conference to measure case progress and ensure case progression.

Plan of Reorganization: Under Subchapter V, the debtor has 90 days to file the Plan of Reorganization.

The Court can further extend this deadline if necessary.

The Subchapter V Plan differs significantly from both Chapter 11 plans and Chapter 13 plans. Here are its significant features:

  • Only the debtor files a plan.
  • The plan length may be no less than three years and no more than five years.
  • The debtor must dedicate all disposable monthly income (D.M.I.) to the plan or pay 100% to general unsecured creditors over the life of the plan.
  • Debtor does not file a disclosure statement. In its place, the plan includes things like a brief history of the business operations, a liquidation analysis, and projections of the debtor’s ability to make the proposed plan payments.
  • The plan can modify the rights of a secured lender with a lien on a principal residence if the loan proceeds:
  • were not used primarily to acquire the home and
  • were mainly used in connection with the small business.
  • Debtors should be able to alter the terms of home equity loans and second mortgages obtained for business purposes (Think S.B.A. loan).

Confirmation of the Plan: The plan will be confirmed (approved by the judge) if it is feasible, does not unfairly discriminate and is fair and equitable to the non-consenting, impaired classes of creditors.

Discharge: The Court will grant a discharge when the debtor completes all payments due under the plan.

All debts are discharged except:

  • Secured debts where the last payment is due after the completion of the plan, or
  • Non-dischargeable debts.

What we don’t know about the SBRA

As with any new piece of legislation, the SBRA leaves unanswered questions about Subchapter V of Chapter 11:

  • What will the SBRA trustee charge the debtor as an administrative expense? A Chapter 13 trustee is allowed to charge an administrative fee, maxed out at 10% of the plan payment. There is no similar clause in Chapter 11 or Subchapter V. So, the Subchapter V trustee’s fee may be set by the Court, using a “reasonableness” standard. Without a legislative rule, expect debtors and trustees to fight over fees until the Courts establish a “standard.”
  • Similarly, what interest rate applies to secured loans under confirmed plans? Will it be the contract rate or some presumptive rate established by case law or local rule?
  • As a hybrid, what current case law has precedent in SBRA cases? Will the Courts rely on Chapter 11 case law, or will they rely upon some Chapter 13 case law as well?

As more SBRA cases are filed, litigation between debtors, trustees, and creditors will result in increased guidance from bankruptcy judges.

Small Business Bankruptcy Conclusion

  • The SBRA will undoubtedly result in more small business reorganization filings by debtors who could not afford to file a traditional Chapter 11. Debtors, bankruptcy trustees, creditors, and bankruptcy lawyers will increase understanding and efficiencies even further.
  • The streamlined small business bankruptcy process enables a small business to quickly and easily confirm a Plan of Reorganization, even over creditor dissent.
  • Debtors straddled by business loans secured by a home mortgage have a weapon to shrink or get rid of those balances by “cramming down” these loans to the fair value of their home.
  • The SBRA is better for creditors as well, since it should reduce creditor attorney fees and provide a greater chance of repayment versus liquidation in Chapter 7.

How much does it cost?

Unlike Chapter 7 and Chapter 13, small business bankruptcy cases are all very different.

Therefore, they are tough to pin down on costs.

Generally, the cost of legal services is a function of the time involved, the complexity of the matter, and the experience of the lawyer. Small business bankruptcy is no different.

However, unlike almost every other area of legal practice, the bankruptcy judge must approve attorney fees charged to the debtor.

The judge looks at factors such as time expended and results obtained before determining whether attorney fees are reasonable.

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