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CARES Act Makes Bankruptcy Changes that Benefit Small Businesses

March 31, 2020

By: David E. Peterson

The stress of coronavirus may cause many small businesses owners to seek relief by reorganizing their businesses in bankruptcy. Because typical reorganization (Chapter 11 bankruptcy) can be lengthy and complicated, Congress recently enacted Subchapter 5 of the Bankruptcy Code, giving small businesses a quicker, more affordable option and an increased debt limit.  

Streamlined Process

Chapter 11 involves an often lengthy court process to modify or discharge business debt through a plan of reorganization approved by the bankruptcy court. The court must approve a disclosure statement that provides detailed information about the debtor’s business to assist creditors in deciding whether to accept the plan. The court then determines whether the plan meets the requirements of the Bankruptcy Code for confirmation over any objections by creditors, a process referred to as “cramdown.” The confirmation hearing is often hotly contested by the debtor, secured creditors, and unsecured creditors, whose interests are frequently represented by a committee appointed by the U.S. Trustee.

While Chapter 11 worked well for large businesses such as GM, the Chapter 11 process had been criticized as being too costly and time consuming for most small business debtors. Subchapter 5 is Congress’s effort to remedy that problem.

Among the advantages of Subchapter 5 to the debtor are that it need not file a disclosure statement. The plan will generally be confirmed if it meets the normal cramdown requirements of Chapter 11 with respect to secured creditors and the debtor commits all of its disposable income to the payment of creditors under the plan for a period of 3 to 5 years, as may be ordered by the court. Subchapter 5 provides an expedited process to confirm the debtor’s plan, which must be filed within 90 days after the filing of the bankruptcy.

In addition, there is no committee of unsecured creditors to contend with, and the quarterly fee normally applicable to Chapter 11 is not required. As a result, Subchapter 5 provides a faster, less costly alternative than the traditional Chapter 11 bankruptcy process.

Increased Debt Limit

One major limitation on Subchapter 5, as it was originally enacted, was that the debts of the debtor must not exceed $2,725,625. Pursuant to the CARES Act, that limit has been raised to $7.5 million. However, the higher limit applies only to bankruptcies that are filed within one year after the enactment of the CARES Act.

At the end of the year, the limit will return to the lower amount of $2,725,625, plus any applicable inflation adjustment. In the interim, however, the higher debt limit will enable a much larger number of small businesses to take advantage of the less costly Subchapter 5 process.

Given the economic distress that has resulted from COVID-19, it seems likely that many small businesses will take advantage of Subchapter 5.

This article is informational only. You should consult an attorney before acting or failing to act. The law may change rapidly and no warranty is given. LOWNDES DISCLAIMS ALL IMPLIED WARRANTIES AND WITHOUT LIMITATION, ANY WARRANTY OF FITNESS FOR A PARTICULAR PURPOSE. ALL ARTICLES ARE PROVIDED AS IS AND WITH ALL FAULTS. Consult a Lowndes attorney if you wish to establish an attorney/client relationship.

Dave Peterson has a broad background in bankruptcy and creditors’ rights, as well as commercial litigation, in general.

Dave represents lenders, creditors and lessors in sophisticated Chapter 11 reorganizations and Chapter 7 liquidations. He has represented creditors in negotiating Chapter 11 bankruptcy plans, as well as litigation concerning confirmation of bankruptcy plans. He has handled preference litigation, fraudulent conveyance claims, exemption litigation, and a wide range of other kinds of litigation arising out of bankruptcies, including appeals.

Further, Dave has experience accumulated over a period of approximately 26 years, handling real estate mortgage foreclosures, including foreclosures of hotels, apartment complexes, office buildings, retail property, and other types of commercial property, and in handling litigation arising out of the enforcement of security interests in personal property under the UCC.

He also has significant experience representing receivers in receivership cases, handling and litigating assignments for the benefit of creditors, and in defending lender liability claims. In addition, Dave has spent a number of years working on transactional matters related to his expertise in the area of finance. For example, Dave has experience handling the workout of problem loans and debt restructuring.

Dave has also spent approximately 8 years structuring, negotiating, documenting, and closing sophisticated financial transactions, such as mortgage warehouse facilities, repurchase agreement transactions, real estate loans involving special purpose entities, and revolving credit facilities secured by all kinds of personal property, as well as uniform commercial code transactions of all kinds. Many of these transactions have involved hundreds of millions of dollars.

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