Credit Union Alert – CARES Act Bankruptcy Law Changes Affecting Credit Unions
In February the Small Business Reorganization Act (“SBRA”) became effective. It is discussed below. In addition, the recently enacted CARES Act contained bankruptcy law changes that are significant for credit unions. First, the debt limit for SBRA has been increased from $2,725,625 to $7,500,000, an amount that is almost three times the initial limitation. This will significantly increase the individuals and businesses that will qualify for this relief.
Second, in a provision that will impact Chapter 13 Cases, coronavirus relief payments are to be excluded in calculating the debtor’s income for determining whether the debtor must file a Chapter 13 bankruptcy or take advantage of the more forgiving Chapter 7 option that does not require any monthly plan payments. These coronavirus relief payments also do not have to be considered when calculating disposable income, which determines the amount the debtor must pay into its Chapter 13 plan each month. These provisions also will impact the number of years the plan payments have to be made, making three-year payment plans more likely (than five-year plans). This will lead to a decrease in the amount and frequency of monthly payments, resulting in a lower percentage payment to unsecured creditors in the debtors plan, for debts like unsecured loans or credit card debt (not otherwise secured or for which the collateral is insufficient).
Also, since coronavirus payments will not be considered in determining income, credit unions should expect an increase in Chapter 7 liquidations as opposed to Chapter 13 individual reorganizations, as layoffs and furloughs continue. Some debtors may even be counseled not to file a Chapter 13 now, but instead, wait until the layoff or furlough occurs and file a Chapter 7 liquidation when they no longer have the regular income required to file a Chapter 13 and they now qualify for Chapter 7 relief. All of this has the potential to decrease bankruptcy recovery for credit unions.
Finally, for debtors who have already had their Chapter 13 plan confirmed, they may now modify that plan to make the payment period up to seven years (from the current five) based upon a financial hardship caused by the pandemic. This provision also may allow debtors with confirmed plans to modify them to cure post-petition defaults on car payments, instead of the credit union being able to seek relief from the bankruptcy stay to obtain possession of the vehicle.
However, the CARES Act bankruptcy provisions only apply for one year. So, unless they are extended, debtors will no longer be able to take advantage of them after that time. However, there is already an indication that a serious effort will be made to extend the $7,500,000 debt threshold beyond the one year period.
The Small Business Reorganization Act of 2019 (Effective February 2020)
New provisions added to bankruptcy law in February will make bankruptcy a more likely option for individuals and small businesses in financial difficulty. The Small Business Reorganization Act of 2019 was designed to promote simplicity and efficiency and will more easily allow individuals and business owners to clean up their balance sheets while still maintaining their ownership interests. The Act creates a new subchapter of the Chapter 11 reorganization chapter of the Bankruptcy Code for businesses with secured and unsecured debt of not more than $2,725,625.
The new law is, in some ways, modeled after Chapter 13 reorganization bankruptcies and includes the following significant revisions:
- no disclosure statement is required
- a streamlined version of the information normally required by the disclosure statement is to be provided in the plan of reorganization, which only the debtor can file
- there are no solicitation and voting requirements for confirmation and creditors do not have the right to vote on the plan, but may object to confirmation
- funding for the plan will come from all disposable income of the debtor during the next 3 to 5 years
- the new law eliminates the absolute priority rule, allowing business owners to keep their ownership interests without paying creditors in full or providing new value
- the plan can modify the rights of a creditor secured by a security interest in the debtor’s principal residence if the loan secured by the residence was not used to acquire the residence but was used in connection with the debtor’s business
The new bankruptcy law could have a significant impact on credit unions. Bankruptcy will now be a more realistic option for small business debtors who will be able to confirm Chapter 11 plans that credit unions may not approve of and modify the repayment terms regarding loans secured by residences where the funds were used for business purposes. Also, issues raised by the new law will need to be resolved by the courts, as the involved parties navigate their way through this new process.
The contents of this publication are intended for general information only and should not be construed as legal advice or a legal opinion on specific facts and circumstances. Copyright 2020.