These are uncertain, difficult and therefore, stressful times. It is a good time to remind ourselves, however, that the U.S. economy is highly resilient. An important reason for its resilience is the Bankruptcy Code, which carefully balances the needs of debtors of all kinds, but especially small and large businesses, with the rights of creditors. Facts and information may help blunt the uncertainties and pessimism of these days. Further, a spate of legislation was passed in 2019 and 2020, which greatly enhances the effectiveness of the Bankruptcy Code.
Overview: The Bankruptcy Code allows a debtor, including corporations and other business entities, to file for relief under Chapter 7, a liquidation bankruptcy, or Chapter 11, including the new Subchapter V, for reorganization. Despite their different objectives and outcomes, there are many common principles, powers, and duties associated with each.
In a Chapter 7 proceeding, a trustee is appointed to liquidate the debtor’s assets in an expeditious manner. The Chapter 7 trustee has management and control of the debtor’s assets and has the duty to liquidate them and distribute any available proceeds to satisfy the claims of creditors. The officers, directors, and shareholders of a corporation or business are divested of all management and control over the debtor’s assets.
By contrast, in a Chapter 11 proceeding an entity or person may seek to confirm a plan of reorganization to restructure liabilities and allows the debtor to emerge from the bankruptcy and carry on its business. In most instances, the debtor in possession and its existing management continue to exercise management and control over the estate’s assets. The debtor in possession has most of the same authority, powers, and duties as does a trustee in a Chapter 7 proceeding. Those powers include the power to assume or reject executory contracts and unexpired leases, present and confirm a plan, and file actions to recover preferences and fraudulent conveyances.
Two other types of reorganization cases can be utilized by businesses. Chapter 13 protection is only available to individuals, but sole proprietorships often come into the bankruptcy along with the individual. A Chapter 13 acts like a consolidation loan. A trustee is appointed; the individual makes payments to the trustee, who then distributes payments to creditors. Chapter 12 is available to family farmers or fishermen. A trustee is appointed and payments are made to the trustee and distributed, but there are additional benefits available to the debtor under Chapter 12, which are unavailable under any other Chapter.
Recent Legislation: A flurry of new laws were enacted affecting the Bankruptcy Code in 2019 and 2020. Some laws effect permanent changes in the Code, while others were enacted to blunt the economic impact of the pandemic and these provisions have, at present, sunset clauses.
Small Business Reorganization Act (SBRA): The SBRA created Subchapter V of Chapter 11 and affected many sections of the Bankruptcy Code. It is expected that Subchapter V bankruptcies will proceed faster and at less expense and litigation than under a Chapter 11. Fewer professionals will need to be employed and the Subchapter V trustee, appointed in every case, will facilitate the administration of cases.
A small business debtor is defined as a small business with combined secured and unsecured debt of $2,725,625, increased temporarily under the CARES Act to $7,500,000. A small business debtor becomes a Subchapter V debtor by making an election in the petition. Unlike in a Chapter 11, the debtor may continue to use pre-petition professionals, including legal counsel.
The debtor functions as a debtor in possession unless removed by the Court. There are no creditors’ committees unless the Court orders them. There is also a trustee appointed, whose duties are to facilitate the bankruptcy. Only the debtor may file a plan and it should be filed within 90 days after the order for relief is entered.
No disclosure statement is required, although the plan requirements include some of the information usually provided in a disclosure statement, such as a brief history of the debtor’s business and a liquidation analysis. The confirmation requirements are more lenient than those in a standard Chapter 11. While the trustee must ensure the debtor commences timely payments, the trustee’s services terminate upon substantial confirmation of the plan. All these attributes should result in a less expensive, fast-paced reorganization.
Family Farmer Relief Act of 2019 (FFRA): The FFRA simply increased the debt limit for family farmers and fishermen from $4,411,400 to $10,000,000. It is anticipated that the increase will allow many more farmers to file under Chapter 12. Chapter 12 filings increased by 20 percent in 2019. By comparison, the debt limit under Chapter 13 is $1,677,125, and under Subchapter V for small businesses the debt limit is $2,725,625, although it was temporarily increased under the CARES Act.
Coronavirus Aid, Relief and Economic Security Act (CARES Act): The CARES Act became law on March 27, 2020, as an emergency act in direct response to the Coronavirus Pandemic. Many provisions of the Act affect everybody, but some specific provisions temporarily change portions of the Bankruptcy Code.
- First, the combined secured and unsecured debt limit is increased from $2,752,625 to $7,500,000 for the Subchapter V filings.
- Second, Coronavirus related assistance is excluded from the calculation of “current monthly income” and “disposable income” in Chapters 7 and 13.
- Third, a Chapter 13 plan may be modified after confirmation to extend up to seven years from the date of the first payment under the plan was due. This allows debtors an extra two years to complete a plan, if approved by the Bankruptcy Court.
These provisions automatically expire one year after the date of enactment of the CARES Act. The Act also provides temporary relief through September 30, 2020 to borrowers of federal student loans by allowing six months of deferrals. The Act also provides relief from foreclosure on federally backed mortgages at the written request of the borrower. It provides for a 180-day forbearance period.
As always, bankruptcy – both liquidation and reorganization – will play a role in the economic recovery of individuals and businesses. But the beefed up Bankruptcy Code will especially enable small businesses of every stripe, from the sole proprietor to the family farmer, to reorganize efficiently and, thus, aid them in adjusting to what lies ahead.
There are many remedies available for stressed debtors and numerous protections for their stressed creditors. Sullivan Hill is standing by to consult and explain how the various options apply to your situation and to help you decide on your best course of action. Stay well!
Of Counsel Elizabeth Stephens serves as managing attorney of Sullivan Hill’s Las Vegas office. She practices in the area of insolvency and bankruptcy, primarily representing trustees and creditors in consumer bankruptcies. She is also an experienced appellate lawyer.
About Sullivan Hill:
Sullivan Hill has provided efficient, aggressive, and responsive legal representation for more than 50 years. The firm provides full service representation to clients in a variety of industries with an emphasis in insolvency, construction disputes, insurance coverage, real estate, business disputes, civil litigation, and transactional work. The firm has offices in San Diego and Las Vegas.