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Understanding the New Small Business Reorganization Act

October 29, 2020, 05:00 AM

With COVID-19 and the differing attempts by state and local government to contain its spread by various regulations, smaller companies in almost every industry have been negatively affected by state regulations. As a result, some companies impacted by these COVID-19 regulations may find themselves on the brink of insolvency.

Until recently, there have been two chapters of the bankruptcy code for the use of insolvent companies: Chapter 11 and Chapter 7. Chapter 11 was designed for the restructuring of companies that have a future business. Chapter 7 is designed for the liquidation of companies without a projected future due to market forces or excessive debt.

For a smaller company, the Chapter 11 process is often far too expensive. It requires a source of significant cash and a plan that has been worked out far in advance. Chapter 11 professional fees can begin at $100,000 and for a mid-sized company can become five times that figure. Most financially distressed small and mid-size companies have neither the cash to support the fees nor have done the planning.

In August 2019, Congress created The Chapter V subsection of Chapter 11. Known as the SBRA or Small Business Reorganization Act, it is designed to let smaller companies take advantage of bankruptcy restructuring laws in a way that is both faster and less expensive.

To be eligible for Subchapter V, a debtor must be engaged in a commercial activity and its total debts must be less than $2,725,625. The new CARES Act has temporarily (for one year) expanded that debt level to $7,500,000. This increase allows larger companies to take advantage of Chapter V. Upon filing its bankruptcy petition, the Chapter V debtor must also file a balance sheet, statement of operations, cash flow statement and federal tax returns.

The court will appoint a trustee. The Subchapter V trustee does not take possession of a debtor’s assets and lacks the ability to sell those assets. The trustee is more like an advisor and handler who facilitates the development of a consensual reorganization plan, appears at hearings and ensures the debtor makes timely payments under the plan. The debtor must also pay the trustee.

The Chapter V process moves at light speed by traditional Chapter 11 standards. The court will hold a status conference within 60 days. At least 14 days prior to that conference, the debtor must report, in writing, the efforts made and to be made to obtain a consensual plan. The debtor, and only the debtor, must file its plan of reorganization within 90 days of the filing. The plan must include a brief history of the business operation, a liquidation analysis and financial projections demonstrating the ability of the debtor to make the proposed plan payments.

To get a plan confirmed in Chapter V does not require acceptance by creditors. It must not discriminate unfairly and must be fair and equitable. Creditors must receive as much as they would if the debtor were liquidated in Chapter 7. Subchapter V includes an option for the debtor to contribute all “projected disposable income” to making plan payments for three to five years. Projected disposable income is everything after expenses to maintain and support the debtor and expenses necessary for business operations. This provides an advantage to creditors to whom the debtor owes money and doesn’t have the ability for immediate payment, but is projected to have the funds over the life of the plan.

To confirm a plan, the court must find that the debtor will be able to make the payments ordered under the plan or there is, at least, a reasonable likelihood the debtor will be able to make the payments under the plan, and the plan has appropriate remedies to protect the creditors if payments are not made as proposed.

The SBRA contains many other provisions. A debtor’s attorney and the trustee can help ensure that the filing and plan are compliant with Subchapter V.

Al Davis
Principal | Revitalization Partners
A Principal at Seattle-based Revitalization Partners, Al Davis has served as CEO, President, Chief Restructuring Officer, Court Appointed Receiver and Management Advisor for numerous public and private companies. He has provided significant returns to both creditors and stakeholders in such diverse industries as high technology, real estate, media and broadcasting, consumer products, wholesale and retail distribution, wood products and professional services.

In addition, Davis has raised over $100 million in venture capital and private equity, and structured and executed multiple domestic and international M&A transactions. As a partner in venture and private equity funds, he has been responsible for guidance and interim management of several of the funds’ investments.

Among his professional milestones: reversing a substantial revenue decline at Advanced Interactive Systems; serving as General Manager of Intel’s Software Distribution and Support Operation; Director of Worldwide Marketing for Intel’s Microprocessor Division: General Manager for a technology division of Litton Industries; and Sales Manager for Digital Equipment Corporation. He holds an MBA from Pepperdine University and a B.S. in Electrical Engineering from University of Southern California. He serves on the advisory board of Western Governors University of Washington.
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