The SBRA: Call It the Serendipitous Business Rescue Act

Ryan E. Davis, Esq., and C. Andrew Roy, Esq.

Bankruptcy Law Committee // The Briefs // May 2020, Vol. 88 No. 4

No, that’s not really what SBRA stands for. The SBRA is the Small Business Reorganization Act. It was signed into law in August 2019. Unless someone in Congress knew something even China did not know at that time, this law had nothing to do with the novel coronavirus disease (“COVID-19”). This brand-new legislation to help small businesses reorganize became effective on February 19, 2020, less than a month before our economy was crushed by COVID-19. Could it be anything other than serendipity?

The SBRA gives small businesses an easier path to confirming a plan to reorganize its debts and continue as a going concern. A typical bankruptcy Chapter 11 case has a number of hurdles for a small business, including a requirement for certain creditor votes in favor of the plan, giving other parties a chance to file a competing plan (taking control away from the debtor), and the possibility that equity (the owner) could lose their interest in the business entirely if creditors do not agree to something other than a minimum level of treatment in the plan.

Under the SBRA, qualifying small businesses can elect to proceed under a new “subchapter V” of Chapter 11 and bypass many of those hurdles to successfully reorganize primarily based on the business’s “disposable income.” There are a lot of nuances to the SBRA we do not cover here – our focus in this article is more on the big picture of how the SBRA could not have come at a better time.

A quick note about the “B” word.

Far too often, the stigma associated with the word “bankruptcy” keeps people from even considering it, especially for their business. And, far too often, that stigma delays a bankruptcy filing that, had it been done sooner, could have saved the business. Now, perhaps more than ever, is the time to see the word “bankruptcy” and think “hope,” not “despair.” And when you see “SBRA,” think “serendipitous business rescue,” exactly what it is.

What is a “small business?”

Before the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), which was signed into law on March 27, 2020 and addresses the economic impacts of, and responds to COVID-19, a small business qualified for relief under the SBRA if it had less than $2,725,625 in debt. Under the CARES Act, Congress substantially loosened this limit to $7.5 million. Anecdotally, this conceivably makes most businesses in Central Florida a qualifying “small business.” This loosening is only in effect for a year until March 2021. An individual can be a “small business,” too, and qualify for the benefit of this legislation.

How did the SBRA ease confirmation requirements?

Confirmation is the objective of any Chapter 11 case. It is the bankruptcy court’s approval of the plan of reorganization that effectively becomes the contract between the debtor and its creditors. The SBRA made it easier for a small business to reach this milestone with the following:

(1) Only the debtor can file a plan.

Lenders and other creditors no longer have the right to file a competing plan of reorganization. While debtors in Chapter 11 always have an exclusivity period, debtors can still face competing plans by lenders and other creditors when the timeframe expires. Fending off a competing plan of reorganization can be very expensive, especially for the small business. Under the SBRA, only the debtor can file a plan of reorganization.

(2) No disclosure statement needed.

In a typical Chapter 11 case, the debtor must file a disclosure statement with the plan. The disclosure statement is intended to provide “adequate information” for a creditor to decide whether to accept or reject the plan. Generally, before soliciting votes on the plan, the debtor must get the disclosure statement approved by the bankruptcy court, and then send out the disclosure statement and plan. It is an extra layer of administrative burden and expense that the SBRA dispenses with. Instead, the debtor must provide projections and a liquidation analysis with the plan.

(3) No need for an impaired accepting class.

One of the biggest hurdles for any small business debtor is convincing a class of creditors to vote in favor of the plan of reorganization. In many instances, one creditor, typically a lender, can block confirmation of the plan of reorganization through its secured claim and unsecured deficiency claim. Based upon the size of the deficiency claim, a lender can outweigh the votes of the other unsecured creditors and prevent confirmation, even if trade creditors prefer the plan of reorganization versus liquidation. This is no longer the case under the SBRA – a plan can be confirmed even if no creditor accepts it. This change levels the playing field for small businesses trying to reorganize. However, there are certain consequences if the plan is nonconsensual, including that a trustee administers plan payments.

(4) No more absolute priority rule.

The absolute priority rule is a significant deterrent to filing bankruptcy for many small businesses because it creates a significant risk for equity. Under the absolute priority rule, the unsecured class of creditors must vote in favor of the plan or be paid in full prior to equity’s retention of its interest. This rule puts the owner’s interest in the business at risk of divestment, which results in the owner losing his or her business. Now, small businesses must only meet a disposable income test for equity to retain its interest, which is a much lower standard.

What other benefits did the SBRA create?

There are several other benefits for small businesses under the SBRA, all of which are intended to reduce administrative burdens and expenses, and overall make it easier for a small business to exit bankruptcy as a viable, going concern. These include:

(1) No quarterly United States trustee fees.

Small business debtors no longer have to pay quarterly United States Trustee fees, which are based upon disbursements during the preceding quarter. The quarterly fees create an additional burden for small businesses that are already struggling. These fees are now eliminated for the small business debtor, which preserves cash for the ordinary course of business expenses and for plan payments.

(2) No Committee of Unsecured Creditors.

The United States Trustee’s office can no longer appoint an official committee of unsecured creditors. This is significant in that committees are paid from funds of the bankruptcy estate and create an additional layer of cost and expense for the small business. While a subchapter V trustee will be appointed, with a role similar to that of a committee, the costs of a trustee should be much lower.

(3) Modification of home mortgages.

Home mortgages are generally immune from modification during the course of a bankruptcy case. The SBRA creates an exception under which home mortgages may be modified if the proceeds from the loan were used primarily in connection with the small business of the debtor. This exception will generally pertain to second mortgages, as proceeds from first mortgages will typically be used for acquisition of the home rather than for business purposes. This provision could prove very beneficial to small business owners with home equity lines of credit (“HELOCs”).

What’s a creditor to do?

The SBRA is not all “bad” news for creditors (after all, some creditors are small businesses themselves). First, though somewhat counterintuitive, having a debtor successfully reorganize greatly increases the chance the creditor will get cash in their pocket – everybody wins, even if it’s not the ideal 100% repayment with attorneys’ fees and interest. Second, though many hurdles for the debtor are removed, it’s not a free-for-all. All the usual confirmation requirements still must be met, and the debtor cannot linger for months (even years) in its case – it must file a plan in 90 days after the case is filed. Third, secured creditors, for the most part, will not see a huge change in their treatment – cramdown of their claims generally remains the same. In other words, there is still leverage for a creditor to reach an agreement on acceptable treatment of its claim.

So, what’s next?

As of the date of publication, in response to the COVID-19 pandemic and its accompanying economic shutdown, state and local orders are giving some relief to small businesses already, like suspensions of the issuance of writs of possession “forthwith.”1 Federal and state relief may also be helping get small businesses immediate working capital to help with cash flow and expenses while the economy remains at least partially shutdown. As the effects of that relief begin to wane, expect to see a wave of bankruptcy filings, many of which are likely to proceed under the SBRA’s subchapter V. As those cases progress, the intent of the SBRA “to streamline the process by which small business debtors reorganize and rehabilitate their financial affairs”2 will be put to the test. Time will tell whether the SBRA’s arrival was truly the serendipitous rescue small businesses needed, especially during an unprecedented health and financial crisis.

Ryan E. Davis, Esq., a shareholder at Winderweedle, Haines, Ward & Woodman, P.A., practices in the areas of bankruptcy, creditor’s rights, and commercial litigation and is chair of the firm’s Bankruptcy and Creditor’s Rights Department. He is a Certified Business Bankruptcy Specialist by the American Board of Certification and has been a member of the OCBA since 1999.

Andrew Roy, Esq., a shareholder at Winderweedle, Haines, Ward & Woodman, P.A., practices in the areas of bankruptcy, creditor’s rights, general counsel, and appeals, focusing on helping businesses, including startups and small/medium-sized businesses as their outside general counsel. He is the current president of the OCBA Young Lawyers Section and has been a member of the OCBA since 2011.

1 Florida Supreme Court Administrative Order No. AOSC20-17 suspends the requirement of Florida Rule of Civil Procedure 1.580(a) that requires a clerk to issue a writ of possession “forthwith.” That suspension was extended through May 29, 2020 by Administrative Order No. AOSC20-23.

2 Report of Committee on the Judiciary, House of Representatives, Report 116-171, 116th Cong., 1st Sess., on Small Business Reorganization Act of 2019, at 1, available at https://www.govinfo.gov/content/pkg/CRPT-116hrpt171/pdf/CRPT-116hrpt171.pdf.