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Bankruptcy reform offers relief to small businesses

Small businesses that are struggling to reorganize their debts may find it easier to get a fresh start thanks to changes to federal bankruptcy laws taking effect next year.

The Small Business Reorganization Act, which was signed into law in August with bipartisan support and takes effect in February 2020, creates a new subsection of the Chapter 11 bankruptcy code applying to businesses that have liquid or unsecured debt less than $2,725,625. Typically, Chapter 11 bankruptcy procedures are designed to address the needs of companies that have millions of dollars in operating funds, which small businesses lack.

Bankruptcy attorney Philip Sasser of Sasser Law Firm in Cary has been studying the changes and has written about them in his firm’s blog. Sasser said he’s had small business owners approach him about bankruptcy and he’s told them it would be too complicated and a case would not be worth it financially for them. But the changes will make bankruptcy more feasible for business owners who have less than $2.7 million in debt.

“It streamlines the process. It cuts down on fees and some of the extra work,” he said. “There are some nice shortcuts that are now right there out in the open instead of something you have to work for or hope that you’ll be able to take advantage of.”

George Cauthen, a partner at Nelson Mullins in Columbia, South Carolina, likened the new law to Chapter 12 bankruptcy, which was created in the 1980s to protect farmers and fishermen. He said he could not recall a successful Chapter 11 farming case in the state until Chapter 12 was created, but it remains to be seen whether the new law will do for small businesses what Chapter 12 did for farmers.

“When Chapter 12 came out, it streamlined reorganizations for farmers, just like this one does for small businesses, and all of a sudden we had successful reorganizations for farmers,” he said. “So if it has the same impact on small businesses that it had on farmers when Chapter 12 came out, I think it will be a real positive thing.”

In several respects, the new Subchapter V resembles both Chapter 12 and Chapter 13, which aids individuals who are still earning a steady income. Under the new subsection, the appointment of a trustee to oversee the bankruptcy will be mandatory, and administrative costs can be paid in installments.

Sasser said the law also eliminates the “new value” and “absolute priority” rules for qualifying businesses, which will make it easier for owners to retain their stakes in the business without paying off creditors in full. Debtors will also be able to modify a residential mortgage if their home was used to secure business-related financing.

The law also slows down the process for preference actions, in which a trustee seeks to recover payments made by the debtor to a creditor before the bankruptcy petition was filed, so that other creditors may be treated more equitably.

“One of the changes says ‘look, you need to do your due diligence, look into this, make sure this is legitimate,’” Sasser said. “What kind of defenses could there be? You can’t just shoot first and aim second. You need to be careful about who you’re actually threatening with lawsuits … I think, in general, the legal community should be feel glad that they’re not going to get as many worried phone calls or letters from clients wondering why they got this letter.”

Small businesses also will be able to confirm a reorganization plan over creditors’ objections, allowing them more liberty to negotiate with creditors. The law also reduces procedural requirements and increases oversight by a trustee who manages payments to creditors.

“The court can approve a plan without going through the votes of the creditors,” Cauthen said. “Under Chapter 11, there’s a very complicated formula to determine whether you’ve got a plan confirmed or not. But now, this will be kind of like Chapter 13: the judge overturns the objections of creditors, without taking any kind of voting into consideration, and can approve a plan that he thinks is fair.”

Cauthen said that currently about half of all Chapter 11 bankruptcies would be eligible to file under Subsection V, which he said is surprising.

“Right now Chapter 11 is pretty intensive about having to hire professionals, about having to do reports, about having to do a lot of work designed for the big Chapter 11s like General Motors and things like that,” he said. “This streamlines small business. I think it will be much simpler for them.”

Jamie McCall, vice president of policy and research at the Carolina Small Business Development Fund, a statewide revolving loan fund that provides resources, consultation, and loans to qualified small businesses in North Carolina, said that the SBRA will create a legal environment that makes it easier for companies to restructure to stay in business rather than closing up shop altogether.

“By reducing the costs and the complexity associated with that reorganization and bankruptcy process, smaller firm owners are better enabled to move past those difficulties and hopefully start innovative and new firms that can contribute to the state’s economy,” McCall said.

Follow Renee Sexton on Twitter @BobcatRenee

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