There are many forms of reorganization and bankruptcy, but not all are available to – or make sense for – small businesses. Due to recent changes in the law, however, a Chapter 11 reorganization, which used to be somewhat challenging to access for many small businesses, has become much more accessible.
Here, we discuss what a Chapter 11 reorganization is, the benefits of one to a small business, and the beneficial changes in the law that have recently been made.
What is a Chapter 11 Reorganization, and What are its Potential Benefits?
In short, a Chapter 11 reorganization is a process that enables a business to reorganize and continue to operate despite financial struggles. More specifically, a Chapter 11 filing provides for the following:
- Automatic Stay Protection: The automatic stay is a bankruptcy law mechanism that forecloses creditors from collecting on the small business debtor’s debts. Litigation is put on hold, lenders cannot proceed with foreclosures, and sales of business assets are also put on hold.
- Rejection of Unfavorable Contracts: A small business debtor can reject unfavorable contracts, such as a rental lease, allowing him or her to leave a rental location with above-market rent that is no longer financially feasible.
- DIP Loan access: A small business debtor can borrow money through access to a debtor-in-possession, or DIP, loan. These loans allow lenders to obtain super-priority liens, putting them first in line before the small business debtor’s existing lenders (making these loans very appealing to a lender and, therefore, opening up more credit availability to debtors).
- Asset Sales: Further, a small business debtor can sell its assets (such as equipment, machinery, and other property) free and clear of liens and claims (liens will, however, attach to the proceeds of the sale).
- Debt Reprieve: Finally, a small business owner facing financial struggles can find relief through a debt reprieve. This means that the business owner can seek to take a break from paying pre-bankruptcy debts. This allows the business to direct money to more urgent needs or to build up a cash reserve. While the debts will need to be paid back eventually, the temporary reprieve can offer breathing room for the business.
The Small Business Reorganization Act of 2019
While the benefits above may sound too good to be true, until recently, many small businesses have been unable to take advantage of a Chapter 11 reorganization because of certain restrictions and high expenses involved in a filing.
The Small Business Reorganization Act (SBRA), which went into effect on February 19, 2020, aimed to address some of the issues preventing small businesses from taking advantage of a Chapter 11 reorganization. The SBRA created a sub-chapter V of the Bankruptcy Code, which has the main objective of allowing small businesses to quickly and inexpensively emerge from bankruptcy with a court-approved plan of reorganization.
Here are just a few of the many changes the SBRA made:
- Continued Ownership: allows small business debtors to retain a stake in the reorganized entity, so long as the ultimate reorganization plan is fair and equitable. The debtor’s management may also continue to operate the business.
- Plan of Reorganization Confirmation: holds that creditors no longer need to confirm a small business debtor’s plan of reorganization, as long as they meet certain requirements. This means that small businesses will no longer have to negotiate with creditors regarding payments, saving both time and money.
- Appointment of a Trustee: provides that a trustee is appointed and will act to facilitate the reorganization and assist the small business debtor with following its plan of reorganization.
- Streamlined Process: removes procedural hurdles and many of the costs associated with corporate reorganizations.
- Delayed Payment of Administrative Expense Claims: provides that the small business debtor is no longer required to pay administrative expense claims on the effective date of the plan. Instead, business owners are permitted to pay these administrative expenses claims throughout the term of the reorganization plan.
Further Benefits Implemented by the CARES Act
The SBRA provided for a small business, which it defined as a business with debts in an amount not greater than $2,725,625, to restructure its debts through the more cost-effective Chapter 11 process. However, many small businesses did not qualify because they carried too much debt.
On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act (CARES Act) amended the SBRA to increase the debt limit for debtors filing a Chapter 11 reorganization under subchapter V of the Bankruptcy Code. The debt limit was increased to $7.5 million, allowing for more debtors to take advantage of the streamlined Chapter 11 process. This debt limit will return to its prior limit of $2,725,625 after one year (unless further extended).
Is a Chapter 11 Reorganization Right for Your Small Business?
A Chapter 11 reorganization is not the solution for every struggling small business. However, because of the recent changes to the Bankruptcy Code made by the SBRA and the further (temporary) changes implemented by the CARES Act, a Chapter 11 reorganization is now a more accessible option for many small businesses who find themselves unable to pay their creditors or afford their bills.
Contact Our Experienced Business Law Attorneys
There are many complex issues that you must address in the reorganization process to ensure that you are taking the proper steps to protect your business. There is no one-size-fits-all solution, so it’s vital to consult an experienced business planning attorney who can advise you on the benefits, potential pitfalls, and challenges involved in this process.
At Wilson Ratledge, our attorneys regularly advise our clients on processes like business reorganization. A small business ourselves, we are committed to helping business owners thrive in a post-pandemic climate. For questions or assistance, call one of our experienced North Carolina business attorneys at 919-787-7711 or via our contact form below. We look forward to serving you and helping your business find its way back to success in a turbulent market.