With the recent enactment of new small business bankruptcy provisions, and the expanded eligibility signed into law on March 27, 2020, the question is whether those otherwise eligible business debtors that are already in bankruptcy can take advantage of those provisions?  It appears that the answer may be that they can.

The Small Business Reorganization Act of 2019 (H.R. 3311, “SBRA”) became law on August 23, 2019 and took effect six weeks ago, on February 19, 2020.  The SBRA enacted a new Subchapter V of Chapter 11, containing several cost-effective and streamlined provisions for individual and entity[1] debtors with less than $2,725,625 in noncontingent, liquidated secured and unsecured debts.  Pursuant to SBRA, Subchapter V is a voluntary process, which includes the appointment of a trustee whose primary function is to attempt to reach a consensual plan of reorganization.  Another significant provision of the SBRA is the elimination of the absolute priority rule, which otherwise prohibits business owners from remaining as owners unless they either pay all creditors in full or contribute sufficient additional funds to the business.  The elimination of this rule makes it simpler and much less expensive for business owners to restructure and retain their businesses in bankruptcy.

On March 27, 2020, the “Coronavirus Aid, Relief, and Economic Security Act” (the “CARES Act”), was signed into law, increasing the eligibility cap under Subchapter V to $7.5 million for the next year, thus significantly expanding the number of eligible debtors.  It is expected that this larger cap will provide access to much-needed relief for businesses hard hit by the current pandemic.

In order to take advantage of the Subchapter V provisions, a debtor need only elect to participate by stating in the petition that it is a small business debtor[2] that elects application of Subchapter V.  See Interim Bankruptcy Rule 1020(a).  At that point, the case proceeds under Subchapter V in accordance with that election, unless and until the Court enters an order to the contrary.  Parties have until 30 days after the later of the conclusion of the meeting of creditors or amendment of the statement to object to the debtor’s statement that it is a small business debtor.

What about those debtors who are otherwise eligible under the revised definition of “small business debtor,” but filed petitions before the effective date of the SBRA?  So far, court decisions addressing this question have permitted the debtors to amend their petitions and proceed under Subchapter V, so long as doing so does not constitute an impermissible taking of property rights from the other parties in the case.

In the February 21, 2020 decision In re Progressive Solutions, Inc., 2020 Bankr. LEXIS 467 (Bankr. C.D. Calif. 2020), the debtor, which had filed a petition on November 21, 2018 under the prior small business provisions (as distinguished from Subchapter V adopted by the SBRA), filed a motion for authority to file an amended petition with the SBRA election.  The Court began it analysis with a review of the fast, bipartisan enactment of SBRA with minimal debate and amendment, and the limited legislative history emphasizing the need for timely, cost-effective bankruptcy relief for the benefit of small business owners and their employees, suppliers, customers and others who rely on those businesses.  Id. at *3-8.  The Court then noted that SBRA does not contain any limitation on applying it to pending cases, and recognized other decisions applying other changes in law, such as those increasing U.S. Trustee fees, to pending cases.  Id. at *9.  The Court next considered whether any creditor had vested rights as a result of prior rulings in the case that would be disturbed by application of Subchapter V, and concluded there were none.  Id. at *9-10.  The U.S. Trustee’s office raised valid procedural issues arising from the SBRA designation in a pending case, particularly as to schedules and deadlines, including having timely initial debtor interviews and meeting of creditors, but recognized that the Court had the power to extend those deadlines as necessary in order to provide due process.  Id. at *10-12.  In viewing the debtor’s motion favorably, the Court emphasized that it “is not unmindful of the additional efforts the [U.S. Trustee], the newly appointed Subchapter V Trustee, the creditors, or this Court might have to undertake to administer a re-designated Subchapter V case.”  Id. at *12-13.  The Court continued: “But, the whole, the entire whole, of the legislative history and statements of Congress teaches the Court that the primary purpose of the SBRA is to promote successful reorganizations using the tools that are now available under current law.”  Id. at *13.  However, in an interesting twist, the Court did not grant the motion because it was unnecessary under the rules, since Bankruptcy Rule 1009 permits debtors to amend their petitions without motion.  Id. at *14-15.  No doubt the Court spent the time on the opinion to let the parties know that any objection by creditors to the debtor’s amended petition and election under Subchapter V probably would not be favorably viewed.

Just a week later, the decision In re Moore Props. Of Person Cty., LLC, 2020 Bankr. LEXIS 550 (Bankr. M.D.N.C. 2020) was issued.  In that case, the debtor filed a voluntary petition and stated it was a small business debtor on February 10, 2020, prior to the effective date of the SBRA.  Id. at *2.  Five days after the effective date, the debtor filed an amended petition, still designating itself as a small business and electing to proceed under Subchapter V.  In connection with an objection by the bankruptcy administrator, the parties presented the Court with two questions: (1) may a debtor with a pending case elect to proceed under Subchapter V, and (2) is the debtor, who did not meet the small business debtor definition on the petition date, eligible to proceed under the SBRA when it now meets the definition?[3]  Id. at *4. The Court disagreed with this framework, saying that the real issue is whether the new Subchapter V provisions can be applied to the parties’ pre-existing contractual and property rights and expectations.  Id. at *5-6.  After reviewing rules regarding retroactive application of new statutes, the Court recognized that there is a difference between the permissibility of applying new provisions to modify contract rights, and a prohibition against taking private property without just compensation.  Id. at *7-9.  Applying Subchapter V to the case before the Court presented none of the taking or retroactivity concerns expressed in applicable law.  Id. at *9-10.  The Court carefully reviewed the differences between confirming a plan under chapter 11 versus confirming a plan under Subchapter V, and concluded that none of Subchapter V’s changes to confirmation amount to an impermissible retroactive taking.  Id. at *11.  Conceivably, a case that had been pending for an extended period of time could have been sufficiently advanced that the plan confirmation revisions amount to a taking of vested property rights, but that was not the situation before the Court and so there was no prohibition against its application.  Id. at *11-12.  The Court then recognized that debtor had made a small business designation in its original filing, and since there had been no determination that the designation was incorrect (although it was incorrect under pre-SBRA law), that designation controlled until the hearing.  As of the hearing date, which was after the effective date of the SBRA, the Court properly applied the law then in effect (i.e., the SBRA) to conclude that the debtor was properly a small business debtor under SBRA and so could make the Subchapter V election its amended petition.

Finally, on March 27, 2020, the decision In re Bello, 2020 Bankr. LEXIS 813 (Bankr. E.D. Mich. 2020) was issued.  In that case, the debtor was an individual who had filed a chapter 13 petition[4] on May 3, 2019, four months before SBRA was enacted and more than nine months before its effective date.  Id. at *1.  On December 27, 2019, the debtor filed a motion to convert the case to chapter 11, which was granted on January 15, 2020.  Id. On March 2, 2020, the debtor filed an amended voluntary petition under chapter 11, electing the Subchapter V provisions.  Id.  On March 9, 2020, the Court issued a “Show-Cause Order,” directing the debtor to show cause why the SBRA may be applicable and giving the U.S. Trustee and the creditors an opportunity to respond.  Id. at *2.  The Court reviewed the responses of the debtor, the U.S. Trustee and a creditor, and concluded that the case could proceed under Subchapter V.  Id. at *3.  The Court was particularly persuaded by the Court’s reasoning and holding in Moore Properties, and concluded that such reasoning was applicable to the early, pre-confirmation case before it.  Id. The Show-Cause was thus dissolved, and the case is proceeding under Subchapter V.  It is interesting that the Court did not discuss whether the lengthy chapter 13 period impacted that analysis at all, though presumably that is because the propriety of converting from chapter 13 to chapter 11 had previously been addressed.

Takeaway:  Particularly with the increased cap on debt for SBRA eligibility under the CARES Act, it may be worthwhile to consider whether an amended petition electing the Subchapter V provisions should be filed for those debtors who are now otherwise eligible under Subchapter V.  Doing so may well be permitted in most cases, and could provide debtor with a better opportunity to restructure and retain their businesses for the benefit of employees, vendors, owners and others who rely upon them.

Note: Legislative and other responses to the current pandemic are rapidly changing.  This content is current as of the date hereof, but may well change as things proceed.

Patricia B. Fugée

Cleveland/Columbus/Detroit offices

27100 Oakmead Drive, #306

Perrysburg, OH 43551

Office: (419) 874-6859

email:  [email protected]

 

 

[1] For either an individual or an entity, at least 50% of the debt must arise from the commercial or business activities of the debtor.  11 U.S.C. § 101(51D)(A).

[2] It should be noted that prior to enactment of the SBRA, the Code did define a “small business debtor” and contained certain provisions specific to small business debtor bankruptcies.  Those provisions largely remain intact, with some changes to the definition of “small business debtor” and the additional provisions of Subchapter V acting as a voluntary program for those debtors that qualify.

[3] The debtor did not meet the prior definition of small business debtor because it was primarily in the business of owning and leasing real property.  Id. at *14.  Under SBRA, the definition was revised to exclude only those owners of real property that constitute “single asset real estate” cases under the Code; since the debtor owned more than one separate property, it was eligible as a small business debtor under the SBRA.  Id. at *16.

[4] Chapter 13 is the individual reorganization section of the Code, where eligible individuals commit their net income to paying creditors over a certain period of time.