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Small Business Bankruptcy and Covid-19

The ongoing COVID-19 pandemic and the emergency orders and guidelines issued by Federal, State and local governments have had a particularly devastating impact on small businesses faced with declining revenue and a steady onslaught of bills. As these businesses begin the process of reopening, it could take some time before revenues get back to “normal.” In the meantime, businesses may not have sufficient cash or liquidity to pay all the old bills that accumulated during the downturn plus all the new bills that continue to become due on an ongoing basis. As the owner or operator of a small business you do have options, but it is important to seek guidance from an attorney experienced with both bankruptcy and out-of-court workouts to help weather this storm.

Even when an out-of-court workout is the preferred alternative, a thorough understanding of the Federal Bankruptcy Code is one of the tools necessary for small business owners to negotiate favorable terms for their out-of-court workouts with landlords, suppliers and other creditors. Moreover, in those situations where some creditors simply won’t cooperate, a deep understanding of bankruptcy law is essential to a small business both obtaining the breathing space necessary to get back on it’s feet and evaluating available restructure alternatives that can be enforced against uncooperative creditors through the power of the bankruptcy courts.

Broadly speaking, there are two types of bankruptcy relief available to small business, i.e., liquidation and restructure. Liquidation is available to both large and small businesses under either chapter 7 or chapter 11 of the bankruptcy code, but a reorganization or restructure is available only under chapter 11.

Chapter 7

Under chapter 7, the business files its voluntary bankruptcy petition and a number of statements and schedules providing information about the business, including its assets, liabilities, creditors and financial condition. The court appoints a chapter 7 trustee who is charged with such duties as reviewing the company’s assets, liabilities and financial condition, collecting and liquidating any unencumbered assets that might exist, and disbursing available funds (if any) to creditors on the basis of the priority system established under the bankruptcy code. Chapter 7 is not an option if the owner of a small business wants it to continue operations, retain control of its assets, and survive bankruptcy. If a small business owner has decided not to continue the business, then one alternative is to file a chapter 7 case, but there are number of other options available and pros and cons to each, so it is important to discuss available alternatives with an experienced bankruptcy attorney before filing chapter 7 or simply “throwing in the towel” and walking away.

Chapter 11

Under chapter 11, the business retains control of its operations, decides which assets to keep or liquidate, and restructures its debts through a court-approved plan of reorganization. Historically, even though the business retains control in a chapter 11, it is subjected to increased oversight and confirming a plan of reorganization has been a time consuming and expensive process. As a result, few small businesses typically succeeded in obtaining a court order approving their traditional chapter 11 plan. However, the bankruptcy code recently was amended by the Small Business Reorganization Act of 2019 (SBRA), which became effective February 19, 2020 and attempts to strike a balance for qualified “small businesses” between chapter 7 and chapter 11, lowers the cost and streamlines the process of confirming a plan of reorganization, and better enables “small businesses” to continue operations, retain control of their assets, and successfully emerge from chapter 11 bankruptcy. If you operate a small business that is struggling with a downturn in revenue or an increase in debt, whether due to CoVid-19 or otherwise, the SBRA might be the perfect vehicle to help you get some breathing space, survive difficult times and get back to “normal.”

In order for a business to qualify for the streamlined chapter 11 provisions of SBRA, it must fall within the definition of a “small business debtor” and also affirmatively elect in a timely fashion to have the provisions of SBRA applied to its chapter 11 case. SBRA defines a “small business debtor” as a business (whether a sole proprietor, partnership, corporation, limited liability company or other entity) that is engaged in commercial or business activity (other than owning single asset real estate) and, together with any affiliates that also have filed bankruptcy, has a total of not more $7,500,000 ($2,725,625 for cases filed after March 26, 2021) in liquidated, non-contingent, secured and unsecured debt (excluding debts to owners and other insiders) at least 50% of which arose from the commercial or business activities of the debtor.

Benefits

One of the primary benefits of filing for bankruptcy protection under either chapter 7 or chapter 11 is the automatic stay. As the name implies, the automatic stay takes effect immediately upon filing the case and without the necessity of any action by the court. Among other things, it prohibits creditors from filing lawsuits, seizing or foreclosing upon collateral (whether real estate, inventory, equipment, cash or other property), or taking most other actions to demand, determine or collect a debt, or otherwise enforce rights under applicable State and other non-bankruptcy laws. While the automatic stay is in effect, the business has the breathing room to continue operating without the threat or distraction of demands, lawsuits, seizures or other debt collection activities.

Under its small business chapter 11 plan, a small business debtor could be allowed, for example, to pay past due rent and other bills over a period of time rather than all at once. In addition, a small business debtor could be permitted to stretch tax payments out over time, to reject leases or other executory contracts that are financially unfavorable, to bifurcate into secured and unsecured claims the claims of creditors whose collateral has decreased in value and treat those secured and unsecured claims differently, to pay unsecured creditors less than the full amount of their claim, and to otherwise modify the rights of its creditors.

Other benefits of the new small business bankruptcy provisions of SBRA are the ability in most situations to avoid the time consuming and expensive process of preparing and obtaining court approval of an extensive disclosure statement, and the elimination of quarterly U.S. Trustee fees, both of which are required in traditional chapter 11 cases. In addition, the contents required for a small business plan of reorganization are less strict and creditors generally are not allowed to file their own plan, which saves small business debtors the time and expense of litigating with creditors proposing a competing plan. Perhaps most important, however, are the relaxed restrictions for plan confirmation. In traditional chapter 11 cases, stockholders or other business owners often cannot retain their ownership interest without either the consent of creditors or extensive and expensive litigation and the injection of additional funds or other new value into the business. Under the SBRA, however, a small business debtor can retain their ownership interest in the business as long as the plan does not “discriminate unfairly” and is “fair and equitable” and, generally speaking, the plan can be confirmed by the bankruptcy court if it provides that all projected disposable income over three to five years will be used to make plan payments.

As a result of the modifications to chapter 11 made by SBRA in an effort to make it a more available and promising alternative for small business, the chances of a small business debtor confirming a chapter 11 plan and emerging from bankruptcy as a vibrant and viable business have increased significantly. However, there are many potential traps and pitfalls for those unfamiliar with the process. If you would like assistance from one of our experienced attorneys, we are here to help and you can contact Dave Levy at dlevy@levyzeewy.com or (678) 281-3000 (x207).

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