Small Business Reorganization Act of 2019 (SBRA) is Effective

The Small Business Reorganization Act of 2019 (“SBRA“) is in effect as of yesterday, February 19, 2020.  The SBRA was enacted to provide smaller business debtors with a more streamlined path to restructuring their debts.  Below are some highlights of the new law.

Absolute-Priority Rule

The SBRA exists today, in large part, because small businesses historically have had difficulty confirming their chapter 11 plans. One of the main stumbling blocks to confirmation was the absolute-priority rule, which (in regular chapter 11 cases) denies plan confirmation unless unsecured creditors agree to receive less than 100 percent recovery. The SBRA eliminates this rule in small business cases.

Now, instead of worrying about the absolute priority rule, the first questions in representing a debtor should become: (1) what are our goals, and (2) is there a credible cash flow to achieve those goals? The SBRA offers options to debtors and their counsel not previously available under the Code.

Debt Limit

The SBRA establishes a baseline of total debt ($2,725,625) for small businesses to qualify for relief under this sub-chapter.  Congress is likely attempting–as it did with chapter 12–to measure the SBRA’s impact on small business reorganizations.

Plan Requirements

While the absolute-priority rule is eliminated with respect to small businesses, certain confirmation requirements under § 1129(b) are explicitly incorporated into the SBRA (by § 1191(b) and (c)).  Specifically, the SBRA provides that a plan must not “discriminate unfairly” and must be “fair and equitable” for “each class of claims or interests that is impaired under, and has not accepted the plan.” This is a verbatim copy of the existing language from § 1129(b)(1) of the Code.

The “fair and equitable” standard under the SBRA includes the following details: requirements of § 1129(b)(2)(A) for secured claims must be satisfied; the plan must contribute all of the debtor’s “projected disposable income” to making plan payments for three to five years; the plan must be feasible
(i.e., there must be a “reasonable likelihood” that the “debtor will be able to make all payments under the plan”); and the plan must provide “appropriate remedies” to “protect” creditors from a failure to make payments, including “the liquidation of nonexempt assets.”

The provisions of § 1123 on “contents of plan” will still apply under the SBRA, except for several specific items (see § 1181(a)) relating to the “future income from individual services”; a creditor-plan for an individual debtor; and the “lien on principal residence” of the debtor, as discussed below.

Disclosure Statement

The SBRA retains a light disclosure statement requirement (§ 1190), where only three items are required to be disclosed: a brief history of the business operations of the debtor; a liquidation analysis; and projections on the ability of the debtor to make payments under the proposed plan.

Homestead Liens

The SBRA changes the existing chapter 11 rule, which prohibits modification of lien rights that are “secured only by a security interest” in a debtor’s “principal residence”
(see § 1123 (b) (5)).  The new rule (in § 1190(3)) authorizes modification of such lien rights when the “new value” that a debtor received for such lien was (1) “not used primarily to acquire” the residence, and (2) instead was “used primarily” in the debtor’s small business.

Trustees

A trustee is appointed under the SBRA (§ 1183), and the statutory role and duties of this trustee are similar to those for trustees in chapters 12 and 13.  The primary difference is that in small business cases (per § 1183(b)(7)) “[t]he trustee shall … (7) facilitate the development of a consensual plan of reorganization.” This provision is unique, as in no other place does the Bankruptcy Code (1) authorize a trustee to help a debtor in possession develop a plan of reorganization, or (2) suggest the goal of a “consensual plan” when the absolute-priority rule does not apply.

Section 586(e)(1) and (5) allows the court to “award compensation” to the small business trustee in an amount “consistent with services performed” and limited by 10 percent of “payments made under the plan.” Such compensation is payable upon substantial consummation of the plan, conversion or dismissal of the case, or other termination of the trustee’s services. The small business trustee is expressly excluded from provisions of § 326.

Preference Claims

The SBRA makes some universal changes to preference laws in all bankruptcy cases.  First, it provides that in all cases, before a preference claim can be pursued, a claimant must use “reasonable due diligence” in light of “the circumstances of the case” to consider “a party’s known or reasonably knowable affirmative defenses.”

The SBRA also provides that a preference suit for less than $25,000 against a noninsider, involving a non-consumer debt, can only be brought in the district where the defendant resides.

Presumably these changes were intended to help preference defendants avoid expensive bankruptcy litigation.  But, only time will tell how effective these provisions will be.

Conclusion

The SBRA has been welcomed by many practitioners that have considered the unique problems facing small businesses.  Hopefully, all parties will embrace the opportunities offered by the SBRA to assist small businesses in their reorganization efforts.

Partner at FisherBroyles, LLP

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