S. 1914 Business Bankruptcy Reform Act
Analysis Of Title IV
Small Business Bankruptcy Written by:
Joseph B. Collins
Joseph H. Reinhardt
HENDEL, COLLINS & NEWTON, P.C.
Prepared for the American Bankruptcy Institute
Web posted and Copyright © April 27, 1998, American Bankruptcy Institute.
Introduction. The small business bankruptcy provisions set forth in Title IV of the proposed bill include many of the recommendations made by the Bankruptcy Review Commission ("Commission"). The Commission expressed its concern that no bankruptcy purpose was served by lengthy and inconclusive reorganization proceedings that served primarily to protect debtors from creditor action. The Commission was concerned that Chapter 11 lured many small business debtors that had no realistic hope of confirming a Plan of Reorganization. Conversely, the Commission also recognized that a successful reorganization can save jobs, enhance the return to creditors and preserve the going value of a business.
The proposed bill sets up a class of cases to which special reorganization provisions apply. That class includes all debtors having liquidated debt less than $5,000,000.00 and all single asset real estate cases. Although statistics are not available, this classification may include the great majority of Chapter 11 cases. Certain provisions of the bill seem to relax the difficulty of reorganization for a small business. For example, the provisions that modify disclosure statement requirements should assist debtors in Small Business Cases. The preparation of a disclosure statement sufficient to satisfy the requirements of the existing Code has always been a time consuming and expensive proposition for debtors.
Other sections of the bill seem to make the reorganization process more complex for small companies. The bill not only restricts the time for filing and confirming a Plan of Reorganization, but also increases the debtor's duties during that period by requiring additional reporting requirements and attendance at additional conferences.
With these observations in mind, comment is provided on each of the proposed sections of Title IV - Small Business Bankruptcy.
Sec. 401. Small Business Defined. Under the present version of the Code, §§101(51)(B) and (51)(C), small business activity is bifurcated into small business entities with total undisputed debt of $2,000,000.00 or less (exclusive of owners/operators of real estate) and single asset real estate cases with undisputed secured debt of $4,000,000.00 or less. The bifurcation continues with the distinction that the small business provisions are elective §1121(e), while the single asset real estate provisions are mandatory §101(51)(B). The bifurcation concludes with provisions §§1102(a)(3), 1121(e) and 1125(f), which tend to simplify and expedite the reorganization process in Small Business Cases.
The proposed bill will make designation as a Small Business Case mandatory in single asset real estate cases and when the total debt of other debtors is $5,000,000.00 or less. The bill will eliminate most of the bifurcation between a small business and single asset real estate cases. Certain distinctions will, however, exist for the single asset real estate case as discussed in the analysis of §§415 and 416 of the proposed bill.
Although statistics do not seem to be available, it seems that the vast majority of Chapter 11 cases will be Small Business Cases under the proposed bill. The mandatory application of thesmall business provisions of the bill will, therefore, result in a substantial change in small business reorganization efforts throughout the country.
Sec. 402. Flexible Rules for Disclosure Statements. Under the present Code, Small Business Cases have a simplified disclosure statement procedure. Single asset real estate cases face a full disclosure statement requirement. The proposed bill provides the potential for elimination of a disclosure statement altogether, at the Court's discretion. Even if the Court elects to proceed with the disclosure statement process, it can do so in a procedurally simplified manner, due to the proposed use of form disclosure statements and the combination of disclosure statement and plan confirmation hearings.
Sec. 403. Standard Form Disclosure Statements and Plans. This Section is a major departure from the present Code, which has no provision for standard form disclosure statements and plans. The present disclosure standard is adequate information along the lines of an investment prospectus, §1125. The proposed bill provides for a balance in the construction of standard forms between "reasonably complete information" for the Courts, creditors, economy and simplicity for debtors. Standard form disclosure statements and plans have the potential for reducing the time that a debtor spends in bankruptcy and the expense of the case.
Sec. 404. Uniform National Reporting Requirements. This Section represents an entirely new set of provisions for reporting, unparalleled in the present Code. These reports deal with profit and loss, financial projections, historical comparisons of the current financial data with past projections, statutory and rules compliance, and tax compliance.
These reporting requirements are likely to add to the administrative cost of a Small Business Case. Small businesses do not have the ability to produce them, although the desirability of the reports cannot be denied, many Debtors will be obliged to seek professional assistance to comply with the proposed new reporting requirements.
The new provisions also do not address the fact that the Office of the U.S. Trustee already requires Debtors to provide some of the information required by new §404. The U.S. Trustee's Operating Guidelines and Reporting Requirements for Chapter 11 Cases ("OGRR") requires debtors to provide information regarding cash flow, unpaid administrative expense, and tax compliance. If the OGRR continues, small business debtors will have inconsistent and duplicative reporting requirements for the Court and for the U.S. Trustee.
Title IV generally seems to shift the responsibility for monitoring the Debtors day to day activities from the U.S. Trustee to the Court. The requirement that statutory reports be filed with the Court rather than with the U.S. Trustee is one example of this. In the days preceding the enactment of the Bankruptcy Reform Act of 1978, much concern was expressed about the Bankruptcy Courts involvement in the administrative and business aspects of the case, rather than with the application of the law. By involving the Court in financial reporting and status conferences (See §406), Congress should be aware that it is taking a step back in that direction.
Sec. 405. Uniform Reporting Rules and Forms. The guidelines for the structure and format of the financial reporting rules is the same as that for the content of form disclosure statements and plans, the balancing of a need for information with simplicity and economy for debtors.
Sec. 406. Duties of a Trustee or Debtor in Possession in Small Business Cases. The present version of the Code contains two sections that deal with the duties of a debtor. Section 521 deals with a debtor's duties in general and focuses predominantly on individual debtors. Section 1106 is applicable (with the exception of the investigating requirements) to Chapter 11 debtors in possession through the mandate of §1107.
The proposed bill specifies certain additional duties to be performed by a small business debtor. Some of these duties (i.e., filing tax returns and paying post petition taxes, maintenance of insurance, and filing required post petition financial reports) codify existing practice. Other requirements go beyond existing practice and should be considered separately.
a. Additional Financial Disclosures to be Filed With Voluntary Petition.
The additional documents that a debtor will be required to filed with the voluntary petition are typical of those items that will be produced at the request of the U.S. Trustee or a Creditor's Committee in a Chapter 11 case. What is significant about the requirement is that these documents must be appended to the voluntary petition or in a case of an involuntary case filed within three days after the entry of an order of relief. The Bankruptcy Rules have long recognized the fact that a debtor often enters bankruptcy in response to exigent circumstances, see generally, Rule 1007. The Bankruptcy Rules have established procedures that allow a debtor to seek extensions of time to file the various lists, schedules and statements required to commence a bankruptcy case. In order to make the requirements for Small Business Cases consistent with the debtor's other bankruptcy duties, proposed §1115(1) might be amended by deleting the phrase "append to the voluntary petition or, in an involuntary case, file within 3 days after the order for relief" and inserting the word "file."
b. Attendance at Interviews, Conferences and Meetings.
The present law requires a debtor to attend a meeting held pursuant to §341. The U.S. Trustee has also assumed the responsibility for conducting initial meetings with the debtor and its largest creditors at the outset of a case. Typically these meeting will determine whether a Creditor's Committee is appointed. Proposed §1115(2) modifies current practice by requiring initial debtor interviews and adds the additional requirement for scheduling conferences to held before the Court.
With respect to initial debtor interviews, the law seems to codify the U.S. Trustee's existing practice and require attendance by the debtor's senior management personnel and its counsel.
With respect to scheduling conferences, a new requirement is imposed. These conferences are to be held before the Court and are apparently nonevidentiary. Since a debtor's time is at a premium under the expedited requirements for Small Business Cases, one wonders why senior management personnel of a small business would be required to attend a scheduling conference.
c. Depositing Taxes into Separate Accounts.
Proposed §1115(6)(C) requires the establishment of separate deposit accounts into which all taxes collected or withheld must be deposited within one business day after receipt. The requirement for the escrow of taxes within one business day after receipt is a substantial departure from the routine practice of most solvent and insolvent companies. Every business that collects a sales tax, for example, would be required to implement a procedure for the daily accounting and escrow of sales tax receipts in order to comply with the law. The imposition of this new requirement will undoubtedly add additional pressure to owners of small businesses that are placed under pressure by the condensed time limits of the new bill.
Sec. 407. Plan Filing and Confirmation Deadlines. Proposed §407 reduces the time within which a small business debtor may file a plan from 100 days to 90 days. The Section also reduces the time within which a third party can file a plan from 160 days to 90 days. The Section also makes it more difficult for the debtor to obtain an extension of the time within which a plan might be filed. Under existing law, an extension may be given if the debtor can show that the need for an increased time period is the result of circumstances for which it should not be held accountable. Under the proposed law, the debtor must demonstrate by clear and convincing evidence that is more likely than not to confirm a plan within a reasonable period of time.
The most obvious effect of the compressed time period for the filing of a plan is to place pressure on a debtor to formulate its reorganization alternatives shortly after the commencement of the case. A more subtle effect of this section is to create circumstances in which it would be difficult for a third party to file a competing plan within the statutory time constraints. A debtor that fears a competing plan is not likely to inform its competitor of its reorganization plans until the last day allowed for the filing of a plan. Since the third party will not know whether it can offer a better plan until the debtor's is filed, and since the preparation of a competing plan requires a significant expenditure of time and effort, third parties may be less likely to expend the resources necessary to file a competing plan.
Sec. 408. Plan Confirmation Deadline. Section 408 adds a new paragraph to §1129 of the Bankruptcy Code that mandates the confirmation of a plan on or before 150 days from the commencement of a case. Since most plans are likely to be filed on the 90th day filing the commencement of the case, this basically leaves a 60 day period for plan confirmation. During this 60 day period, the following events would have to occur:
1.The filing of a plan and disclosure statement presumably with a Motion seeking the Court's conditional approval of the disclosure statement.
2.A hearing on conditional approval of the disclosure statement, together with any objections that might be filed to the Debtor's Motion seeking conditional approval.
3.The modification of the disclosure statement in order to comply with any requirements that the Court might make in granting conditional approval.
4.The printing of the plan and disclosure statement and the circulation of the plan and disclosure statement to creditors.
5.The expiration of a 25 day solicitation period; Rule 2002(b), plus a three day mailing period, Rule 9006(f).
6.The preparation of a report on acceptances and other documents and materials necessary to confirm the plan.
7.The confirmation hearing and funding of the plan.
The events noted above, of course, involve only the bankruptcy requirements. Since many plans contemplate a sale of assets or a financing transaction, the debtor would have to coordinate these events so that they took place within the statutory deadlines. Although no statistics seem to exist, we feel that it is safe to say that very few Chapter 11 cases have been confirmed on this fast of a track. Even with the reduced disclosure statement requirements, the schedule for the debtor will be grueling.
Sec. 409. Prohibition Against Extension of Time. Section 105 of the Bankruptcy Code gives the Bankruptcy Court broad authority to enter Orders necessary and appropriate to carry out the bankruptcy process. Under this section, the Bankruptcy Courts have historically entered a wide variety of orders that have been deemed appropriate to further the bankruptcy process.
Proposed §409 will restrict the Court's discretion to grant extensions of time for the filing or confirmation of a Plan under §105.
Sec. 410. Duties of the U.S. Trustee and Bankruptcy Administrator. The present Code does not contain any statutory duties for the U.S. Trustee or Bankruptcy Administrators that are aimed at Small Business Cases. The duties promulgated in the proposed bill, however, are similar to those that have already been undertaken by many U.S. Trustees without the statutory mandate. For example, an initial conference is held in many jurisdictions in which many of the issues enumerated in proposed §586(a)(3)(H) are discussed.
The proposed statute departs from existing practice by suggesting that the U.S. Trustee should attempt to develop a scheduling order. The concept of a scheduling order is new to the Bankruptcy Code. The proposed statute contains no guidance as to what is to be scheduled, how an order will be presented to the Court, or what the U.S. Trustee's rights are if its attempts to reach agreement with a debtor fail.
Sec. 411. Scheduling Conferences. Under the present Bankruptcy Code, the Court had the discretion to hold status conferences. The proposed bill mandates status conferences that are requested by parties in interest. As noted in connection with §404, status conferences tend to deal with administrative, rather than legal aspects of the case.
Sec. 412. Serial Filer Provisions. The present Code does not contain any specific provisions for dealing with serial filers. The serial filer problem is becoming increasingly prevalent in consumer and Small Business Cases. The proposed bill seems to adequately address the problem.
Sec. 413. Expanded Grounds for Dismissal or Conversion and Appointment of Trustee. In the present Code, the Court has a significant level of discretion as to whether to convert, dismiss or appoint a Trustee. The proposed bill serves to significantly reduce this discretion, making conversion or dismissal mandatory in certain specified circumstances. The proposed bill goes on to force motions to dismiss or convert to the top of the Court's docket by requiring hearings to be held within 30 days from the filing of the Motion and decisions within 15 days thereafter.
There are two places in the proposed bill where the language might be changed to clarify the apparent intent of the bill. Specifically, §1112(b)(2)(A)(i) should be changed by deleting the word "an" and inserting the word "the". Also, §1112(b)(2)(A)(ii) might be changed by deleting the phrase "by order of" and inserting the phrase "within the period of time ordered by". Also, §1112(b)(3)(J)(i) and §1112(b)(3)(J)(ii) might be revised to conform more precisely with Paragraph (2)(A). Specifically, Paragraph (3)(J)(i) could be amended to read "within the applicable period of time specified in this title; or" and Paragraph 3(J)(ii) could be amended to read "within the period of time ordered by the Court; and".
Sec. 414. Single Asset Real Estate Defined. Under the present Code, a single asset real estate case is limited to situations where the aggregate secured debt does not exceed $4,000,000.00. The proposed bill removes the debt limitation and thus subjects all single asset real estate projects to the requirements of a Small Business Case.
The new bill continues to exclude from the definition of single asset real estate cases, those companies in which substantial business, other than the business of operating the real property, is involved. Given the difficulties that real estate projects will have in meeting the deadlines of the proposed bill, and in consideration of the difficulties that a real estate project will have in confirming a plan under the revisions to §1129, it can be anticipated that litigation over the "substantial business" exclusion will increase.
Sec. 415. Plan Confirmation. There is considerable debate under the present Code and its interpretive case law as to whether there is a "new value exception" to the Absolute Priority Rule. This conundrum frequently arises in single asset real estate cases in which the plan proposes to "cram down" the secured creditors' claim. The proposed bill gives the secured creditor the right to limit the Court's ability to find that the new value exception has been satisfied to circumstances in which the new value is at least equivalent to 25% of the value of the real estate. The 25% capital contribution would be payable in cash. This requirement, taken together with the time frame in which the single asset case must proceed to confirmation, will make it very difficult for real estate projects to successfully reorganize.
Sec. 416. Payment of Interest. This section of the proposed bill requires that a Debtor pay a contract rate of interest on the value of the creditors' interest in collateral in a single asset real estate case. This changes the current law which required the payment of a fair market rate of interest.
The proposed bill also provides that such payments may begin as early as 30 days from the date that the Court determines that the debtor is a single asset real estate case.