By Dennis T. Lewandowski, Bankruptcy, Creditors’ Rights & Business Restructuring, Lender Representation

You probably have heard as much as you want to hear about the potentially disastrous economic effects that may be brought on by the Coronavirus and the efforts to slow its spread. However,  you likely have heard much less about the new bankruptcy law provisions that will make it easier for small companies to use bankruptcy to reduce their liabilities. These two events have the potential to come together in an exponential way that, while providing much-needed relief for some, could lead to even more financial difficulty for others. 

Previously, a small company needing to file for bankruptcy faced two unappealing options. It could either file a Chapter 7 bankruptcy, and turn over all of its assets to a trustee for liquidation, or file a Chapter 11 reorganization bankruptcy and face significant operational, legal, and administrative costs for an extended period of time, all the while realizing that the vast majority of such reorganizations are unsuccessful and lead to liquidation.  

However, some new provisions added to the bankruptcy law may make it easier for small companies that file bankruptcy. The Small Business Reorganization Act of 2019 went into effect on February 19^th. Acknowledging that the previous bankruptcy reorganization law was more appropriate for larger companies, this new law was added to promote simplicity and efficiency for small business bankruptcy reorganizations and eliminates many of the more costly procedures of the current bankruptcy law.

Under the new law, companies with actual, undisputed total debt of less than $2,725,625 may elect this relief. If the election is made, the new law operates much like a Chapter 13 individual reorganization bankruptcy. Unlike traditional Chapter 11 reorganizations, the bankrupt does not have to solicit acceptances for its plan, as creditors will not be able to vote on it, but may object to the plan’s confirmation if the legal requirements are not followed. No lengthy disclosure statement is required which, under the prior law, was subject to creditor objection and court approval. And, now only the bankrupt may file a plan of reorganization, eliminating the potential bargaining leverage creditors had by the possibility of them doing so. However, under the new provisions, the bankrupt now has only 90 days from the bankruptcy filing to propose a plan. 

Also significant, the new law eliminates the absolute priority rule in that it allows small business owners to keep their ownership interest in the company over the creditors’ objection without having to pay their creditors in full or provide new money to fund their plan. Under the new law, funding for the bankrupt’s plan will come from all disposable income of the company for the next three to five years. Disposable income is defined as all income of the bankrupt that is not reasonably necessary for the payment of expenditures necessary for the continuation, preservation, or operation of the business. 

For creditors who obtain liens on the customer’s personal residence to secure their credit advances, the new law, unlike current law, allows the plan to modify the rights of a creditor secured by a lien on the bankrupt’s principal residence if the new value received was not primarily to purchase the property, but used primarily in connection with the bankrupt’s business.

While the new bankruptcy law provisions may provide much-needed relief for some, it also may cause yet additional economic hardship for others. Companies should establish policies that anticipate the likelihood of a significant increase in small business customer bankruptcies. The increased use of personal guarantees from the company principles is one option. Also, credit managers reviewing new credit requests should determine if potential customers’ debts are below the threshold of $2,725,625 debt amount (although the debt limit may be increased in the future) and, if so, carefully analyze the potential customer’s financial situation before making a credit determination.

If you have any questions regarding the new provisions or lender issues in general, please contact Dennis Lewandowski at (757) 624.3252 or dtlewand@kaufcan.com.

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 2024.