The Small Business Reorganization Act: Big Changes for Small Businesses

Legal commentators have long lamented that chapter 11's high costs and complexities make it too difficult for small businesses to successfully reorganize. In response to these concerns, Congress recently passed amendments to the Bankruptcy Code known as the Small Business Reorganization Act (SBRA). On August 23, 2019, SBRA was signed into law.

Before SBRA, struggling businesses considering bankruptcy had two options: chapter 7 or chapter 11. Upon the filing of a chapter 7 case, a bankruptcy estate is created that is comprised of the debtor's nonexempt property. A trustee is appointed to liquidate the assets of the bankruptcy estate and distribute the proceeds to the debtor's creditors. Chapter 7 is not an option for businesses hoping to survive bankruptcy and retain control of its operations.

In contrast, a chapter 11 debtor retains control over its operations and restructures its debts through a court-approved plan. Although the chapter 11 debtor retains control, the debtor is subject to increased oversight from the bankruptcy court and the U.S. trustee. The chapter 11 debtor's plan to repay its debts must meet stringent requirements and be confirmed (i.e., approved) by the bankruptcy court before the debtor can exit bankruptcy. While in bankruptcy, the debtor is required to obtain the court's approval of all nonordinary course-of-business transactions and must comply with the U.S. trustee's monthly reporting requirements. As a result, a small business may not be able to afford the costs of a chapter 11.

The SBRA endeavors to strike a balance between chapter 7 and chapter 11. Under the SBRA, certain debtors can retain control over their business operations while reorganizing. However, they will no longer be subject to the more costly requirements in chapter 11. Unlike chapter 11, a trustee will be appointed to each small-business debtor case. The SBRA’s sponsors explain that the trustee will "perform duties similar to those performed by a . . . Chapter 13 trustee and help ensure the reorganization stays on track."

In addition, the SBRA provides that a committee of creditors will not be appointed unless ordered by the bankruptcy court for cause. This should decrease the costs of a chapter 11. When a creditor committee is formed in a chapter 11 case, the committee can hire its own professionals. However, the debtor is required to pay for the fees and costs of the committee's professionals. Generally, the SBRA will now allow the small business debtor to avoid this additional expenditure.

Many of the SBRA’s amendments will streamline the plan confirmation process and potentially reduce plan confirmation costs. In a chapter 11 case, the debtor must file a disclosure statement with the bankruptcy court. The disclosure statement is a detailed document intended to inform creditors of key provisions in the debtor’s plan. It must be approved by the bankruptcy court before creditors can vote to accept the debtor’s plan. Under the SBRA, a debtor will generally not be required to prepare a disclosure statement. In a chapter 11 case, the debtor’s exclusive right to file a plan is limited. Once this exclusivity period expires, creditors are free to file their own competing plans. The SBRA permits only the debtor to file a plan of reorganization. The SBRA’s elimination of a disclosure statement and potential competing plans will prevent contested hearings that prolong the reorganization process and increase costs for debtors.

The SBRA also relaxes the requirements to confirm a plan. First, the owners of small-business debtors can retain their ownership interest provided the plan does not “discriminate unfairly” and is “fair and equitable.” It is also easier for the small-business debtor to confirm a plan over creditors’ objections. Essentially, a plan will be confirmed so long as it provides that all projected disposable income for three to five years will be used to make plan payments. In addition, the required plan contents under the SBRA are less stringent than those for chapter 11 plans.

Ultimately, by lowering costs and simplifying the plan confirmation process, the SBRA aims to provide another option for small businesses wishing to reorganize.