Changes to Federal Bankruptcy Law May Help Small Businesses

Changes to federal bankruptcy law will make it easier and cheaper for small businesses and family farmers to restructure or deleverage.

COVID-19 continues to shake the global economy. New figures from the US Department of Commerce show gross domestic product fell 9.5% in the second quarter of the year. By the end of July, new jobless claims had exceeded one million for 19 consecutive weeks.

In Michigan, Chapters 7 and 13 bankruptcy filings rose 17% in July, beating the national increase of 6%. Nationally, Chapter 11 filings for business reorganizations increased 79% in the first half compared to 2020.

Although we are tired of the overuse of unprecedented, it is clear that we live in unprecedented times. Starting in March, small businesses in Michigan had to close or serve only their essential customers. Some areas remain closed. Others have been forced to operate at 50% capacity or less, despite facing the same fixed costs, or even rising costs.

Many small businesses and family farms are crumbling under their operations. Although federal loan and grant programs have been extremely helpful, they will not be enough for businesses that have been closed for a long time. Many will not be able to recover without restructuring or reducing their debt.

The same goes for family farmers, especially dairy farmers, who were already suffering before the start of the pandemic. The expense of milking and tending their herds continues even as the nationwide school closure has dried up demand for their product, forcing them to dump milk.

As we head into the fall, a time when bankruptcy filings traditionally rise in Michigan, we expect a significant increase in new filings. Changes to bankruptcy law brought about by the coronavirus will make the restructuring process simpler and easier for small businesses and family farms.

Changes to Chapters 11, 12

For decades, small businesses seeking to restructure their operations and debt had the same requirements under Chapter 11 that a mega deal had. Bankruptcy was costly for small business owners, which made filing Chapter 11 an unrealistic option.

The addition of Subchapter V, or SBRA, to Chapter 11 brings significant changes that will increase the number of eligible small businesses, streamline the process and make it easier for owners to retain their equity. Prior to COVID-19, a business could not have more than $2.7 million in unsecured debt to be eligible to file under the small business rules. The CARES Act raised the debt cap to $7.5 million, adding a March 2021 sunset provision.

Similar but not identical changes have been made to Chapter 12, which covers restructuring for family farms. Debt limitation here has gone from $4 million before coronavirus to $10 million now, which encompasses a larger percentage of family farms.

Small businesses and farms must still comply with many provisions of the bankruptcy code, such as opening new accounts and filing monthly financial statements. Significant changes have been made to Chapters 11 and 12. These include:

• Elimination of the creditors’ committee in favor of a single trustee who does not operate the debtor’s business or farm, except in the event of a finding of fraud or mismanagement. The trustee is paid to oversee the process and make sure the debtor follows the rules, unlike a creditors’ committee which typically works to maximize the plan for creditors.

• Allow the sole debtor to file a plan of reorganization. No competing creditor or plan can be filed. In addition, it is no longer necessary to have a disclosure statement unless the court requires it, which makes the plan document simpler and less expensive to draw up.

• Elimination of the absolute priority rule, which states that no subordinate interest can retain or receive ownership until all higher-level interests have been paid in full. In many cases, a creditor may have a secured claim that represents a small fraction of the total debt, allowing them to prevent confirmation of a reorganization plan. This change allows shareholders to retain shares in the company and eases the path to confirmation.

• Allow the payment of administrative costs over the life of the plan. In a regular filing, expenses must be paid upon confirmation of the plan, but can now be stretched for three to five years, giving the debtor additional breathing space.

There are many other changes to Chapter 11 and Chapter 12 that are designed to benefit small business owners and family farmers. We now have a window that provides the ability to reorganize more cheaply and easily.

Sue Cook and Rozanne Giunta are partners at the law firm Warner Norcross + Judd LLP which focus their bankruptcy and restructuring practices. They can be contacted at [email protected] and [email protected] They wrote this article as part of the Daily News’ Community Connections initiative.

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