The international health pandemic brought about by COVID-19, more commonly known as the coronavirus, has created fear and uncertainty not only as to the health and well-being of the general public, but the stability of the U.S. economy.

While it's difficult to forecast with certainty the number of retailers and other businesses that will shut their doors due to COVID-19, it will clearly have a significant effect on consumer spending, with the related negative repercussions in particular on small businesses. Reportedly, more than 170,000 small businesses in the United States closed during the recession years of 2008-2010. Between 2005 and 2017, only about 20% of small businesses survived more than 1 year and only 33% survived up to 10 years.

The U.S. Bankruptcy Code provides relief for small businesses facing insolvency. Chapters 11 and 13 of the Code permit a debtor to reorganize and emerge post-bankruptcy to continue operations. The only other alternative for a small business under the Bankruptcy Code is to liquidate under Chapter 7.

Chapter 13 is for individual debtors only; corporations, partnerships and trusts may not reorganize under this chapter. Accordingly, insolvent small business entities seeking to avoid liquidation need to invoke Chapter 11 to reorganize. But Chapter 11 involves a complex process—one requiring appointment of a creditors' committee for unsecured creditors, a plan of reorganization subject to stringent standards that can be proposed by the debtor or, in certain circumstances, its creditors, approval by creditors of such plan by solicitation through a disclosure statement, monthly reporting and the involvement of a court-appointed U.S. trustee throughout. Clearly this can be an overwhelming process for a small business. Although Congress amended the Bankruptcy Code in 2005 (pursuant to the Bankruptcy Abuse Prevention and Consumer Protection Act) to make Chapter 11 more user-friendly to small business entities, the costly and litigious nature of the Chapter 11 process, which can run 10 times the cost of a Chapter 13 reorganization in fees and expenses, pushed reorganization out of the reach of many small business owners. As a result, too many small businesses that could have reorganized instead wound up liquidating.

To address this predicament, and in a moment of true prescience in light of current circumstances, last year Congress amended the U.S. Bankruptcy Code by enacting the Small Business Reorganization Act of 2019 (SBRA). The SBRA was signed into law on Aug. 23, 2019 and became effective Feb. 20, 2020. The SBRA is the federal government's latest effort to make bankruptcy reorganization a more attractive option for small businesses, something particularly important given the potential crippling economic effects of the current pandemic.

The stated purpose of the SBRA is to "expedite and reduce the cost of bankruptcy" for small businesses. It creates a new subchapter V of Bankruptcy Code Chapter 11 specifically for small business debtors, whether companies or individuals. It also renders inapplicable numerous sections of Chapter 11 that continue to make reorganization unduly burdensome and costly for a small business. As enacted in 2019, the statute applied to businesses with not more than $2.7 million ($2,725,625 to be precise) in secured and unsecured debts. Effective March 27, 2020, pursuant to the just-enacted Coronavirus Aid, Relief and Economic Security Act (CARES Act), that ceiling has been raised to $7.5 million, widening its potential reach to a much larger group of businesses.

The biggest structural change stemming from the act is the ability of a debtor to move forward with a reorganization plan without creditor confirmation. In the past, a debtor was only able to proceed with a Chapter 11 plan if at least one class of impaired creditors voted to accept its plan. Now, as described further below, a debtor is able to adopt a plan without a creditor vote so long as certain other requirements are met. Some of the biggest benefits small business owners can expect to see (with, in certain instances associated trade-offs), in comparison to Chapter 11, are:

(1) Debtor Can Propose Plan. Only the debtor is allowed to propose a plan of reorganization. By contrast, Chapter 11 allows the creditors to propose a plan if the debtor has not done so within 120 days. The trade-off is that debtor must propose its plan within 90 days of commencement of its bankruptcy proceeding.

(2) Elimination of Creditors' Committee. A creditors' committee is a common feature of a Chapter 11 reorganization proceeding. As noted above, under subchapter V, there will be no creditors' committee for unsecured creditors unless ordered by the bankruptcy court—a huge potential expense savings for the debtor since it typically has to pay the fees and expenses of professional advisors to that committee. The trade-off is that a plan will be confirmed only as long as it provides that all projected disposable income of the debtor for three to five years will be used to make payments under the plan. "Disposable income" is defined to mean income that is not "reasonably necessary to be expended" for continuation, preservation or operation of the debtor's business, maintenance or support of the debtor or a dependent, or a domestic support obligation payable after filing of the debtor's bankruptcy petition.

(3) Creditor Approval of Plan/Modified Cramdown Rule. As noted above, the debtor's plan need not be approved by its creditors, eliminating the requirement for a court-approved disclosure statement and the costly process of soliciting creditor votes (although creditors can object if not all of the debtor's projected disposable income for a period of at least three years is to be used for repayment).

(4) Elimination of U.S. Trustee. Chapter 11's automatic imposition of a U.S Trustee (with its associated quarterly trustee fees and reporting requirements) to oversee the debtor's business has been eliminated. Again, the trade-off is that a private trustee (from among candidates approved by the Department of Justice under its U.S. Trustee program) is required, but under the SBRA, the private trustee is there solely to facilitate a plan of reorganization rather than oversee or operate the debtor's business.

(5) Elimination of the Absolute Priority Rule. The absolute priority rule is used to decide what portion of payments will be received by which creditors. Here, the SBRA's elimination of this rule allows the debtor to retain its ownership interest in its business through the bankruptcy proceeding even if it fails to contribute "new value" towards a reorganization plan or offer a plan that will not pay its creditors in full. The trade-off, if it can be considered one, is that the plan cannot discriminate unfairly, and instead must be adjudged to be fair and equitable, with respect to each class of impaired creditors.

(6) Deferral of Administrative Claim Payments. The debtor is allowed to pay its administrative claims over the term of its plan, as opposed to on the date of confirmation of the plan (as is the case in a Chapter 11).

Other Considerations

Along with its numerous benefits, there are some limiting and negative considerations in regard to the SBRA. Among other things, as noted above, the debtor must commit all of its disposable income (or the property to be distributed under the plan) to payments under the plan during its three to five year term, it is obligated seek a consensual plan of reorganization and must report its efforts to the court not later than 46 days after its petition filing, and participate in a court status conference 60 days after the petition filing. Most notably, the small business debtor is discharged from its pre-petition debt (other than non-dischargeable debts) only after payment of all amounts due within the first three years following effectiveness of its plan (which, as noted above, is its projected disposable income during that period) or up to five years if determined by the court), as opposed to immediately upon confirmation of the plan as with other Chapter 11 cases. Finally, in the case of small business debtors, all exceptions to discharge apply, as compared to other Chapter 11 cases that have a more limited set of exceptions to discharge.

Conclusion

In challenging economic times such as these, legislative options such as the ones now made available by the SBRA could offer a much-needed lifeline to small business owners. However, even with the flexibility, cost-savings and streamlining offered by the SBRA under new Bankruptcy Code subchapter V, many small business entities may still find that bankruptcy reorganization is not a viable option. This subchapter will certainly be put to test over the coming year.

Barbara M. Goodstein is a partner in the finance practice at Mayer Brown. Monique J. Mulcare, counsel in the restructuring practice, and Lindsey Ferguson, an associate in the finance practice, assisted in the preparation of this article.