Last month, Congress reintroduced the Small Business Reorganization Act (“SBRA”), under which a new subchapter V would be added to chapter 11 of the United States Bankruptcy Code.  This new subchapter would provide small businesses with aggregate liabilities that do not exceed $2,566,050 with an opportunity to resolve outstanding liabilities through a streamlined and cost‑effective chapter 11 bankruptcy proceeding.  The SBRA also offers small business owners the opportunity to preserve their ownership interest in the company, unlike state and federal receiverships or assignments for the benefit of creditors which typically result in the company’s liquidation.  Under the SBRA, with proper planning and execution, a small business can successfully emerge from bankruptcy within several months with a court-approved plan of reorganization.  In short, the immense benefits offered to businesses that file chapter 11 bankruptcies will soon no longer be reserved for only large, well-known companies.

New Chapter 11 Opportunity for Small Businesses

Established companies that find themselves financially or operationally distressed may decide to file a voluntary petition in a United States bankruptcy court to initiate a chapter 11 proceeding.  During the bankruptcy case, the company may institute a number of strategies to, among other things, right-size its balance sheet, reduce its outstanding liabilities, renegotiate its funded debt, improve certain lease and contract terms, and auction off all or a portion of its assets, all while its creditors are barred from initiating or continuing any actions against the company to try to collect their debts.  Many chapter 11 bankruptcy cases culminate with the company confirming a plan of reorganization, which allows the company to exit bankruptcy on stronger footing.  To pay for such a substantial undertaking, at the beginning of the case the company will normally obtain debtor-in-possession financing that includes sufficient funds to pay the company’s bankruptcy professionals.

This is the picture through rose-colored glasses.  For the majority of smaller companies, the burdensome and expensive chapter 11 process can quickly shatter the illusion of reaping the same chapter 11 benefits.  However, on April 9, 2019, six members of the Senate Judiciary Committee reintroduced the SBRA, which was initially introduced on November 29, 2018, and sponsored by Representative Doug Collins and Senate Judiciary Committee Chairman Chuck Grassley.  The SBRA is designed to “take into account the unique needs of small businesses and streamline[] existing reorganization processes.”^[1]  If the SBRA is enacted, a small business would have the opportunity to restructure and exit chapter 11 bankruptcy at significantly reduced costs.

Standing Trustee

To ensure that the small business’s reorganization stays on track, the SBRA requires that a “standing trustee” be appointed during the chapter 11 case and remain throughout the plan of reorganization payment period.  The standing trustee has a number of duties, some of which include:

• accounting for all of the property received by the company;
• examining and rejecting any claims against the company;
• conducting a review of the company’s financial condition and business operations;
• reporting any fraud or misconduct to the bankruptcy court;
• appearing at the status conference and materially significant hearings;
• producing a final report of the case for the bankruptcy court;
• assisting, as necessary, the facilitation of a plan of reorganization;
• distributing certain company property in accordance with the plan of reorganization; and
• confirming the company’s adherence to the court-approved plan of reorganization during the payment period.

The company is responsible for paying any fees owed to the standing trustee during the plan’s payment period.  Once the company has concluded making all of its necessary payments under the plan of reorganization, the standing trustee’s services will be terminated.

Retain Ownership

Within the first week of filing for chapter 11, the small business is required to file certain financial documents and statements with the bankruptcy court, along with periodic financial updates throughout the case.  During the chapter 11 proceeding, the company’s management will have the right to continue operating the business, but may be removed for cause, including fraud, dishonesty, incompetence, or gross mismanagement of the company’s affairs.

Additionally, after the bankruptcy court approves the company’s plan of reorganization, so long as “the plan does not discriminate unfairly, and is fair and equitable,” the company will remain in possession of “all property of the estate.”  “[A]ll property of the estate” includes all of the property owned by the company before it filed for bankruptcy, and any property acquired by the company after filing, including earnings received from services.

There are two ways for a company to comply with the “fair and equitable” requirement in the SBRA.  The first option is for the company’s advisors to identify the company’s “disposable income,” meaning income that is not used to maintain and support the company or pay the company’s necessary expenses.  Thereafter, the plan of reorganization must explain how the disposable income will be distributed to the standing trustee during a three- to five‑year period in order to effectuate payments to creditors under the plan of reorganization.  Alternatively, the second option is for the plan of reorganization to require the company to distribute some or all of its property to the standing trustee for the benefit of its creditors.  The plan must demonstrate that such property “is not less” than the projected disposable income during the company’s next three- to five-years.  Of significance, if circumstances change for the company after the plan of reorganization is confirmed by the bankruptcy court, after notice and a hearing, the plan may be modified by the company.

In summary, the SBRA gives small business operators the ability to maintain their ownership interests.  But in exchange, small businesses must pay certain parties-in-interest for a period of three to five years pursuant to a court-confirmed plan of reorganization.

Condensed Chapter 11 Timeline and Substantially Reduced Expenses

Chapter 11 cases commonly take several months, if not years, to complete.  The SBRA proposes to condense the bankruptcy timeline to reduce the small business’s expenses.  For example, no later than 60 days after filing for bankruptcy, the bankruptcy court will hold a status conference “to further the expeditious and economical resolution of [the] case.”  No later than 14 days before the status conference, the company’s counsel is required to file a report that details the steps the company and its advisors have taken to attain a consensual plan of reorganization.

Moreover, unless the company requests an extension related to circumstances outside the company’s control, the plan of reorganization must be filed with the bankruptcy court no later than 90 days after filing for chapter 11 protection.  This 90-day window provides the company with the opportunity to collaborate with creditors and other parties-in-interest in order to reach a consensual agreement.  The 90-day period also provides the small business’s advisors with an ample amount of time to draft the plan, which is required to include the history of the company, financial analyses and projections, and a breakdown of how the company’s property and/or future earnings and income will be transferred to the standing trustee to execute the plan.  This information is normally included in a disclosure statement; however, the SBRA allows a small business to avoid the substantial costs and expenses attendant with preparing and seeking court-approval of a disclosure statement before plan approval is solicited

Once the company completes all of its mandatory payments according to the plan of reorganization, the bankruptcy court will discharge all of the company’s debts.  Thus, the reward for a company that complies with its payment plan is to be granted a clean slate free from prior financial encumbrances.

Next Steps

When the SBRA was first introduced in late 2018, it was referred to the House Committee on the Judiciary and the Senate Judiciary Committee.  Congress has not yet passed the SBRA.  But as a bipartisan, bicameral bill that was developed with the assistance of, among others, the National Bankruptcy Conference, American Bankruptcy Institute, and National Conference of Bankruptcy Judges, proponents of the SBRA are hopeful that the bill will soon be passed and signed into law.

The Restructuring & Insolvency Practice Group at Squire Patton Boggs will continue to monitor developments and opportunities for small businesses to utilize the protections under the SBRA.

[1] Chuck Grassley, U.S. Senator for Iowa, Chairman of the Senate Judiciary Committee, Grassley, Bipartisan Colleagues Introduce Legislation to Help Small Businesses Restructure Debt (Apr. 9, 2019); S. 1091, 116th Cong. (2019); S. 3689, 115th Cong. (2018); H.R. 7190, 115th Cong. (2018).