New Small Business Chapter 11: Perfect Solution To Save Struggling Family Businesses

By Paul Hollender
Board Certified Business Bankruptcy Attorney
Board Certified Consumer Bankruptcy Attorney

After years of searching for a solution to the high cost of classic Chapter 11 Reorganizations, which effectively left troubled small family businesses no choice but to close, Congress, with the assistance of the American Bankruptcy Institute and its small business bankruptcy task force, has miraculously passed an important bi-partisan piece of legislation which may be a true life-saver for financially strapped family-owned businesses.

This new law, codified in Article V of Chapter 11 is effective February 19, 2020.

It is designed to streamline the chapter 11 process, avoid litigation, and pave the way for court-approval of a plan even if creditors fail to vote for the plan.

Keeping the Company Without Putting in New Capital

The greatest problem in classic Chapter 11 is what is known as the “Absolute Priority Rule”. This principal prohibits junior classes from receiving any property ahead of senior classes, absent consent of the senior classes. The effect of this rule is to prohibit equity holders (i.e. shareholders, or members of an LLC) from retaining ownership of the company if the creditors vote down the plan.

The exception to this rule is what is called a “cram down”: i.e. cramming a plan down the objecting creditors’ throats by convincing the Judge to approve the plan on the condition that the owners of the company contribute “New Value” to the extent of the remaining equity in the company after confirmation of a plan.

This means it is necessary to conduct a full hearing, with testimony, exhibits and expert witnesses to establish what the remaining company is worth, after pre-bankruptcy debt is written down and scheduled to be paid over time under the terms of the plan. There are two problems with this: (i) small business owners can’t afford the cost of such a hearing; and (ii) by the time these individuals have come to see a bankruptcy lawyer they have typically exhausted all their personal resources in an effort to save the business, and have no more capital to contribute to the reorganized company.

This new law solves this problem.  Instead of the need to put in money, or even to have a hearing on value of the company, the owners can agree to contribute the “disposable income” of the reorganized company to the pre-bankruptcy creditors for a period of at least 3 (and at most 5) years.  Creditors don’t have to approve this plan, and they don’t have to get paid in full.

This is a great solution and is based upon the traditional chapter 13 plan under which individual debtors can keep all their assets and pay their creditors over either 3 or 5 years (depending upon their income level). In chapter 13, a Bankruptcy Trustee collects and makes all these payments. Unsecured creditors are paid without interest, and at the end of the plan any unpaid unsecured debt is discharged.

In this new Small Business Chapter 11 a Trustee is appointed and collects money until a plan is approved by the Court. If the creditors agree on the plan, the Trustee makes a one-time distribution of funds on hand, and the reorganized debtor makes the future payments. The company will get a discharge after 3 years, unless the court wants to make it longer, up to 5 years.

If the creditors don’t approve the plan, but the Judge does, after the debtor agrees to make time payments of its profits, then the Chapter 11 Trustee stays in place as the disbursing agent until the term of the plan is completed.

Streamlined Process Reduces Costs

The second major problem with classic Chapter 11 cases is the complex procedures which must be complied with, which escalate the internal costs of such cases. These costs include the debtor’s legal fees, accounting fees, U.S. Trustee fees, and the legal fees for the Creditors Committee.

The new Article V eliminates or reduces most of these costs:

  • There is no Creditors’ Committee
  • There are no quarterly US Trustees fees based upon the level of the company’s cash receipts
  • There is no fighting about competing plans, because only the Debtor can file a plan
  • The policy is to encourage a negotiated plan within 3 months of filing the case, with the Trustee serving as a facilitator.
  • There is no deed to draft a separate and complex Disclosure Statement (like a prospectus) or to hold a hearing to determine if that Disclosure Statement contains “adequate information”, all of which typically is time-consuming and expensive.
  • There is no longer the requirement to make separate motions dealing with “assumption” or “rejection” of existing contracts or leases. These issues can now simply be dealt with in the plan itself
  • There is no deadline for confirmation of the plan, thus no need to make motions to extend those deadlines.

Eligibility

This new subchapter V of Chapter 11 is available only to defined “small businesses”.  Unlike Chapter 13, which is available only to individuals, this subchapter is available to individuals, corporations, partnerships and LLC’s.

Specifically excluded, however, are single asset real estate entities, which are restricted to classic chapter 11 treatment

What makes a business “small”, so as to be eligible? It’s total debt including secured. Priority and general unsecured claims must be less than $2,566,050. This total does not include unliquidated or contingent claims.   SPECIAL NOTE: Due to the the COVID-19 Pandemic, Congress has, for one year, tripled the eligibility ceiling to $7.5 million.

Residual Requirements

  • Debtor’s counsel and accountant must be approved by the U.S. Trustee’s office
  • The Debtor must file monthly Operating Reports
  • The Plan must provide for payment of the Trustee’s fees

Conclusion

Having practiced Bankruptcy Law for 42 years, I have seen dozens of companies simply close their doors because they could not afford to pay for bankruptcy protection under a classic Chapter 11 Reorganization.  Accordingly, I am thrilled that Congress has acted in a bi-partisan fashion to adopt the recommendation of experienced bankruptcy practitioners, judges and academics, to address the real need of our country’s struggling family businesses.

While not all failing business can be saved, if the company

  • Can afford to pay current bills with current income
  • can adapt to today’s new economy by making meaningful changes
  • can show a profit which can be distributed to creditors for at least 3 years and
  • the principals believe that they just need some “breathing time” to restructure

then, the company may be a good candidate for an Article V, Chapter 11 Bankruptcy Reorganization.