The CARES Act, perhaps the single largest stimulus package in US history, carries a multitude of very important provisions from SBA loans and grants to payments to individuals. However, one of the smaller provisions may have one of the larger impacts in the long run. As part of the CARES Act, Congress amended the Small Business Reorganization Act (“SBRA”) in a crucial way – raising the maximum debt limit from $2,725,625 to $7.5 million for a year. This small change will dramatically increase the number of companies that can take advantage of the SBRA’s provisions in the coming months.
To understand the import of raising the debt limit its important to understand how the SBRA amended the provisions of the Bankruptcy Code to make a chapter 11 proceeding more palatable to small businesses. The SBRA was passed last year and only recently became effective on February 19, 2020. Before it was enacted, small businesses were required to follow the same provisions and requirements as the largest bankruptcy filings (think General Motors, Leman Brothers or PG&E). For the mom and pop pizza shop or manufacturer, chapter 11 proceedings were daunting, expensive, and likely impossible. Accordingly, many simply gave up, closed their doors, and filed a chapter 7 bankruptcy to liquidate what little was left.
The SBRA made several important changes to the provisions of the Bankruptcy Code provided the debtor had debts under $2,725,625. Notably, in an SBRA case:
- A case trustee is appointed to monitor the progress of the bankruptcy and help promote consensual plans of reorganization
- No creditors committee is appointed
- A disclosure statement is no longer required to accompany a plan of reorganization and the plan of reorganization requirements were tweaked to provide additional information normally found in a disclosure statement
- The timing of the case was moved up rapidly. A plan of reorganization must be filed within 90 days of the petition date
- Only the debtor can file the plan of reorganization
- The debtor must commit between three and five years of disposable income to plan payments after which it receives a discharge of any remaining debt
- Owners are able to retain their interests in the business even if claims are not paid in full
- As part of the plan or reorganization, the debtor may modify a loan secured by a principal residence if the proceeds were used primarily on connection with the business.
- No US Trustee fees
These changes were designed to decrease costs and the time it took for a business to file and exit bankruptcy while providing meaningful relief to those debtors.
The CARES Act temporarily addresses a common criticism of the SBRA – namely the debt limit. Many had argued that the SBRA’s debt limit was too low and prevented many debtors from taking advantage of the program. The CARES Act almost triples that debt limit and allows far more businesses to take advantage of this crucial program at a time when many small businesses will be severely impacted by the economic slowdown. This in turn will hopefully encourage small businesses to fight to stay open and not simply shut their doors and lay off their workers.
There is no question that the current economic climate is causing a substantial disruption to the cash flow of small businesses. This lack of cash flow will lead to missed or late payments to lenders, landlords, or other creditors. Which in turn will trigger defaults and demands for payment that will further strain small businesses to the breaking point. Absent the provisions of the SBRA and the higher debt limits, many small businesses would have no realistic option to reorganize their business and remain in operation. Every shuttered business leaves a wake of unpaid debts and unemployment that further impacts the economy. By opening up the SBRA to more debtors, Congress has created a mechanism by which small businesses can seek the protections of a bankruptcy filing, restructure their debts, and emerge from bankruptcy with a viable business model.
For the creditors, landlords, and lenders of these small businesses it is important to understand how the SBRA (and the new debt limits) alters the playbook in bankruptcy. As described above, the debtor has substantial power in shaping its plan of reorganization and the terms of repayment to the detriment of its creditors Accordingly, even an experienced party in the chapter 11 world will find things markedly different when navigating the SBRA process as a creditor. This will also impact how these creditors deal with debtors pre-petition in loan and other workouts as the threat of a chapter 11 filing for a small business debtor has additional teeth to it. With the increased debt limit more creditors will find themselves subject to an SBRA proceeding that will substantially impair their ability to get repaid.