CARES Act Expands Eligibility for Small Business Reorganization Act

The Coronavirus Aid, Relief, and Economic Security (CARES) Act was signed into law March 27^th and is now considered yesterday’s news as we have come to realize that no amount of government stimulus will effectively bail out businesses and individuals affected by COVID-19.  In my last blog I projected  a significant increase in bankruptcy filings as a result of COVID-19 and social distancing measures. The past few months bankruptcy filings have increased with many large notable businesses making headlines:  Tuesday Morning, J Crew, J. C. Penney, Neiman Marcus, Hertz, Golds Gym, 24 Hour Fitness, GNC, Tuesday Morning, Centric Brands, Bluestream Brands, just to name a few. Lost in the headlines are the small businesses that are taking advantage of the CARES Act’s temporary amendments to the Bankruptcy Code. One of the temporary amendments to the Bankruptcy Code, provides streamlined reorganization procedures for businesses with debt of less than $7.5 million.

Small Business Reorganization Act 

The Small Business Reorganization Act (SBRA) aka Subchapter V of the Bankruptcy Code went into effective in February 2020; just in time for the COVID-19 pandemic to bring the U.S. economy to a standstill in March 2020.  Prior to SBRA small business had to choose between Chapter 11 Reorganization which was expensive and Chapter 7 Liquidation.  SBRA was created to lower the cost and reduce the complexity of reorganization for small businesses. Prior to the CARES Act temporary amendment, small businesses with non-contingent, secured and unsecured debt less than $2,725,625 may elect to file bankruptcy under Subchapter V.  

Subchapter V

Subchapter V allows small businesses to file and confirm a plan quickly with the assistance of a trustee and without the formation of a creditors committee. Normally in a Chapter 11 Reorganization, a trustee is only appointed for cause, such as fraud or gross mismanagement, and seizes control of the business’ operations. A Subchapter V trustee does not take control of the business and their primary function is to help negotiate and facilitate a consensual plan between the small business and its creditors. In addition, Subchapter V allows a small business to confirm a plan without the need for a disclosure statement; eliminates the requirement that at least one impaired class accept the plan; eliminates the absolute priority rule; permits administrative expenses to be paid over time and not on plan effectiveness date; and allows a small business to cram down lenders on the value of residential collateral used for business loans; and allows owners to retain their business without providing new value under the plan[1].  

For the next year, the CARES Act expands eligibility for Subchapter V by increasing the debt limit under the SBRA from $2,725,625 to $7.5 million. This increases allows much larger businesses to access streamlined reorganization under Subchapter V. Even as States are reopening and reducing social distancing restrictions, many businesses will need a complete reset as many creditors, who also have their own financial obligations, will be less likely to make additional concessions now that businesses are back open.

Small businesses should carefully consider the timing of a Subchapter V filing in relation to obtaining a SBA Paycheck Protection Program Loan (PPP). The U.S. Small Business Administration has indicated that applicants presently subject to a bankruptcy proceeding are ineligible for PPP loans. Subchapter V bankruptcy filings will drastically increase once PPP funds run out, particularly among businesses who are unable to meet the requirements for loan forgiveness.

Small businesses need to be aware of their range of options during these highly uncertain financial times. Debtors’ and creditors’ rights, obligations, and potential liabilities under the Bankruptcy Code can be hard to navigate.

If you need assistance understanding how to safely proceed in Bankruptcy Court or out of court workouts, contact the experienced litigation attorneys at Goosmann Law in our Sioux City, Sioux Falls, and Omaha offices.

[1] Subchapter V eliminates the so-called “new value rule,” which normally requires equity holders to provide “new value” if they want to retain their equity interest in the business.