The U.S. lost 170,000 small businesses in the last recession. Whether things go better this time may depend on a new law aimed at easing their path through bankruptcy.
The Small Business Reorganization Act, which went into effect just two months ago, was intended to make the process of reorganizing an insolvent company with less than $2.7 million in debt faster and cheaper. The $2 trillion coronavirus relief package enacted in March will allow as many as 70% of small businesses to qualify by temporarily raising the debt limit to $7.5 million for the next year.
The change could make a big difference for companies’ survival at a time when normal business activities across nearly every major industry are indefinitely put on hold and liabilities continue to accrue.
“This is going to help a lot of small businesses survive this thing,” said bankruptcy attorney Bob Keach of Bernstein, Shur, Sawyer & Nelson PA. “Thank God they got it passed.”
Still, the novelty of the law—and the tremendous uncertainty caused by the Covid-19 pandemic—means there are likely to be some delays and extra costs along the way. Because debtors don’t yet have the luxury of knowing when their businesses may return to normal, the SBRA’s shortened restructuring time frame isn’t necessarily advantageous.
Small business bankruptcies “may not end up being as cheap as people think they’re going to be,” attorney Avrum Rosen of Rosen & Kantrow PLLC said.
A Chapter 11 case can be prohibitively expensive for smaller companies lacking the resources to both run their businesses and pay high-priced professionals for what are typically lengthy periods of time.
Revisions to the bankruptcy code in 2005 made the process even more difficult for small businesses, afflicting debtors during the 2008 financial crisis, restructuring lawyers say.
Those changes created additional reporting and procedural hurdles that can prolong an already expensive Chapter 11 case. They also limited the leverage debtors can gain over creditors by remaining in bankruptcy.
To alleviate the strain, the law signed by President Trump last August created Subchapter V of the bankruptcy code’s Chapter 11. Qualifying debtors are freed from the requirements for an estate-funded creditors’ committee and court approval for restructuring plan voting materials. The law also empowers an independent trustee to oversee proceedings and expedite case resolution.
Crucially, the act permits debtors to propose and confirm plans without the approval of any impaired creditor groups, while keeping equity in the business to maintain it going forward. “That was a big hurdle for a lot of owners of these small businesses,” said Leon Cosgrove LLP attorney Andrew Zaron said.
That a bitterly divided Congress passed this measure with overwhelming support, and “the fact that it went into effect in February was fortuitous,” he said.
It’s common in Chapter 11 cases for creditors to receive equity in the debtor and previous owners to lose their stake in the business, Cozen O’Connor PC attorney Eric Scherling said But “under the small business provision, that rule doesn’t apply,” he said.
The one-year $7.5 million debt cap established by the Coronavirus Aid, Relief, and Economic Security (CARES) Act follows the National Bankruptcy Conference’s recommendation to cover more small businesses. The nonpartisan group of attorneys, law professors, and bankruptcy judges said extending the relief would benefit business owners, suppliers, customers, employees and the wider economy.
The temporary expansion should extend eligibility to about 60% to 70% of small companies, said Bernstein Shur attorney Keach, who had advocated for a $10 million debt cap in the SBRA. The SBRA is well-suited for companies that have been hobbled by the pandemic but are poised to be profitable again in the future, he said.
On top of expanding access to Chapter 11 and making it “less expensive and quicker,” the new law will also encourage more out-of-court resolutions, said bankruptcy lawyer James Bailey of Bradley Arant Boult Cummings LLP. “That’s one way how they’ll negotiate and hopefully avoid bankruptcy,” he said.
Despite expressing concerns with the new law, Rosen said that the ability to approve a plan without a creditor vote “will give bankruptcy attorneys who know what they’re doing extra weapons to negotiate out-of-court settlements.”
Still, the law may have created new issues, he said.
Under Subchapter V, a debtor has 90 days to file its reorganization plan of reorganization or ask the court for an extension if faced with it faces circumstances for which it “should not justly be held accountable.”
This could become problematic, as taxing authorities are supposed to be given 180 days to file proofs of claim, and a debtor may need time to determine whether certain property leases are vital to the business, Rosen said.
“That 90 days is going to get extended all over the place,” he said.
Not knowing when the coronavirus pandemic will abate also creates some uncertainties for companies that seek immediate relief in bankruptcy, said Klenda Austerman LLC attorney Eric Lomas.
“If a case was filed today, it may be difficult for a business to predict its post-virus ‘new normal’ within that timeframe,” he said.
The automatic appointment of a standing trustee could also cause more administrative burdens on a small business, said Jonathan Pasternak of Davidoff Hutcher & Citron LLP. Paying a case administrator to oversee payments will add to the cost even if the process allows companies to make it through Chapter 11 more easily, he said.
Because the SBRA so far has only been used sparingly, it remains to be seen whether its benefits will turn the tide for small businesses, Rosen said. “We may get another technical fixing bill correcting this.”