Understanding the Small Business Reorganization Act

The impact of the current COVID-19 pandemic has dealt an unprecedented financial blow to American small businesses. Prior to the crisis, the SBA claims that the 5-year survival rate for small businesses was 50%. Now, half of all small business owners foresee operations ceasing within three months, according to a survey from Goldman Sachs’ 10,000 small business program.

In an effort to avoid a catastrophic downturn in the American economy, the U.S. government passed the C.A.R.E.S act, providing $349 Billion in loans to small businesses through the EIDL and PPP. However, only 5.7% of U.S. businesses received loans in the first PPP round, despite a 65% application rate according to Lending Tree.

Although relief through government loans has eluded many small business owners, the passage of the Small Business Reorganization Act (SBRA) provides an alternative aide to businesses facing insolvency. The Act was originally signed into law on August 23rd, 2019 and went into effect on February 20th 2020, coinciding with the beginnings of COVID-19’s widespread impact in the United States.

The SBRA is intended to allow insolvent small businesses the chance to avoid liquidation via Chapter 7 bankruptcy. Instead, it amends Chapter 11 of the United States Bankruptcy Code to create a more efficient process for businesses to restructure their debts.

Before the SBRA, Chapter 11 bankruptcies were a costly and cumbersome process. It required the debtor to implement a plan for reorganization subject to extensive regulation, a requirement occasionally transferred to the creditors. A creditor committee was then needed to approve of the plan, whose associated costs were assumed by the debtor. Additionally, quarterly payment for a required U.S. Trustee overseer could reach thousands of dollars. Naturally, many small businesses were unable to afford the time and cost commitment of a Chapter 11 bankruptcy and were forced to liquidate via Chapter 7.

The SBRA seeks to remedy the barriers and costs associated with a Chapter 11 filing. Insolvent businesses can now file via Chapter 11, Subchapter V, which is subject to much fewer rules and regulations. When the SBRA was originally signed into law, a business qualified if their total debts amounted to less than $2,725,625, with at least 50% of these debts arising from business activity. The C.A.R.E.S act increased this debt ceiling to $7,500,000, allowing more small businesses to qualify.

Subchapter V streamlines the filing process by:

• Removal of the Need for a Creditor Committee — Allowing the debtor avoidance of the costs associated with the activities of the Committee, as well as reducing the time needed for plan approval.
• Lessens the Involvement of the U.S. Trustee — Although the appointment of a Trustee is still required by Subsection V, he or she will have a more passive role in the filing process. Rather than acting as an overseer, the Trustee will provide guidance on the reorganization plan. Additionally, the debtor is no longer required to pay for the Trustee’s services.
• Allowing solely the debtor to create the reorganization plan The plan must be proposed within 90 days of the bankruptcy filing.
• Removal of the Absolute Priority Rule — Before the SBRA, the debtor had no say in which of its creditors and shareholders were prioritized for repayment. Instead, repayment followed a set “liquidation preference” beginning with secured creditors, flowing to unsecured creditors, with the remainder to equity holders. As part of the Absolute Priority Rule, debtors were only allowed to keep ownership interest in their company if their reorganization plan included a 100% payout to unsecured creditors. The amendment to Chapter 11 removes this rule, allowing business owners to keep ownership in their company, even if they cannot guarantee full repayment to all creditors.

The implementation of the SBRA is a welcome coincidence with the COVID-19 pandemic and subsequent economic shutdown. It provides an additional safety net available to small businesses, without the limitations of government loans.

Here at GrowthLab Financial Services, we have over 10 years of experience helping customers restructure their debts to turnaround ailing businesses. Although the SBRA allows you more control over your Chapter 11 filing, it is still important to tackle your reorganization plan thoughtfully and pragmatically. GrowthLab will act as a guide throughout this process, helping you dive deep into your business’s financials, operations, and accounting to discover its core competencies and limitations. We will create an organized and realistic cash flow plan, allowing you to manage repayment to creditors and get your business back on track. Even with looser guidelines, filing for bankruptcy can still be a confusing and overwhelming process. GrowthLab will work with you to craft an effective go-forward plan for your company.

If you liked this post, you can learn more about the topic from GrowthLab Financial’s latest Podcast “All About the Business Recovery Plan”.

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