A New Small Business Bankruptcy Law Takes Effect, Just In Time

(Bloomberg Businessweek) -- Formal bankruptcy, particularly for reorganizing, has long been out of reach for most small businesses, especially after a "reform" 15 years ago gave creditors more power. So you could be forgiven for having missed it last summer when Congress streamlined the rules for small businesses hoping to use bankruptcy to make a fresh start. And not many people noticed when this law, the Small Business Reorganization Act, took effect just two months ago—perhaps because, as written, the new provisions applied only to businesses or proprietors with less than $2.7 million in debt.

But then, in late March, Congress temporarily upped this debt cap to $7.5 million as part of the $2 trillion coronavirus relief package. Now beleaguered companies and their lawyers are taking a second look and weighing whether to use bankruptcy court to reorganize.

Here’s how the new law helps small businesses in bankruptcy.

1. The odds of keeping your business have improved.

The streamlined procedures for reorganizing—which typically involve overhauling the business to make it profitable and then getting creditors to agree to more generous repayment terms —appear in a new part of Chapter 11 of the bankruptcy code, designated Subchapter V. The procedures change dozens of different elements of a traditional reorganization; the biggest advantage for debtors may be that they have a far better chance of holding on to their company. In a traditional Chapter 11 reorganization, the bankrupt company's equity owners usually get no stake in the reorganized enterprise unless all of its debts are repaid in full. 

Now business owners can keep their equity, so long as they distribute their disposable income to creditors over the next three to five years. "The goal of the Subchapter V is to let the small business owner remain in possession of the assets," says Deborah Williamson, who heads the bankruptcy practice at the law firm Dykema. "That's a different goal than the bankruptcy goal."

2. You don't have to win over creditors.

Small businesses do get somewhat simpler treatment under Chapter 11 without Subchapter V, but only about a quarter of these cases end with a reorganization plan approved by a judge. Often that's because at least one group of creditors—typically lenders—object. "Almost by definition, when you get to the point that you're filing to stop a foreclosure, you're at odds with the lender," says San Antonio bankruptcy lawyer Ray Battaglia. "They don't want to deal with it. They don't trust you. They don't believe your credibility."

But under Subchapter V, with the repayment plan in place that includes full repayment of debt secured with collateral, a court will confirm the plan over this opposition. Under the new system, "I can have every creditor voting against me and still theoretically confirm a plan," Battaglia says. Only debtors—not creditors or other interested parties—may propose a plan under Subchapter V.

3. Bankruptcy case costs may be cheaper. 

The new law also makes further changes that could make a Subchapter V case less costly. It eliminates, unless the judge decides otherwise, the requirement for a separate document that discloses the background to the case and alternatives to the plan; this can add at least a month, and further chances to object, to a case. It eliminates—for all small-business cases, not just those pursued under Subchapter V—the automatic creation of creditors' committees (with attorneys’ and other professional fees paid by the debtor) unless the court similarly orders them. And the debtor's reorganization plan doesn't have to be nearly as detailed as in a typical Chapter 11 proceeding.

4. Bigger companies can use it—for now.

A small-business debtor must choose, or "elect," a Subchapter V proceeding. Otherwise the case will fall under the normal rules—and, says Williamson, there's no reason to do that unless you're determined to sell the company "and avoid working for the creditors." That's especially true now, because the $7.5 million debt ceiling in the coronavirus relief law applies only to Subchapter V cases. However, she says, companies that are already reorganizing through Chapter 11 and that qualify for Subchapter V treatment can switch to it.

The higher cap is much closer to the $10 million debt limit that bankruptcy reformers originally sought. The bad news is that, as the law currently stands, the limit will fall back to the parsimonious $2.7 million cap after one year, on March 27, 2021.

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