Opportunities and Challenges for Small Businesses Under New Laws Enacted During the Pandemic

• Publication year: 2020
• Author: Zev Shechtman

Opportunities and Challenges for Small Businesses Under New Laws Enacted During the Pandemic

Zev Shechtman

Zev Shechtman is a partner at Danning, Gill, Israel & Krasnoff, a boutique Los Angeles law firm specializing in business bankruptcy, insolvency and restructuring.

The COVID-19 pandemic has resulted in the most severe economic decline since the Great Depres-sion.¹ News accounts have predicted a "tsunami" of bankruptcy filings.² The increase in bankruptcy filings was not immediate, likely due to a combination of factors, including governmental financial interventions,³ societal shutdowns due to social distancing and governmental "stay at home" orders,⁴ the legal and practical inability of creditors to pursue collection,⁵ and a freeze of civil litigation.⁶ In fact, the number of bankruptcy filings in the United States dropped 39% from March to April 2020.⁷ However, from April through July 2020, many national retail and restaurant chains, including Pier 1 Imports, J Crew, JC Penney, Ann Taylor, Chuck E. Cheese, Souplantation, and CPK, among others, filed chapter 11 bankruptcy petitions. A number of travel-related businesses, most prominently Hertz Rental Cars, filed bankruptcy petitions during that same period. Although national business bankruptcy filings started trending up in May and June 2020, the factors mentioned above are likely still playing an important role in easing financial pressures on businesses and individuals.

This article focuses on two bankruptcy topics that have been featured in recent legislation and bankruptcy cases. This article starts by addressing recent amendments to the United States Bankruptcy Code⁸ utilized by small businesses seeking streamlined chapter 11 proceedings under the new subchapter V of the Bankruptcy Code. This article also addresses other statutory relief provided to debtors, for while Congress enacted revisions benefiting small business prior to the pandemic, the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act") signed into law March 27, 2020, expanded that relief.⁹ Specifically, the CARES Act expanded access to subchapter V. This article goes on to address some of the early judicial decisions regarding subchapter V.

Next, this article addresses a slew of nationwide cases addressing the Small Business Administration's (SBA) blanket denial of funds under Paycheck Protection Program ("PPP") to debtors in chapter 11 bankruptcy. A split has developed between bankruptcy courts issuing emergency injunctions against the SBA and other courts denying the same relief. The issue appears to be on track to adjudication before multiple circuit courts and, if the split persists, inevitably will result in a petition for writ of certiorari at the United States Supreme Court.

1. Subchapter V of the Bankruptcy Code and Cases Addressing Subchapter V

a. Statute

In 2019, Congress amended the United States Bankruptcy Code by enacting the Small Business Reorganization Act (the "SBRA").¹⁰ One of the most important features of the SBRA is the creation of a new bankruptcy option for small businesses, subchapter V of chapter 11 of the Bankruptcy Code. Subchapter V is designed to streamline the chapter 11 process and remove some of the challenges for small businesses seeking to reorganize through bankruptcy.¹¹

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Initially, subchapter V was available to debtors with aggregate secured and unsecured debt of no more than $2,725,625.¹² However, as part of the CARES Act, enacted as an emergency response to the COVID-19 pandemic, the debt limit has been increased to $7,500,000, opening subchapter V to a broader segment of businesses.¹³

b. Major Features of Subchapter V i. The Chapter 11 Plan Must Be Filed Within Ninety Days After the Bankruptcy Filing, and Only the Debtor May Propose a Reorganization Plan

In a typical chapter 11 bankruptcy case, the debtor has the exclusive right to file a plan of reorganization during the first 120 days of the case, and that exclusive right may be extended for up to eighteen months if the court finds "cause."¹⁴ Once exclusivity expires, other parties may submit a plan.¹⁵ Eliminating the costs and risk associated with plans proposed by competing parties, subchapter V provides that only the debtor may submit a plan.¹⁶ Further, subchapter V requires that the plan be filed within ninety days after the filing of the petition, shortening the length of time the debtor will be subject to bankruptcy proceedings.¹⁷ An extension beyond ninety days is allowed only "if the need for the extension is attributable to circumstances for which the debtor should not justly be held accountable."¹⁸ Among other key requirements, unless all classes of creditors vote in favor of the plan, the plan must pay creditors an aggregate amount equal to the debtor's projected disposable income over a three-to-five-year period.¹⁹

ii. Owners May Keep Equity in Company (No Absolute Priority Rule)

The "absolute priority rule" in chapter 11 requires that owners of the debtor (i.e., the bankrupt company) contribute new value to maintain their equity in the reorganized company. That requirement is expressly eliminated from subchapter V, removing a major financial cost and risk from the reorganization process.²⁰

iii. Discharge

If a plan is consensual (meaning that all classes of creditors vote in favor of the plan), the debtor will receive a discharge upon confirmation. If the plan is not consensual, the debtor's remaining debts will be discharged only if the debtor makes all its required plan payments.²¹

iv. Trustees

All subchapter V cases have a trustee, a professional fiduciary, who oversees the case.²² The trustee's role includes investigating the business and financial affairs of the debtor, and may include distributing plan payments. The trustee also has a duty to "facilitate the development of a consensual plan of reorganization."²³ The subchapter V trustee's role is more limited than the role of a chapter 7 trustee or that of a trustee appointed in a chapter 11 case for cause. Unlike those situations, in subchapter V, the debtor stays in control of its business operations, as a "debtor in possession," unless removed for "cause, including fraud, dishonesty, incompetence, or gross mismanagement of the affairs of the debtor."²⁴

v. No Disclosure Statement is Required Unless Ordered by the Court for Cause

In a typical chapter 11, the debtor is required to prepare a "disclosure statement" that the court reviews for adequacy of information as a preliminary step before the plan can be voted on by creditors and confirmed by the court. Preparation of the disclosure statement is one of the factors that contributes to the time and expense of a typical chapter 11 case. Subchapter V eliminates that step from the process unless ordered by the court for cause.²⁵

vi. No Creditors' Committee

Creditors' committees can play an important role in chapter 11 cases.²⁶ The committee allows creditors to advocate collectively for the best interests of all the general unsecured creditors (or other classes of creditors or interest holders). However, the creditors' committee is also sometimes cited as a major expense that prevents small businesses from utilizing and successfully emerging from chapter 11. Subchapter V eliminates committees from the process unless expressly ordered by the court for cause.²⁷

c. Cases Examining Subchapter V

Subchapter V of the Bankruptcy Code became effective on February 19, 2020. Most of the initial court decisions addressing subchapter V focused on whether a bankruptcy petition filed prior to the effective date of the SBRA could be amended to change an existing case into a subchapter V case. Those cases have broadly come down in favor of permitting amendment. Although there are many other topics that may arise as the case law develops, for now the only other issue addressed in cases submitted for publication is the ability of subchapter V trustees to employ counsel...