With the COVID-19 pandemic continuing to drag down the economy and creating financial hardships for individuals and small businesses, it is likely that bankruptcy will become an important tool for overcoming the financial effects of the pandemic in 2021.  Several recent changes to the bankruptcy laws provide important new options and benefits for those individuals and businesses that need to seek bankruptcy assistance to resolve their debt problems.

Bankruptcy Law Changes for Business Debtors

In early 2020, the Small Business Reorganization Act (SBRA) went into effect.  The SBRA amended Chapter 11 of the Bankruptcy Code, adding new provisions aimed at small business debtors, and adding a new Subchapter V to Chapter 11, creating a simplified reorganization process.  The purpose of the law was to make it easier for small business debtors to reorganize through bankruptcy.  Prior to the passage of the SBRA, the reorganization process for business debtors was very time-consuming, often taking a year or longer, and complicated, requiring a multi-step process for approval of the bankruptcy plan.  In addition, in order to take advantage of bankruptcy reorganization under Chapter 11, a business debtor was required to pay quarterly fees to the bankruptcy trustee.  These fees are calculated based on the business’s disbursements.  For businesses that have significant inventory costs but low relative profits, this could make bankruptcy cost-prohibitive.

The SBRA did away with many of these requirements for small business debtors, making the approval of the bankruptcy plan a one-step process, imposing fairly short to limits to expedite the processing of these bankruptcies, and eliminating the quarterly trustee fees.  The SBRA also simplifies the Chapter 11 process in several other respects, discussed below.

Under the SBRA, a “small business debtor” that can take advantage of Subchapter V is defined as any business (or individual operating a business as a sole proprietor) that has non-contingent debt of less than $2,725,625.  While Subchapter V was not designed to specifically deal with the impact of the COVID pandemic, the economic effects of the pandemic give Subchapter V new importance as a tool for helping small businesses recover from the effects of the pandemic.  To assist in this, Congress made an important change to Subchapter V as part of the Coronavirus legislation (CARES Act).  The debt limit for small business debtors has been temporarily increased to $7,500,000 (currently until March 27, 2021).  This should allow many more small businesses to take advantage of reorganization under Subchapter V of Chapter 11.

The following are some of the features of Subchapter V that are likely to be most beneficial to small business debtors:

  • One-step plan confirmation process. Under a regular Chapter 11 reorganization, the debtor is required to file and obtain approval of a disclosure statement before obtaining approval of the plan of the reorganization.  Subchapter V eliminates the disclosure statement requirement, which should expedite the plan approval process.
  • Expedited process. Under Subchapter V, the plan must normally be filed within 90 days of the filing of the bankruptcy.  While this means the debtor must act promptly in preparing a plan of reorganization, it also expedites the entire plan confirmation or approval process.
  • A 3 to 5 year payment schedule. Subchapter V requires the small business debtor to commit all of its disposable income to the reorganization plan for the duration of 3 to 5 years.  This is similar to the rules applicable under Chapter 13 to individual non-business debtors.  The benefit of this payment schedule is that it sets an upper limit on the duration of the reorganization plan and on the amount that must be paid to creditors.
  • Appointment of a trustee to facilitate reorganization. In a regular Chapter 11 bankruptcy, a trustee is only appointed in exceptional circumstances to take over the management and operation of the debtor.  In a subchapter V case, a trustee is appointed in every case.  Although the trustee can investigate the debtor’s finances and even manage the debtor if needed, the trustee’s primary purpose is not to do this, but to facilitate the negotiations with creditors, development of the reorganization plan, and its approval.  The drawback of having a trustee is that the small business debtor is responsible for paying the fees for the trustee’s service.
  • No creditors’ committee unless the court orders otherwise. Chapter 11 normally requires the appointment of a creditors’ committee, comprised of representatives of the debtor’s unsecured creditors.  The role of the committee is to oversee the reorganization and to work with the debtor in developing the reorganization plan, in order to maximize the payments to unsecured creditors.  Although in many smaller Chapter 11 cases a creditors’ committee is not appointed due to lack of interest from the creditors, when it does get appointed, the legal costs associated with the committee’s work must usually be paid by the debtor.  Subchapter V eliminates the creditors’ committee requirement unless the court specifically orders one.  This should result in savings to the small business debtor, and presumably also make to easier to propose and confirm the reorganization plan.
  • Delay of administrative expense payments. In a regular Chapter 11 cases, administrative expenses must be paid at confirmation.  The most common administrative expenses are legal fees, trustee fees, and certain post-filing taxes.  Under Subchapter V, payments on administrative claims can be spread over the duration of the plan.  This should make the plan more feasible for the many small business debtors who may not have sufficient cash flow to pay the administrative fees all at once at confirmation.
  • Creditors not allowed to propose a plan. In a regular Chapter 11, creditors can propose their own plans or reorganization, or even liquidation, with the court ultimately deciding whether to approve the plan proposed by the debtor or a plan from one of the creditors.  Subchapter V eliminates this option, giving the small business debtor the exclusive right to propose a plan.  This in theory should make it easier for the debtor to confirm a plan, because it gives incentive to the creditors to cooperate with the debtor on reaching an agreed-upon plan of reorganization, since the creditors cannot propose their own plan.
  • No need for creditor approval. In a regular Chapter 11 bankruptcy, at least one impaired class of creditors must approve the plan.  Without this, the plan cannot be approved.  Subchapter V eliminates this requirement.  As long as the plan is fair and equitable to the creditors, it can be approved even without support from any of the creditors.
  • Discharge upon confirmation when plan is consensual. On the other hand, Subchapter V provides an incentive for the small business debtor to develop a plan that the creditors will approve.  When a plan is confirmed with consent from the creditors, the small business debtor receives a discharge at confirmation.  If the plan is not consensual, the debtor receives a discharge at the conclusion of the plan.
  • Equity holders can retain their interest without new contribution. One of the biggest issues with a regular Chapter 11 is how it affects the equity holders, or the owners, of the business debtor.  In a regular Chapter 11, unless all classes of creditors approved the plan, the owners would have to contribute significant new amounts to the business in order to retain their interest in the business.  Courts have also held that this contribution must be in cash, and not in the form of future labor or services.  An even bigger issue arises when the business filing for Chapter 11 is a sole proprietorship.  Courts have ruled that in such cases, the individual debtor cannot retain any of his/her assets unless all classes of creditors approve the plan, or the individual debtor “buys out” the assets by contributing new value from assets that are not part of the bankruptcy.  Because in most cases all of an individual debtor’s assets are already part of the bankruptcy, this rule often effectively gives the creditors a veto power over the debtor’s plan.  Subchapter V eliminates this requirement.  The owners of a small business debtor no longer need to contribute new value in order to retain their ownership of the business.  In sole proprietor cases, the individual does not need to contribute new value in order to keep his or her assets.
  • Modification of lien on principal residence relating to business debt. An important benefit of Subchapter V is that it allows modification of liens on the debtor’s principal residence, if the lien relates to a loan used primarily in connection with the debtor’s small business.  By contrast, in a regular Chapter 11, modification of liens on the principal residence is prohibited, with some minor exceptions.  This option may be particularly beneficial to those small business owners who took out a second mortgage on their home, or a home equity line of credit, in order to finance their business operations.

Bankruptcy Law Changes for Individual and Consumer Debtors

2021 also brings changes to the bankruptcy laws applicable to consumer debtors.  These changes were promulgated by the COVID Relief Bill, passed at the end of December 2020 to tackle the COVID-19 pandemic.  The following are some of the important changes:

  • Protection of stimulus payments in bankruptcy. The law added a new provision to the Bankruptcy Code, which excludes stimulus payments from “property of the estate” in bankruptcy.  Simply put, this means that the bankruptcy trustee in a Chapter 7 bankruptcy case cannot take the stimulus payments.  This was previously a concern for many people contemplating filing for bankruptcy.  Normally, a Chapter 7 trustee can seize any property of the estate that is not exempt.
  • Protection against discrimination. The COVID Relief Bill added a new provision stating that a consumer cannot be denied a mortgage forbearance or other similar relief, including protection under the foreclosure and eviction moratorium, simply because he/she is a debtor in a pending bankruptcy case or has received a bankruptcy discharge.
  • Maintenance of utility services. The COVID Relief Bill relaxes requirements for maintaining or restoring utility service where the debtor is delinquent in payments to the utility company at the time the bankruptcy is filed.  Normally, a debtor is required to provide adequate assurance of future payment in order to maintain or re-establish utility service.  This often requires paying a deposit.  The new law eliminates the “adequate assurance of payment” requirement, providing that a utility may not alter, refuse, or discontinue service so long as debtor  (1) makes a payment to the utility for “any debt owed to the utility for service provided during the 20-day period beginning” on the bankruptcy filing date and (2) subsequently pays for ongoing utility service when payment is due.  This provision may make retention of utility service easier for debtors dealing with utility companies that require a deposit.  However, it should be noted that not all utility companies require a deposit.
  • Chapter 13 discharge with missed payments. The new law allows Chapter 13 debtors who missed ongoing residential mortgage payment due to the COVID-19 pandemic to still complete the bankruptcy and get a discharge.  The debtor may get a discharge if (1) he/she missed three or fewer mortgage payments because of a hardship related to COVID-19, or (2) he/she has entered into a loan forbearance or modification.  The request must still be submitted to the court, and the court has discretion to grant or deny it.

It is important to note that all of the above changes to the consumer bankruptcy laws are temporary, and were enacted to deal specifically with the effects of the COVID-19 pandemic.  However, as new COVID-related legislation is passed, it is possible that these modifications will be extended, or new and more wide-ranging protections for debtors introduced.

Bankruptcy Assistance for Businesses and Individuals Impacted by the COVID-19 Pandemic

 Yusufov Law Firm regularly advises clients dealing with the economic effects of the COVID-19 pandemic. If you have been impacted by the COVID-19 pandemic and would like to discuss your options, please contact us online, or call 480-788-0098 in Phoenix/Mesa or 520-745-4429 in the Tucson area. Consultations are free with no obligation.