By: Lindsey Emerson Raines
The Small Business Reorganization Act (SBRA) took place Wednesday, February 19, 2020, marking one of the most significant changes in bankruptcy law since 2005. The SBRA attempts to create a simplified and expedited process for small business debtors to propose, confirm and complete a plan of reorganization.
A debtor may elect to proceed under the new framework of the SBRA if the debtor is engaged in “commercial or business activities” (except for a person whose primary activity is the business of owning single asset real estate) with noncontingent liquidated debts under an established debt limit. At least half of this debt must be based on the commercial or business activities of the small business debtor.
The SBRA appears to present noteworthy benefits for debtors electing to have their cases administered under the new provisions; however, it is yet to be determined how the new framework will practically affect and/or benefit a small business debtor. Notably, the SBRA eliminates certain requirements that were considered expensive and burdensome for small business debtors. One of the key barriers preventing small businesses from filing or completing successful plans of reorganization was the “absolute priority rule,” which precludes retention of equity ownership unless creditors consent. This in effect could result in a loss of ownership for shareholders or owners of small businesses, many of whom were the founders or managers of the business.
With the SBRA, a business can confirm a plan of reorganization, even over creditor objection, by dedicating three to five years of net operating income in payments to its creditors, and the absolute priority rule will not apply. Additionally, a small business debtor can receive its discharge at the time of plan confirmation if it is able to file a consensual plan, or after three to five years of payments, regardless of whether additional payments are required by the plan if the plan is confirmed over objection.
Significantly for lenders, the SBRA permits the modification of secured creditors’ rights, even when a creditor’s claim is secured by the debtor’s principal residence. <11 U.S.C. § 1190(3)> An SBRA debtor’s plan may modify the rights of a creditor’s claim if the claim is secured only by a mortgage on the debtor’s principal residence, and if the loan (i) was not used “primarily to acquire” the property; and (ii) was instead “used primarily in connection” with the debtor’s business.
This is a departure from the anti-modification provisions found in Chapters 11 and 13 of the Bankruptcy Code, which generally allow a plan to modify the rights of holders of secured claims, except for claims secured only by the debtor’s principal residence. <11 U.S.C. § 1123> Pursuant to the new provisions, a small business debtor may be able to modify the claim of a creditor holding a mortgage on a principal residence (if loan proceeds were used primarily in connection with the small business) by proposing a lower interest rate, extending maturity, or even cramming down the loan to the value of the secured claim. It is unclear whether this will apply when a small business debtor grants a security interest in the principal residence as additional collateral but did not receive a new value.
As small business debtors begin to elect to proceed under the new provisions of the SBRA, courts will be tasked with answering a number of questions involving the interpretation of the law, as well as practical issues that may develop with implementation.
Lindsey Emerson Raines is an associate in the firm’s Litigation Practice Group. Her practice focuses on business litigation, creditors’ rights and bankruptcy.
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