28 May 2020

How the SBRA and CARES Acts May Affect Creditors in This Pandemic Setting

Topics: Bankruptcy

Subchapter 5 of chapter 11 of the US Bankruptcy Code (11 USC Sections 1181 through 1195), known as the Small Business Reorganization Act of 2019 (SBRA), went into effect on February 19, 2020. The SBRA provided a streamlined and more cost-effective reorganization process for small businesses with total debts of less than $2,725,625.00.  
When Congress passed this law on August 23, 2019, no one had any idea that the landscape in 2020 would be so dramatically different due to the COVID-19 pandemic, forcing many small businesses to shut down completely, while those that managed to stay open suffered giant financial hits.
Examples of hard-hit small businesses include restaurants, retail shops, and personal service providers.  In many cases, these businesses were shut down with no revenue for over two months, despite remaining responsible for expenses such as rent, employee salaries, and insurance, and so forth.
To address some of the issues raised by the pandemic shutdown, Congress passed the Coronavirus Aide, Recovery, and Economic Security Act (CARES Act). Among other things, the Act amended the SBRA to give struggling businesses an attempt to survive the shutdown. Some of the more significant alterations to the SBRA include:
  • A one year window through March 27, 2021, temporarily raising the total debt ceiling to $7,500,000.00.
  • Permanently eliminating the eligibility of affiliates of public companies from filing under the SBRA.
Key SBRA provisions that remained unchanged include:
  • The U.S. Trustee will appoint a trustee in every SBRA case, who will serve much like a chapter 13 standing trustee, disbursing plan payments, assisting the debtor developing its plan of reorganization, and otherwise participating in the reorganization process.
  • To save on costs, other professionals, such as appraisers and accountants, will not be hired unless ordered by the court.  Likewise, no unsecured creditor committee will be appointed unless by an order of the court.
  • A status conference must be held within 60 days of the petition date.
  • A plan of reorganization must be filed within 90 days of the petition date.
    • Only the debtor may file a plan.
    • A plan will include information once included in a Disclosure Statement, such as an overview of the debtor’s business operations, a liquidation analysis, and a projection of the debtor’s ability to make the payments proposed in its plan.
    • The plan must be no less than three years and no more than five years in length with all disposable income dedicated to the plan.
    • A plan may modify the rights of a secured lender, secured by a personal residence, if the proceeds were not used to acquire the property and were used primarily in connection with the business operations of the debtor.  This is a significant change, allowing debtors to cram down mortgages and home equity lines of credit used primarily to finance the debtor’s business operations, etc.
  • Under the SBRA, a discharge is not granted until the debtor completes all payments due within the first three years of the plan, or such longer period not to exceed five years as the court may fix. The discharge applies to all debts addressed by the plan, except for debts:
    • (1) on which the last payment is due after the first three years of the plan, or such other time fixed by the court not beyond five years, or; 
    • (2) that are otherwise non-dischargeable.
From a creditor’s perspective, the pandemic will likely mean a surge in bankruptcy filings of small businesses.  Assuming such a surge of filings under the SBRA, creditors should expect to see plans confirmed over creditor objection and dissent, including modifications to loans secured by personal residences that were previously largely unassailable from a security standpoint.  At this time, it is unclear what the interest rates will be for secured loans under SBRA plans, as courts may follow local rule presumptive rates or perhaps the contract rate.
On the plus side of the ledger, preferential transfers within 90 days of the bankruptcy filing date (one year for insiders) are now harder to avoid and take back from creditors. The threshold for non-insider defendants is raised from $13,650.00 to $25,000.00, and preference suits of less than $25,000.00 would need to be filed in the geographic district where the debtor resides and not where the case was filed.  The result is fewer preference suits will be filed due to the high costs and travel involved, especially when it must be filed in another district.
In addition, the bankruptcy process should be generally much faster.  A faster process means less cost to creditors, and, due to the involvement of an appointed trustee in each case who will facilitate payments and distributions, creditors are likely to recover more over the long term.  
The SBRA, along with its modifications under the CARES Act, expands chapter 11 eligibility - which is predicted to result in a flood of new chapter 11 cases in the next six months.  To protect their own interests, creditors should stay informed on the SBRA and any changes enacted in the future, by subscribing to our email list.

Questions? Contact the authors, attorney James McDonough, and shareholder Eric Craig, from our Louisville, KY office.

For more comprehensive information and insights, watch our Ask a Pro: Navigating Chapters 11 & 12 Bankruptcies webinar.
This blog is not a solicitation for business, and it is not intended to constitute legal advice on specific matters, create an attorney-client relationship, or be legally binding in any way.

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