CARES ACT INCREASES BANKRUPTCY OPTIONS FOR SMALL BUSINESSES IN FINANCIAL DIFFICULTY
April 9, 2020
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On March 27, 2020, President Donald Trump signed into law The Coronavirus Air, Relief, and Economic Security Act (CARES Act), the culmination of many programs designed to aid small businesses. Unfortunately, in our Country’s current economic condition, this aid may not be enough nor get to you soon enough to keep you out of an economic calamity.
If you find yourself in economic straits, you might consider viewing the options provided for you in bankruptcy.
This client alert provides insight and information regarding the CARES Act’s expansion of bankruptcy options for small businesses which will impact debtors, lenders, and investors.
There are two types of bankruptcies available to business entities under the Bankruptcy Code: Chapter 11 reorganizations and Chapter 7 liquidations. Filing Chapter 11 gives businesses a chance to catch their breath and propose a plan to pay the claims of their creditors. Along with Chapters 7 and 11, individuals may also file a special type of individual reorganization under Chapter 13 of the Bankruptcy Code.
Chapter 11 reorganizations generally are very expensive and certain conditions must be met in order for the debtor’s equity holders to retain their interests. As a result, prior to the recent enactment of new bankruptcy provisions, Chapter 11 was a difficult option for cash-strapped small businesses.
Relief for small businesses came a month before the creation of the CARES Act, when the Federal Small Business Reorganization Act (Subchapter V) became effective, creating a new more cost-effective method for small businesses to reorganize under Chapter 11 of the Bankruptcy Code so long as at least one half of their debts derived from the business. This method is designed to be much faster and less expensive than traditional Chapter 11 cases. Some key features of a Subchapter V case are:
This new reorganization initially was limited to businesses with aggregate debts of $2,725,624 or less. The CARES Act, however increases the debt limit to $7.5 million. The only debts that must be counted against this new cap are those that are noncontingent, liquidated, whether secured or unsecured. Insider and affiliate debts are excluded from the calculation. This expansion will sunset one year after its enactment.
It appears that the new EIDL and PPP SBA loans created by the CARES Act may be available to Chapter 11 debtors as long as they have less than 500 employees. Debtors will still have to obtain bankruptcy court approval for these loans.
The CARES Act also modifies individual bankruptcy cases by excluding CARES Act payments from income in Chapter 7 and disposable income for Chapter 13 Plans. Individual plans in Chapter 13 run from three to five years and are based on the payment of net income to unsecured creditors. The income provided by the CARES Act does not have to be counted as income. The Act also allows modification to approved Chapter 13 Plans if the modification is the result of a material financial hardship due to the Coronavirus, including extending the plan term to a maximum of seven years. This provision will also sunset one year after its enactment. The Act does not provide an exemption for these payments however, and it is unclear whether a trustee in a Chapter 7 case will be able to obtain turnover of these payments from the debtor.
The enactment of these new temporary provisions likely will cause a significant increase in bankruptcy filings and Chapter 13 plan modifications in the coming months. Qualifying small business debtors may find fewer roadblocks to confirmation and creditor’s ability to protect their interests in these cases will in some instances, become more difficult. Underwood Perkins will continue to monitor the impact and judicial interpretations of the CARES Act bankruptcy provisions.