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CARES Act’s Impact on the Bankruptcy Code

The CARES Act (see my prior posts online at Burns White’s COVID Resource Center), signed into law by President Trump on March 27, 2020, not only created significant small business loan initiatives, it modified and amended provisions of the U.S. Bankruptcy Code. These CARES Act changes which will immediately impact the bankruptcy landscape for small businesses and individual debtors alike.

CHANGE 1: CARES Act Raises Debt Limit for Chapter 11 Small Business Debtors under the Small Business Reorganization Act
With passage of the CARES Act, the debt limit for small business debtors seeking relief under the recently enacted Small Business Reorganization Act (P.L. 116-54) (“the “SBRA” a/k/a “Subchapter V”) was significantly increased from $2,725,625 to 7.5 million dollars (excluding debt to affiliates and insiders). This debt limit increase will remain in effect for one year after enactment of the CARES Act. The debt limit increase makes the provisions of SBRA an attractive (and now significantly more available) option to small businesses seeking to reorganize under Chapter 11.

A Chapter 11 bankruptcy is typically referred to as a reorganization. A Chapter 11 bankruptcy can be filed by individuals who have too much debt for a Chapter 13 bankruptcy repayment plan (see note), but Chapter 11 is more often utilized by businesses to reorganize and restructure debt.

In a traditional Chapter 11 bankruptcy, the debtor continues to operate the business as the “debtor in possession,” unless a trustee is appointed for cause. A traditional Chapter 11 bankruptcy plan is voted upon by creditors and interest holders and then must be confirmed by the Bankruptcy Court, subject to various statutory hurdles to confirmation. One significant hurdle to confirmation is rejection of a plan by impaired classes of creditors and the need for a cramdown of the plan over creditor objection, if debtor is unable to obtain consensual acceptance of the plan. A Chapter 11 plan may be confirmed over objection of impaired creditors if at least one impaired class of creditors accepts the plan and the plan is fair, equitable and does not unfairly discriminate.

The SBRA recently became effective on February 19, 2020. Under the SBRA, a small business debtor is a person engaged in commercial or business activities (note the term “person” includes partnerships and corporations) with less than $2,725,625 (now 7.5 million under the CARES Act) of aggregate, noncontingent liquidated debts (unsecured and secured), of which not less than half of the debt arose from the business activities of the debtor.

The SBRA was created to expedite bankruptcy relief and reduce the cost of Chapter 11 reorganizations for small business debtors. In an attempt to effectuate that end, the SBRA modifies and supplements traditional Chapter 11 requirements in a number of ways, including but not limited to the following:

  • Debtor will continue to operate the business as a debtor in possession. However, a trustee will be appointed to, inter alia, review the debtor’s financial condition, facilitate a plan of reorganization with the debtor, ensure payments are made by debtor and be heard on significant issues such as property valuation, asset sales and confirmation.
  • Unsecured Creditor Committees will not be appointed except for cause.
  • Only the debtor may file a SBRA Chapter 11 plan, with a plan due within ninety (90) days after the order for relief (subject to extension for cause shown).
  • An individual debtor may modify the rights of a secured creditor holding a security interest in the Debtor’s principal residence if the security interest resulted primarily from debtor’s business activities and not from the purchase of the residence.
  • As to confirmation of an SBRA plan:
    • A plan may be confirmed without the Debtor providing creditors a disclosure statement or soliciting votes on the plan (unless the Court would order otherwise).
    • A plan may be confirmed if the plan is fair and equitable and does not discriminate unfairly, even if there are impaired classes of claims and interests and no impaired class accepts the plan. Note that “fair and equitable” under the SBRA means debtor must contribute all projected disposable income for three (3) to five (5) years to plan payments, or that the value of the property to be distributed under the plan for three (3) to five (5) years is not less than than the debtor’s projected disposable income.
    • Additionally, a small business debtor may retain equity in the business without full payment of unsecured debt.

Because the SBRA is so new, it is anticipated that there there will be ongoing developments in case law as SBRA cases make their way through the Courts. Please contact me with any questions.

Change 2 – Confirmed Chapter 13 Plans May Be Modified and Extended Up to Seven (7) Years Due to COVID-19 Hardships
Under 11 U.S.C. §1325, a Chapter 13 payment plan will range from three to five years, unless all unsecured debt can be paid sooner. The CARES Act provides that Chapter 13 debtors who have (1) filed Chapter 13 Bankruptcy; and (2) are making payments under a confirmed Chapter 13 Plan; (3) which was confirmed before the date of the enactment of the CARE Act may extend their confirmed Chapter 13 plans up to seven (7) years after the due date of their first payment after confirmation. In order to extend the plan term, the debtor must have experienced a material financial hardship due to COVID-19, and there must be notice and hearing on the modification.

Change 3- Exclusion of COVID-19 Payments from Income
For Chapter 7 and 13 bankruptcies, the CARES Act modifies the definition of “current monthly income” in the Bankruptcy Code to exclude the payments made under the National Emergencies Act as a result of COVID-19. Additionally, the CARES Act excludes those payments from the disposable income requirement in 11 U.S.C. §1325(b)(2).

Please check back for more information on these topics and others. The Bankruptcy and Creditors’ Rights attorneys at Burns White will provide updates periodically. Our attorneys remain available and accessible to handle any immediate and future needs. If you have any concerns or are need of representation, planning or guidance, please contact me at [email protected].

Note: The current debt limit for an individual debtor entering Chapter 13 bankruptcy is $419,275.00 in noncontingent, liquidated unsecured debts, and $1,257,850 for a debtor’s noncontingent, liquidated secured debts.