Small Businesses Are (Finally!) Afforded Access to Bankruptcy Relief - At Least For Now

WRITTEN BY JOSEPH J. BELLINGER

​Joseph Bellinger has nearly thirty years of experience as an attorney working in business bankruptcy cases, advising businesses on insolvency issues, restructurings, and workouts.
 
The Small Business Debtor Chapter 11 process is a streamlined bankruptcy reorganization that is now available to businesses with less than $7.5 million in debt, but this may not last more than a year.  

The Bankruptcy Code endeavors to balance the interests of the debtor and the interests of creditors in bankruptcy proceedings.  As that balance applies to Chapter 11 reorganization proceedings, one nagging concern has been whether the burdens placed on debtors, including monthly financial reporting and other disclosure obligations, and the substantial professional fees and costs of Chapter 11 proceedings, make Chapter 11 relief cost-prohibitive for small businesses.  Many of us who represent small businesses in financial distress view Chapter 11 proceedings as a limited tool – it provides a transparent process to conduct an orderly sale of substantially all of a debtor’s assets (sometimes as a going concern) as an effective means to maximize value for creditors.  However, for many financially troubled small businesses that wish to reorganize, Chapter 11 drains desperately needed cash and imposes significant burdens on management that is already stretched thin.  Consequently, many small businesses resort to negotiating payment plans with their creditors outside the protections of the bankruptcy process.  Their success or failure is almost entirely dependent on unanimous support of creditors, because it only takes one dissenting creditor to cause significant disruption to an out of court restructuring.     

In an effort to address greater access to Chapter 11 reorganization proceedings for small businesses, the formulation of an expedited and streamlined Chapter 11 proceeding for the “Small Business Debtor” began with amendments to the Bankruptcy Code enacted in 1994.  In general, a debtor qualifies as a “Small Business Debtor” if it is engaged in lawful commercial or business activities (other than primarily owning or operating real property[1]) and if its total debt is no greater than $2 million. The advent of the Small Business Debtor has provided significant benefits of an expedited and therefore more cost-effective Chapter 11 process for small businesses to reorganize. However, many practitioners have supported broader eligibility for Small Business Debtors by increasing the debt ceiling to $5 to $10 million.    

Fast forward to August 2019, when Congress passed the Small Business Reorganization Act of 2019 (“SBRA”) that went into effect in February 2020.  The SBRA further streamlines Small Business Debtor Chapter 11 proceedings and thereby improves access to affordable Chapter 11 relief for small businesses.  The COVID-19 virus was not the reason for the passage of SBRA, but it went into effect on the eve of the outbreak; a fortuitous morsel of good news for small businesses.   Unfortunately, SBRA only increased the debt ceiling for eligibility as a Small Business Debtor to approximately $2.7 million.  For advocates of broader access to Small Business Debtor bankruptcy relief, SBRA was a missed opportunity to fix the affordable access to Chapter 11 challenges faced by small businesses.

In March 2020, the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) was passed into law.  Among other things, the CARES Act increased the debt ceiling for Small Business Debtors from $2.7 million under SBRA to $7.5 million, which is a substantial expansion of eligibility to proceed as a Small Business Debtor in Chapter 11 bankruptcy proceedings. However, the increase of the debt ceiling to $7.5 million will expire in March 2021 and revert to $2.7 million unless the deadline is extended by new legislation, and that is by no means a certainty.  
 
For at least the next year, small businesses that fall within the debt ceiling of $7.5 million have access to a streamlined and efficient Small Business Debtor Chapter 11 reorganization process.  The benefits and protections afforded to Small Business Debtors are substantial and come at a time when so many small businesses are going to need every advantage to survive this unprecedented shut-down of our small businesses caused by the COVID-19 virus.  

If you wish to learn more about Small Business Debtor Chapter 11 proceedings or to talk about the financial worries that keep you up at night, please email us at [email protected] or call us at (410) 598-0582.  
 
[1] Debtors whose primary purpose is to own and/or manage real property are not eligible to proceed as “Small Business Debtors” because there is a similarly streamlined Chapter 11 process for “Single Asset Real Estate Debtors.”  

This article is not intended as legal advice and readers are admonished not to consider the content as legal advice or as recommendations they should follow.