On Aug. 23, 2019, President Trump signed into law the Small Business Reorganization Act of 2019 ("SBRA" or the "Act"), Pub. L. No. 116-54 (2019). The SBRA, which becomes effective on Feb. 19, 2020, seeks to address problems encountered by small business debtors in reorganizing under the provisions of the United States Bankruptcy Code. The Act creates a new Subchapter V to Chapter 11, which aims to make small business bankruptcy proceedings more expeditious and less costly. It also contains provisions that may reduce a creditor's leverage and require their greater vigilance in a small business case.

The key components of the SBRA are the following:

Eligibility

To be eligible for relief under Subchapter V, a debtor (whether an entity or an individual) must be engaged in business and have total debt, secured and unsecured, not exceeding $2,725,625 (subject to adjustment every three years). In calculating the debt amount, the SBRA does not include "contingent" or "unliquidated" debt. Further, one-half or more of the debt must have arisen from business, as opposed to personal, activities. Finally, single asset real estate debtors are ineligible for relief under Subchapter V.

Appointment of a Trustee

While the debtor will remain in possession of its property as a debtor-in-possession, the United States Trustee, an arm of the United States Department of Justice charged with supervising bankruptcy proceedings, is required to appoint a trustee to oversee the case. This trustee's powers will be far less broad than those of a Chapter 7 trustee or a Chapter 11 trustee. The Subchapter V trustee will have neither "possession" of a debtor's assets nor the ability to sell those assets. Rather, the trustee's duties will include facilitating the development of a consensual reorganization plan, appearing at major hearings in the case, and ensuring that a debtor commences making timely payments under a plan.

Creditors Committee

Unless otherwise ordered by the court, no creditors committee will be formed. This changes existing law, which permits a debtor to file a motion to dispense with the appointment of a committee but does not mandate that no committee will be appointed. As a debtor is generally obligated to pay committee expenses, the appointment of a committee and the resulting of expense of the retention of committee professionals often hinders the debtor's ability to reorganize.

Filing a Plan

The Act provides that only a debtor may file a plan of reorganization. This differs from practice in other Chapter 11 cases where, after applicable periods of a debtor's exclusivity to file a plan have expired, creditors or other parties in interest may file a plan. The Act requires that a plan be filed within 90 days after the entry of an order for relief, subject to extensions under limited circumstances.

Disclosure Statement Not Required

The Act eliminates the requirement that a disclosure statement be filed, thereby reducing costs to the debtor and streamlining the plan confirmation process. However, the debtor must include in the plan certain information customarily included in a disclosure statement, such as a short history of the debtor, a liquidation analysis, and financial projections reflecting the ability of the debtor to make the payments required by the plan.

Plan Term

Consistent with current practice in Chapter 13 cases, a reorganization plan will customarily be three years in length, but may be as long as five.

No Impaired Class Required

Under existing law applicable to all Chapter 11 bankruptcy proceedings, at least one impaired class must accept a plan to render the plan confirmable. A class is impaired if the plan changes the claim holder's legal, equitable, and contractual rights—if, for example, the contractual term or interest rate stated in loan documents is modified. Under the SBRA, a plan can be confirmed without the vote of an impaired accepting class, providing that the plan does not discriminate unfairly and is deemed "fair and equitable" as to each class of claims. To meet the "fair and equitable" requirement under the Bankruptcy Code, the Act requires that all of the debtor's projected disposable income during the length of the plan be applied to plan payments.

The Act defines "disposable income" as income received by a debtor and that is not reasonably necessary to: (1) maintain and support the debtor or a dependent; (2) satisfy domestic support obligations that first become payable after the bankruptcy case is filed; or (3) continue, preserve, or operate the business. This contrasts with other Chapter 11 proceedings, which do not require that all projected disposable income be applied to pay creditor claims.

Elimination of the Absolute Priority Rule

The Act eliminates the Absolute Priority Rule, under which a debtor cannot retain an ownership interest in its assets unless all creditor claims are paid in full. However, courts have held that a debtor can retain an interest in its assets if it contributes "new value," generally in the form of capital, to fund a plan. Under the Act, no "new value" contributions are required as a condition of the debtor's asset retention. This provision substantially benefits a debtor, who often must defend against assertions by a creditor objecting to plan confirmation on the basis that the proposed "new value" is inadequate.

Administrative Claims

Under Chapter 11, all administrative claims (which generally include claims that accrue post-petition and, in limited circumstances, reclamation claims arising from goods shipped to the debtor within 20 days of the bankruptcy filing) must be paid in full as a condition to confirmation. Subchapter V eliminates this requirement, and claims may be paid over time. This provision is of concern to creditors who do business with a debtor post-petition and expect to be paid, if not in the ordinary course of business, then upon plan confirmation, as is currently required in Chapter 11 cases.

Modification of Loans Secured by the Principal Residence

Under existing law, loans secured by a debtor's principal residence may not be modified under a plan. Under the SBRA, if the proceeds of the loan were used to finance a debtor's business, the loan may be modified. The claim of a first position secured creditor who loaned money to a debtor, the proceeds of which were used primarily to acquire the debtor's residence, may not be modified; it continues to have the same protections as in other Chapter 11 cases. Thus, creditors who extend mortgage loans to a debtor must scrutinize how the proceeds will be used, in order to avoid the possibility of an involuntary loan modification in a borrower's bankruptcy case.

Discharge

If the court confirms a consensual plan, a debtor is entitled to a discharge upon confirmation. If the court confirms a nonconsensual plan, a debtor receives a discharge after completing all payments due within the first three years of the plan, unless otherwise ordered. If all such payments are made, the debtor would be relieved of liability except for future payments due under the plan. Exceptions to discharge set forth in Section 523(a) of the Bankruptcy Code apply.

The Act holds the promise of improving the likelihood of reorganization for a viable small business debtor by reducing the time, expense of a proceeding, and eliminating certain legal impediments to confirmation of a Chapter 11 plan. From a creditor perspective, lenders need to consider the provisions of the Act in underwriting loans, given the possibility of loan modifications when loan proceeds are utilized for personal and business purposes. Creditors who sell goods or provide services to a debtor post-petition must be cognizant of the possibility that a debtor may propose an extended payout of their claims. Time will tell whether the changes to be implemented will result in increasing the percentage of small business debtors who successfully emerge from bankruptcy.

As the Act becomes effective this month, debtors and creditors should be aware of their rights under the SBRA.

Melissa A. Peña is a member of Norris McLaughlin in Bridgewater. She chairs the firm's Bankruptcy and Creditors' Rights Group. Bruce J. Wisotsky is a member of the firm, representing debtors and creditors in Chapter 11 and 7 bankruptcy proceedings.