Maryland Legal Alert for Financial Services

The Small Business Reorganization Act of 2019 (“SBRA”), which was signed into law on August 23, 2019, adds new Subchapter V to Chapter 11 of the Bankruptcy Code.  It will go into effect on February 19, 2020.  The SBRA  will apply to a “small business debtor” which is defined by the Code as a person (which includes an individual, corporation, partnership and limited liability company) that has no more than $2,725,000 of non-contingent liquidated secured and unsecured debt of which at least 50% arose from commercial or business activities.  The definition excludes a single asset real estate debtor.  A small business debtor must elect Subchapter V when it files its Chapter 11 case in order for Subchapter V to be applicable.

The SBRA is reportedly the product of a bipartisan effort in Congress to reduce the cost of Chapter 11 for a small business and expedite the process.  The most significant change made by the law is the elimination of the “absolute priority rule”.  Under existing law if equity holders in a debtor wish to retain their equity interests under a plan of reorganization, unsecured creditors must be paid in full or the equity holders must make a meaningful financial contribution to the plan from personal or nondebtor assets.  This rule will be replaced by a requirement that the debtor distribute all of its “projected distributable income” over a 3 to 5 year period. The SBRA did not secured creditors’ existing rights under the Code.

Although the SBRA is intended to benefit small business debtors, Congress also imposed requirements that should benefit creditors.  Among these is a requirement that a Subchapter V trustee be appointed to oversee the case, facilitate a consensual plan, investigate and report fraud and mismanagement, and distribute money under the plan.  The trustee will be similar to the trustee that is appointed in Chapter 13 cases.

Another significant requirement is that the debtor must file its plan within 90 days from the start of the case.  While the court may extend this period, it may do so only “if the need for an extension is attributable to circumstances for which the debtor should not justly be held accountable.”

In addition to the above changes, the SBRA amended Section 547 (b) of the Bankruptcy Code by requiring that trustees or debtors in possession investigate the likelihood of defenses to a preference claim before filing suit. Another change is that suits to collect less than $25,000 must be filed in the jurisdiction in which the defendant resides.  Under existing law, the dollar threshold is $13,650.

Practice Pointer:  While the enactment of the SBRA will make it more difficult for unsecured creditors to block the confirmation of a plan filed by a small business debtor that elects Subchapter V, the appointment of a trustee and the expedited time frame for the filing of a Chapter 11 plan should benefit creditors.  Many of the small business cases that are being filed today are by debtors that lack sufficient capital and/or are poorly managed.  Subchapter V will not help a business that cannot survive under any circumstance.  The requirements imposed by the SBRA should result in a more expeditious resolution of the Chapter 11 case than exists today.  The amendment made by SBRA to the preference section of the Bankruptcy Code further benefits creditors by providing another affirmative defense to a preference claim.

For questions concerning this topic, please contact Lawrence D. Coppel.