Small Business Bankruptcy Considerations

The economic effects of COVID-19 are adding to the challenges faced by companies that are undertaking – or may soon need to undertake – an attempt at restructuring under the protections of the Bankruptcy Code. Successful restructurings generally involve infusions of capital at some point in the process, and the turmoil in financial markets will make it more difficult and more expensive to source the financing to fuel restructuring options.

Does the CARES Act Revise the Code?

The CARES Act revises the Code – effective immediately – to afford relief to small business debtors and individuals that are coping with the COVID-19 pandemic and its financial impact.

In August 2019, the Small Business Reorganization Act of 2019 was signed into law with an effective date of February 19, 2020, representing a substantial change in bankruptcy law – Subchapter V of Chapter 11 – and practice for debtors that qualify for small business treatment. The new treatment was available to debtors engaged in commercial business activities, excluding the ownership of single asset real estate, with aggregate debts (secured and unsecured) less than $2,725,625 (subject to adjustment for inflation after 2020). To proceed under the new provisions, a small business debtor is required to make an affirmative election to do so.

The CARES Act expands the definition of a small business debtor by raising the threshold for aggregate debts (secured and unsecured) from less than $2,725,625 to less than $7,500,000 for the next year, attempting to simplify the road to reorganization for more small businesses that find themselves in COVID-19 related distress.

What Does this Mean?

Subchapter V offers a more straightforward and less expensive path to reorganization. It limits trustee fees and powers. It obviates the need for the formation of a creditors' committee or the rigorous disclosure statement otherwise required, unless ordered by the Bankruptcy Court for cause, and eliminates the need for an impaired class in the proposed plan. Moreover, under Subchapter V, a creditor’s leverage to block plan confirmation is limited, as the “absolute priority rule,” under which a debtor cannot retain an ownership interest in its assets unless all creditor claims are paid in full, gives way to a more pragmatic approach. A small business debtor’s plan can be approved so long as it is deemed fair and equitable to objecting unsecured creditors and the debtor makes payments to those creditors from projected disposal income over at least three years.

For more resources and LP's response to COVID-19, visit this webpage.