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COVID-19 Stimulus Legislation Aims to Make Chapter 11 Easier for Many More Small Businesses

On March 27, 2020, President Trump signed into law the Coronavirus Aid, Relief and Economic Security Act (CARES Act), a Senate bill passed just days earlier in response to the public health crisis that has emerged from the spread of COVID-19. The CARES Act significantly raises the debt ceiling for chapter 11 debtors to elect to proceed under the Small Business Reorganization Act of 2019 (SBRA) from $2,725,625 to $7,500,000.

By way of background, the SBRA was signed into law by the President on August 26, 2019, and became effective on February 19, 2020. It offers substantial benefits to chapter 11 debtors who are eligible and is intended to make the bankruptcy process quicker and more efficient by eliminating a number of costly and long-standing chapter 11 requirements.

The benefits of filing a chapter 11 case under the new SBRA include: (1) there is generally no creditors’ committee which decreases costs; (2) creditors cannot file competing plans; (3) a separate disclosure statement is not required; (3) payment of quarterly fees to the Office of the U.S. Trustee is not required; (4) the so-called ‘new value requirement’ which requires equity holders to contribute something to the bankruptcy estate in order to retain equity is waived; (5) the requirement that the plan has at least one impaired consenting class is waived; and (6) a debtor no longer must pay all post-petition administrative expense claims on the plan’s effective date and may instead stretch payments out over three to five years.

While the SBRA has only been law for a little over a month, practitioners expect it to achieve Congress’ stated goal of making chapter 11 reorganizations cheaper and easier for struggling small businesses. Notwithstanding the significant benefits the SBRA provides to distressed businesses, however, there had been criticism that the debt limit of $2,725,625 was too low and thereby failed to help many small family-run businesses, especially in major cities and population centers. Thus, the decision to raise the SBRA debt limit to $7.5 million as part of the CARES Act is a major change to existing law and is expected to substantially increase the number of Debtors eligible for the new SBRA.

There is a catch, though. The increased debt limit under the CARES Act will only apply to cases filed on or after March 27, 2020, and, further, one year after the enactment the debt limit reverts back to $2,725,625. As such, while the SBRA was silent as to whether or not it applied to cases commenced before the law went into effect on February 19, 2020,[1] the CARES Act is clear that the increased debt limit is truly an emergency measure directed at the COVID-19 crisis and will only apply to cases filed during the year after it becomes law.

In light of the substantial disruptions wrought by COVID-19, distressed businesses should consider the benefits of a reorganization under the SBRA and, at least for the year, it seems many more small and even mid-sized companies may be eligible to reorganize under the SBRA.

[1] At least one decision has held that the SBRA does apply to cases filed prior to it becoming law. See In re Progressive Solutions, Inc., 2020 WL 975464 (Bankr. CD CA February 21, 2020) (“[T]his Court has found no legal reason to restrict a pending Chapter 11 case to redesignate to a Subchapter V case….”).

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