By Kirk B. Burkley and Lara S. Martin –
Most lawyers and business owners are not familiar with the bankruptcy process. Many think of bankruptcy as being utilized only by large corporations or just for individuals. The bankruptcy process however can be advantageous for small businesses and the filing dependent on the particulars of each business. The bankruptcy process allows a business to bring all debt issues into one forum which allows for a faster resolution to benefit not only the business but also its creditors.
Additionally, the enactment of the Small Business Reorganization Act of 2019 (SBRA) has broadened and streamlined the process for small businesses to file under Chapter 11 in a newly created Subchapter V. Chapter 11 is commonly known as the chapter under which large companies, like Sears or General Motors, file for bankruptcy and sell their assets or reorganize the business. The SBRA’s newly created Subchapter V qualifies more small businesses to file for protection and quickly reorganize. Subchapter V was also subsequently expanded in March 2020 as a result of the pandemic’s economic impact to allow even more businesses to qualify. Currently, the requirements for a Subchapter V debtor include that the debtor must be pursuing business activities and have debt that does not exceed $7.5 million, and that debt cannot include those owed to company insiders. At least 50% of the debt must come from business activities and single-asset real estate debtors are not eligible.
Both Chapter 11 and Subchapter V of Chapter 11 provide benefits for small and mid-size businesses in bankruptcy. The purpose of bankruptcy is to provide businesses a little breathing room to reorganize their affairs or sell assets in an organized fashion in order to save jobs and maximize value for creditors. The effect of Subchapter V is to streamline the process even more for small companies that meet certain thresholds and is intended to get small business debtor’s in and out of bankruptcy faster and thus with reduced expenses. One of the key components of this is the appointment of a Subchapter V Trustee who is primarily tasked with facilitating the development of a consensual plan of reorganization and thereafter making the plan payments. The process is meant to be much faster than a traditional Chapter 11 as evidenced by the requirement that the debtor must file a plan of reorganization not later than 90 days after the filing. In a traditional Chapter 11, there is no mandatory deadline to file a plan and a debtor’s “exclusive” period to file a plan is often extended. The debtor’s “exclusivity period” means the debtor’s exclusive right to confirm a plan, once this has expired, any party-in-interest may file a plan. Significantly, in a Subchapter V case, no creditor is permitted to file a competing plan.
Further, unlike a traditional Chapter 11 plan, a Subchapter V plan may be approved by the court even if no class of creditors accepts it and the existing owners can continue to own and manage their businesses even where all creditors vote against the plan or owners who can’t contribute new capital to the company (provided however the plan does not discriminate unfairly and is fair and equitable).
Small business owners should also know about some of the general advantages to filing for bankruptcy protection. Many small to mid-size businesses find significant value in their ability to assume or reject unexpired contracts and/or leases in bankruptcy. If a lease or contract is assumed, the debtor must cure any default. But the debtor can also shed itself of unprofitable contracts or leases. If the debtor chooses to reject the lease, it is treated as a pre-filing breach and damages are treated as unsecured claims that may be discharged in the bankruptcy or paid a percentage of the debt. This process is helpful for a debtor if it has a burdensome lease it needs to get out but can’t. Rejection of a contract allows the debtor to stop performing under the contract and focus on more profitable endeavors. Likewise, the debtor can reject any collective bargaining agreements during its filing which is particularly helpful if the debtor has a collective bargaining agreement that is contributing to financial distress. The Bankruptcy Code has a specific section to address the treatment of collective bargaining agreements and allows for their rejection and renegotiation if the company can prove that the rejection is necessary for reorganization.
Additionally, small businesses can restructure their secured debt by modifying terms and stretching payments over time. If a loan is maturing, bankruptcy can provide a path to force an extended or re-amortized repayment period. Lenders may also benefit in that they are involved in an open and transparent process and discussions which benefits both parties in having the debtor be able to repay the debt. Many lenders see a benefit to a clear final resolution of their debt and ahead of unsecured creditors that might otherwise be applying pressure on the debtor to get paid outside of bankruptcy. During the course of the bankruptcy process, the business maintains ordinary operations and has time to assess how to more efficiently operate, maximize profit and rehabilitate. This is particularly important when a business has onerous pending litigation, burdensome contracts and/or needs time to strategize and reconfigure or reorganize its operations or structure while benefitting from the protection of the automatic stay (which prevents creditors from attempting to start or continue taking actions against the debtor or its property).
Burkley is Managing Partner at Bernstein-Burkley, P.C. He is experienced in representing secured and unsecured creditors in bankruptcy, financial restructuring, and workout situations, including the representation of numerous unsecured creditors’ committees, equipment lessors, financial institutions, and commercial landlords. Martin is an associate attorney at Bernstein-Burkley, P.C. with expertise in commercial bankruptcy, corporate and nonprofit consulting, and mediation, she represents businesses, corporate debtors, financial institutions, non-profit organizations, and secured and unsecured creditors in commercial, corporate, credit, and litigation matters. Please contact us with questions or for additional information.