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SBRA: Frequently Asked Questions and Some Answers

The following Q&A are taken from a feature in the November 2019 ABI Journal article.

When does the new law take effect? The Small Business Reorganization Act of 2019 (SBRA) became law on Aug. 23, 2019 (Pub. L. 116-54). However, its effective date is “180 days” later: to cases filed on or after Feb. 19, 2020.

How does the SBRA compare to chapter 12? Relief under the SBRA is modeled on chapter 12 relief. Chapter 12 came into existence in 1986 because farmers had difficulty getting plans confirmed under chapter 11. The SBRA exists today because small businesses have had difficulty getting plans confirmed under chapter 11. In both cases, the problem was the absolute-priority rule, which denies plan confirmation unless unsecured creditors agree to receive less than 100 percent. Both chapter 12 and the SBRA eliminate the absolute- priority rule. In other ways, the standards for confirmation of a plan under the SBRA follow chapter 11, not chapter 12.

Is a disclosure statement required under the SBRA? Yes, but it’s a disclosure statement “lite.” The SBRA retains a disclosure statement requirement (§ 1190), but only three items are required to be disclosed: a brief history of the business operations of the debtor; a liquidation analysis; and projections on the ability of the debtor to make payments under the proposed plan.

Does the SBRA eliminate any of the chapter 11 confirmation requirements? Yes. Plan-confirmation standards for chapter 11 are established in § 1129 (a) and (b). Generally, the standards of § 1129 (a) will still apply. However, the SBRA declares (in § 1191 (a) and (b)) that the following provisions of § 1129 do not apply in a small business case: Unless explicitly incorporated, cramdown provisions of § 1129 (b) do not apply; such (b) requirements take effect only when paragraph (8) of § 1129 (a) is not satisfied. Paragraph (8) of § 1129 (a) does not apply.

Paragraph (8) requires that each class of claims has either “accepted the plan” or “is not impaired under the plan.” This exclusion eliminates the absolute-priority rule, which appears in the cramdown requirements of § 1129 (b). Moreover, the “at least one class” of impaired claims “has accepted the plan” requirement in paragraph (10) of § 1129 (a) does not apply. This exclusion removes any requirement for creditor acceptance of a debtor’s plan. Special provisions for “individual” debtors, under paragraph (15) of § 1129 (a), do not apply.

Does the SBRA specifically incorporate any of the confirmation requirements in the cramdown provisions of § 1129 (b)? Yes. The following confirmation requirements from § 1129 (b) are explicitly incorporated into the SBRA (by § 1191 (b) and (c)): The plan must not “discriminate unfairly” and must be “fair and equitable” for “each class of claims or interests that is impaired under, and has not accepted the plan” — this is a verbatim copy of the language from § 1129 (b) (1).

The “fair and equitable” standard under the SBRA includes the following details: requirements of § 1129 (b) (2) (A) for secured claims must be satisfied; the plan must contribute all of the debtor’s “projected disposable income” to making plan payments for three to five years; the plan must be feasible (i.e., there must be a “reasonable likelihood” that the “debtor will be able to make all payments under the plan”); and the plan must provide “appropriate remedies” to “protect” creditors from a failure to make payments, including “the liquidation of nonexempt assets.”

Will the “contents of plan” provisions in § 1123 apply under the SBRA? The provisions of § 1123 on “contents of plan” will still apply under the SBRA, except for the following specific items (see § 1181 (a)): the “future income from individual services” rule in § 1123 (a) (8); the creditor-plan rule for an individual debtor in § 1123 (c); and the “lien on principal residence” rule discussed below.

Can a lien secured only by a debtor’s principal residence be avoided? It depends. The SBRA changes the existing chapter 11 rule, which prohibits modification of lien rights that are “secured only by a security interest” in a debtor’s “principal residence” (see § 1123 (b) (5)).The new rule (in § 1190 (3)) authorizes modification of such lien rights when the “new value” that a debtor received for such lien was (1) “not used primarily to acquire” the residence, and (2) instead was “used primarily” in the debtor’s small business.

Does voting on plan confirmation still exist under the SBRA? Probably, but this appears to be ambiguous. Here’s why: For starters, “acceptance of plan” provisions in § 1126 are not mentioned in the SBRA — neither explicitly included nor excluded. Second, the SBRA explicitly eliminates § 1129 (a) (8) and (10) requirements that impaired classes must accept the plan (see § 1191 (b)). Third, § 1191 (b) requires fair and equitable treatment of an impaired claim that “has not accepted” the plan. Fourth, the trustee is to facilitate the development of “a consensual plan.”

How does the role of a trustee under the SBRA com¬pare to the role of a trustee under chapter 12 and 13? A trustee is appointed in each: under the SBRA (§ 1183), under chapter 12 (§ 1202) and under chapter 13 (§ 1302). The statutory role and duties of these three trustees are similar, particularly as between the SBRA and chapter 12.

The primary difference is a small business chapter 11 provision in § 1183 (b) (7), which states that “The trustee shall ... (7) facilitate the development of a consensual plan of reorganization.” This provision is unique; in no other place does the Bankruptcy Code (1) authorize a trustee to help a debtor in possession develop a plan of reorganization, or (2) suggest the goal of a “consensual plan” when the absolute-priority rule does not apply.

How will the small business trustee be compensated? Section 586 (e) (1) and (5) allows the court to “award compensation” to the small business trustee in an amount “consistent with services performed” and limited by 10 percent of “payments made under the plan.” Such compensation is payable upon substantial consummation of the plan, conversion or dismissal of the case, or other termination of the trustee’s services. The small business trustee is expressly excluded from provisions of § 326.

What exactly are the nature and limits of this “facilitate the development” role? That remains to be determined, but here are a couple suggestions. One suggestion is that the SBRA trustee should be a financial wizard who can work with all parties on cash flows, interest rates, payment requirements and all the numbers puzzles that comprise a plan. After all, financial advisors fill a crucial role in large bankruptcy cases. Such a role is still needed — but rarely used — in small business cases because of limited resources.

The SBRA trustee could also fill a mediation role: The statutory “facilitator” role of the small business trustee, combined with the statutory goal of a “consensual plan,” seems to suggest a mediation-type role. After all, that’s what mediation does: It “facilitates” a process of achieving a “consensual” result.

How does the existence of the SBRA affect representation of a client who qualifies? Before the SBRA, the first question in representing a debtor who now qualifies was this: How do we deal with the absolute-priority rule? Upon the effective date of the SBRA, the first questions in representing a debtor who qualifies will become: (1) What are our goals, and (2) is there a credible cash flow to achieve those goals? The SBRA thus offers options to debtors and their counsel not previously available.

When does the small business debtor get a discharge: upon confirmation like chapter 11, or after completion of plan payments like chapter 12 and 13? Under the SBRA, the debtor receives a discharge only “after completion” of “all payments due within” the three- to five-year term of the plan (§ 1192) — like chapters 12 and 13 — but without incorporating the hardship-discharge provisions of § 1328 (b). However, if creditors consent, the debtor can receive a discharge at confirmation.

Regarding rates of interest under a plan, will the U.S. Supreme Court’s formulation for chapter 13, established in In re Till, 541 U.S. 465 (2004), still apply? This question probably has a district-by-district answer. Some bankruptcy courts follow In re Till in circumstances outside of chapter 13. However, others don’t. Future practice under the SBRA will probably follow the same course: Courts that are accustomed to following In re Till in chapter 11 or 12 contexts will probably continue to do so, while courts who aren’t won’t.

What impact will the SBRA have on preference claims under the Bankruptcy Code? The impact is not limited to small business cases and is twofold. Before a preference claim can be pursued, a claimant must use “reasonable due diligence” in light of “the circumstances of the case” to con-sider “a party’s known or reasonably knowable affirmative defenses.” However, a preference suit for less than $25,000 against a noninsider, involving a non-consumer debt, can only be brought in the district where the defendant resides.

Why did Congress set the total debt limit for SBRA eligibility so low, at $2,725,625? The reality is that, as with chapter 12, Congress is establishing a baseline from which to measure the SBRA’s impact. In 1986, Congress set the debt limit for chapter 12 at only $1.5 million. Chapter 12 has worked as Congress intended. Legislation recently enacted (Pub. L. 116-53) raises the limit to $10 million. It is hoped that the recommendations of ABI ($10 million) or the National Bankruptcy Conference ($7.5 million) will be considered in the near future.

Are there any federal rules or model local rules being proposed for the SBRA? The Committee on Bankruptcy Rules of the U.S. Judicial Conference is considering the development of model rules. Watch this space for more details to come.

Q&A from "Subchapter V Nuts and Bolts" Webinar

ABI's Consumer Bankruptcy Committee sponsored an abiLIVE webinar on May 7, 2020, titled "Understanding the Nuts and Bolts of the “New” Subchapter V Small Business Chapter 11." The following is a compilation of the questions that came up during the program and answers provided by the panelists.

Please note that replies of Bankruptcy Judge Paul Bonapfel to questions directed to him are made for educational purposes only, not as an opinion or judgement for proceedings within his courtroom.

Can a nonprofit corporation elect Subchaper V? The statute does not directly address this. The issue would be whether a nonprofit is “engaged in commercial or business activities.” The same issue exists under former small business debtor law, so perhaps there is some case law out there.

Since there is no committee in a Subchaper V case, what is the purpose of the list of 20-largest unsecured creditors? Good question. I’m not sure that the Rules Committee considered this in the process of implementing the new rules.

Do you know what the legislative intent was in excluding debtor whose prinicipal activity is ownership of real estate? It’s hard to claim to know legislative intent, but SBRA actually expanded the availability of small business relief for debtors operating real estate. Prior to SBRA, a debtor whose principal activity was real estate did not qualify as a small business debtor. It could be that Congress thought that a single asset real estate debtor problem is usually a dispute between a debtor and the mortgage holder, with little unsecured debt, and that it did not want to interfere with the current chapter 11 regimen for such debtors.

On page 11, how does this "no substantial business" comment apply during the current remote working? I’m not sure that I understand the question but I think a good argument can be made that a debtor who shut down because of COVID-19 but intends to reopen qualifies as being engaged in commercial or business activity. And under the ruling in the Wright case in South Carolina, it looks like the fact that the debtor is seeking to deal with commercial and business debt would be enough to qualify.

Can the Subchpater V Trustee seek to retain counsel? The statute does not prohibit it. The question is whether courts will routinely permit it. The materials at section IV(F) discuss the issues.

For Judge Bonapfel: trustee selected by UST and no court order. There's trend in the law to remove powers from courts, e.g. mandatory sentencing. Do you have any thoughts about this? This is actually the same as it would be in chapter 12 and 13 if we did not have standing trustees.

Why not simply call it non consentual plan instea of crammdown plan? Why not simply consentual vs. non-consentual plan confirmation? “Cramdown” has become a colloquial “term of art” for many, meaning “nonconsensual.” It’s the common term that has made its way into my vocabulary.

Are documents such as tax returns to Are documents such as tax returns to be filed with the court or provided with the UST? 1116(1)(A) and (B), which does not apply in sub V cases (new 1181(a)) but which the debtor must comply with under new 1187, requires their filing. In an individual case, it would be appropriate to redact the social security number.

For Judge Bonapfel: If a Subchaper V operating trustee cannot file a plan, could he have standing to convert to a regular small business chapter 11 which allows a case trustee to file a plan. This would only be where the debtor will not file a plan suggested by the case trustee. I don’t think the case could be “converted” to a regular chapter 11 case because it’s a question of whether subchapter V has been elected and applies. It’s an interesting thought that perhaps a debtor could “unelect” application of subchapter V. The sub V trustee could file a motion to dismiss or convert to chapter 7. If it’s a question of whether the business should be operated so that it can be sold as a going concern, a chapter 7 trustee could do that. As a practical matter, I wonder whether putting a trustee in possession in a sub V case will be a viable option in most cases. If the situation has deteriorated so badly that the debtor can’t be trusted to run the business, and if the debtor (or its principals) are essential to the business (as they frequently are in a small business), putting a trustee in is not likely to produce a positive result. And of course there is the additional expense of a trustee operating the business.

Are there any forms for a Subchaper V "Report" or "Plan" or any other pleadings? The materials include the New Jersey form plan. Official Form 425A is a national form that is permissive and has been adapted for use in subchapter V cases. Check your district’s web site. Some courts may have required or optional plan forms, and may have requirements relating to the debtor’s report required for the status conference, as well as other matters.

Can you please clarify that "only the debtor may file the plan." No other party can propose what to do with the debtor’s business or income. The Trustee cannot assist in preparation? No problem with the trustee assisting in its preparation (or insisting on provisions to avoid objections, probably like chapter 13 practice) as part of trustee’s duty to facilitate a consensual plan. But neither the trustee nor any other creditor can file a plan (both can in a standard chapter 11 case) or modify it (the trustee or an unsecured creditor may seek modification in a chapter 13 case.

If a case is to be converted FROM a Subchaper V case, an it be converted TO a non-Subchaper V case? Conversion is not the precise term; a subchapter V case arises from election. I had not thought of this, but it does occur to me that, if the debtor can amend a petition, it could amend to change the election. Query whether a court would permit that based on laches or some other equitable consideration. As a general observation, my understanding is that some small business debtor lawyers don’t much like being in a non-subchapter V case.

RE: Real estate exclusion under Subchapter 5: I am told "owning & operating real estate" is determined by revenue being from rents. Is this correct? I suppose in the usual case that revenue from real estate ownership and operation would consists of rents, if “rent” includes charges for overnight stays in, say, a hotel or B & B, or revenues like green and cart fees from a golf course. If yes, then are development projects that produce units (e.g. condos) or lots. What about development leased income projects that are not finished, not rented, no revenue (yet)? I can’t answer this specifically, but as long as the debtor is not a single asset real estate debtor (see the definition in 101(51B)), it looks like it can be a small business debtor.

Should the mandatory status conference be "on the record" or is it more informal similar to a pre-trial conference? Check local listings as to what your court will be doing. Almost all matters in ND Ga. are on the record.

For Ms. Miller: Can you elaborate on the need for a detailed report prior to a status conference, and in particular, indicate what type of information may satisfy that requirement without breaching client confidentiality or dislcosing settlement and compromise negotiations? Not my question, but this will depend on what the local court requires. Courts may pusblish guidelines, directives, general orders, case-specific orders, or local rules that state the court’s expectations with regard to the status conference and the report. We are not doing any of that in ND Georgia. I would at least expect a report on how business operations are going, whether the debtor is current on postpetition bills (and taxes), what negotiations are underway with the major creditors (secured lender, landlords, or whatever caused the filing), and an overview of what the plan is likely to be.

Is there an opportunity to convert a small business 11 to a Subchaper V? If so, what are the restrictions (e.g., timing)? The materials discuss the four cases that permit an amendment to the voluntary petition in an existing case to elect subchapter V at Part XIII. There is no specified deadline in the statute. One court suggested that laches (or some other equitable doctrine) might preclude changing the election at some point. Some of the cases note that the deadlines in sub V for the plan and status conference can be changed so that the fact that they have passed is not an absolute bar to an amendment to the petition to elect subchapter five.

Re: Disinterestedness: OK to waive fees to get amount under $10k? This is a typical action by professionals and nothing is wrong with it. SBRA eliminates the requirement. This feature may be particularly helpful in dealing with other professionals, particularly accountants. Lawyers understand why theyhave to waive fees and that they probably won’t be paid anyway; it’s worth it to write off prepetition fees (that won’t be paid anyway) in connection with getting the new business (which, unfortunately, may also result in some reduction or nonpayment). Accountants – and nonbusiness lawyers (think of the lawyer who handles litigation or some specialized business or regulatory issues) – don’t easily understand the need for the write-off and may decline employment on the theory that they don’t work if they have to write off fees.

Merchant Cash Advances involve a "factor" purchasing all of a merchant's account receivables at a deep discount and then getting the small business merchant to guarantee risk of repayment at full price. Can a SBRA debtor stretch out the repayment term of such a secured claim beyond 5 years if the Merchant Cash Advance company elects under 1111(b) , since most Merchant Cash Advances are undersecured? This is an 1111(b) question beyond my pay scale for this program. But as I remember how 1111(b) works, the effect of the election is to allow the claim as fully secured, which doesn’t necessarily address the timing of payments under the plan. Further, the cramdown rule (under pre-SBRA law and under SBRA for secured creditors) is that the debtor pay the present value of the allowed claim with payments that equal its total. See 1129(a)(7)(B) and 1129(b)(2)(A). So, for example, if a creditor has real estate worth $ 50,000 as collateral to secure a $ 100,000 claim, the plan must make payments that total $ 100,000 with a current value of $ 50,000, even if the election is made. $50,000 amortized with interest over 30 years, for example, would easily meet that requirement: the interest component takes care of providing present value, and the total of the payments (interest and principal) over that time frame will exceed $ 100,000. In this example, the payment schedule could not permit prepayment unless the amount of the prepayment is stated to be $ 100,000 less the sum of all payments previously made.

For a cramdown plan, if debtor agrees to pay 100% of disposable income, but that income is projected to be zero or very low, will the plan be approved? If the disposable income is zero or very low, that’s what the statute requires. The factual issue is whether the projection is correct. Early chapter 13 case law might suggest that a zero-percent plan might not be “in good faith.” See Chapter 13 Practice and Procedure (Westlaw: CHAP13PP, and cited in the materials at footnote 60) sections 4:30 – 4:34, especially 4:31.

What if residence financing was used to remodel or improve the RP? Check out the Ventura case – it will depend on whether the purpose of the financing was for business. If the remodeling or improvement was to create space for business or commercial purposes, 1190(3) probably works. It probably doesn’t work if the debtor put in a pool or tennis court. Unless, perhaps, the debtor coaches swimmers or tennis players.

I understood that admin claims do NOT have to be paid at confirmation - can be spread out. Which is correct? For confirmation in a standard chapter 11 case, administrative claims have to be paid in full at the time of the effective date (usually defined in the plan and often when payments begin). 1129(a)(9). Consensual confirmation under new 1191(a) requires compliance with 1129(a)(9). Admin claimants may, however, agree otherwise, in which case it is consensual. So a consensual plan can provide for deferred payment with consent. Deferral is permissible in cramdown plan.

Is there a voting process if a consensual Plan? Yes. Just like in standard chapter 11, but with no disclosure statement.

Can a debtor (such as a restaurant) in a cramdown plan force a lease modification? What leverage would a Sub V debtor have? Lessors probably could not agree to a modification under their mortgage terms. The usual rules under 365 for assumption or rejection of executory contracts and unexpired leases apply. Lessors who cannot agree to a modification under mortgage terms face the prospect of not having a tenant, which isn’t a problem if demand for the space is high but could be quite important if occupancy is really low. The mortrgage lender should take that into account and be prepared to make an appropriate business decision. But there doesn’t appear to be any “legal” leverage beyond typical business considerations.

Any estimates on number of consensul vs. cramdown SBRA plans that will ultimately be confirmed? Subchapter V doesn’t change the economic realities of distressed debtors. But prospects should be better based on legal considerations if the debtor can make the business work at least well enough to handle essential parties, primarily landlords and secured creditors.

I note that Section 1181(a) makes the plan modification provisions of Section 1127 inapplicable to subchapter V cases. Could a subchapter V plan nonetheless provide for its subsequent modification? It might; the modification would then, it seems to me, be pursuant to the plan, not the statute. But I wonder whether creditors (especially a secured creditor) is going to agree to a plan that permits a later modification. And if it’s acceptance of the modification would be required (probably would be; otherwise it’s not consensual), a change in payment terms could be effected by agreement without having to come back to court.

You noted that in a consensual plan, a subchapater V trustee and other professionals may agree to be paid over time, but wouldn't the Trustee have to say in place is the consensual plan provides for payment over time? If it’s a consensual plan, the trustee will have nothing to do. (Query whether, notwithstanding the plan, a consensual plan could provide for the trustee to do something? Might have to play with the definition of “substantial consummation” to make that happen under the statute). In any event, the trustee’s compensation will be fixed without regard to what is disbursed under the plan, presumably at or around or shortly after confirmation. So the trustee would not have to stay in place.

Who pays to litigate 523(a) matters? The debtor will have to work that out with the debtor’s lawyer.