Fixing Ch. 11 For Small Biz: SBRA Has Room For Improvement

By Brook Gotberg
Law360 is providing free access to its coronavirus coverage to make sure all members of the legal community have accurate information in this time of uncertainty and change. Use the form below to sign up for any of our weekly newsletters. Signing up for any of our section newsletters will opt you in to the weekly Coronavirus briefing.

Sign up for our Bankruptcy newsletter

You must correct or enter the following before you can sign up:

Select more newsletters to receive for free [+] Show less [-]

Thank You!



Law360 (February 12, 2021, 8:42 AM EST) -- On Feb. 19, 2020, Congress enacted the Small Business Reorganization Act to improve the Chapter 11 reorganization process for small business debtors. In this Expert Analysis series, bankruptcy experts reflect on ways the law has worked — and ways it hasn't — during the past year, a time of crisis for many small businesses. 


Brook Gotberg

For many in the bankruptcy community, the timing of the Small Business Reorganization Act[1] was strikingly fortuitous, with the SBRA becoming effective mere weeks after the outbreak of a global pandemic that would have widespread and long-lasting economic impacts on the small business community.

Particularly in the spring 2020, there was a great deal of excitement regarding how the law could be used to best serve the needs of the small business community, which many assumed would turn to the bankruptcy system in droves to find relief from the inevitable economic distress provoked by the global pandemic. Academics eagerly sent proposals to Congress adjusting the bankruptcy laws in expectation of that eventuality.

But, although there were bankruptcy filings dominating the headlines in 2020, the debtors tended to be large corporate entities, not the small businesses targeted by the SBRA. Indeed, if the SBRA is to prove a game-changing force for the COVID-19 economic crisis, its time is yet to come. 

The SBRA was a triumph for many in the bankruptcy community, which for several decades had observed the difficulties faced by small- and medium-sized enterprises attempting a reorganization under the standard Chapter 11 process.

The new law had two particularly notable provisions: The first permitted a fast-track approach by removing the need for extensive disclosures prior to proposing a plan of reorganization, and the second allowed debtors to force the plan over the objection of creditors without giving up owners' equity.[2]

It was believed that these provisions would allow for more successful bankruptcy filings among smaller businesses.[3]  

The changes introduced by the SBRA had yet to be extensively tested before the COVID-19 pandemic began to alter the landscape for most Americans. Indeed, there was scarcely time for the law to be implemented before courts nationwide shut down in an effort to reduce the spread of the virus.

Many of the planned continuing legal education forums and explanations of the new law were cancelled in the early days of the pandemic, leaving practitioners, members of the court and others even more in the dark than they might otherwise have been regarding the parameters and function of the new law.

A positive take on this state of affairs could be that the law was ripe for innovation. Because the law was still new, it seemed possible to make early adjustments to better facilitate its use among businesses hurt by the pandemic.

An interdisciplinary group of scholars who study the corporate bankruptcy system and the problems associated with financial distress, the Bankruptcy & COVID-19 Working Group, began to meet regularly in the spring of 2020 to discuss what legal action might be taken to assist large corporations, small businesses and individual debtors.

The subcommittee on small businesses was particularly interested in how the SBRA might be harnessed to provide meaningful assistance in a COVID-19 environment. 

On May 26, 2020, as chair of the Small Business Committee of the Bankruptcy & COVID-19 Working Group,[4] I sent a letter to the U.S. Congress recommending specific changes to the SBRA intended to assist small businesses struggling to survive.[5] While Congress did not enact our recommendations at that time, these proposals continue to be relevant considerations as the challenges posed by the pandemic continue.

These changes were intended primarily to give debtors essential breathing room to manage their debts in the wake of the national shutdown, when it seemed impossible to make any meaningful distinction between companies that were viable and those that were not.

The principle features of the suggested changes would permit businesses to file for bankruptcy under the SBRA primarily to take advantage of the automatic stay, which would extend for a full six months before the debtor would be required to proceed with the case.

In other words, debtors could receive the immediate benefit of the automatic stay, but put off filing the required schedules and statements, attending the mandatory status conferences and preparing the plan of reorganization necessary to successfully obtain a discharge, for a full six months.[6] 

In making this recommendation, the committee reasoned that six months' time would likely give filers under this provision a better understanding of what the future would hold, at which point they could decide whether to continue with the bankruptcy or voluntarily dismiss the case.

The proposal also recommended extending the timeframe in which debtors must assume or reject leases and permitting the cure of leases to be amortized over the life of the plan.[7] This would give filers additional time to determine if the company was viable in its current location, with its current obligations. It would further allow the company to repay any overhang of debt over a matter of years, rather than the weeks currently required under the law.[8]

These recommendations represented a major departure from preexisting legal norms and were intended to respond to the unprecedented nature of the moment. One of the committee's primary concerns was that many small businesses, particularly those without significant debt, would choose to simply close when faced with ongoing rent obligations they could not meet, or with an overhang of past-due rent accrued during months when revenue was artificially depressed due to the pandemic shutdown.

The group believed that such closures would likely be inefficient and create a downward pressure on the greater economy. Business closures would lead to greater unemployment and waste the going-concern value of a company, represented in part by the synergies of an already-developed business plan, a system of operations and workable location.[9]

Furthermore, mass closures could lead to the problems experienced during the 2008 financial crisis. Then, lenders foreclosed on home and business owners rather than negotiate a modified repayment, only to realize that the properties would then sit vacant in the absence of replacement tenants, inviting blight, crime and similar negative externalities.[10] 

Congress did not take up the majority of the group's recommendations. Instead, congressional actions have been focused primarily on the provision of additional capital to struggling businesses through the Paycheck Protection Plan, which was recently approved to distribute a second round of funds.[11] While many small businesses benefitted from the PPP, the bulk of the funds distributed when to larger companies, many of which had access to other sources of financing.[12]

Furthermore, the PPP failed to provide selective assistance, granting funds to businesses relatively unfazed by the pandemic, which necessarily reduced the relief available to those who really needed it.[13]

Although these funds have no doubt assisted some companies who would have otherwise failed, there is reason to believe that many small businesses did not receive sufficient help, and will continue to struggle for the foreseeable future.

According to a statement made by review website Yelp Inc. in September 2020, nearly 100,000 small business users were estimated to have permanently closed since March 1, 2020[14] and more have closed since the statement was made. It should be assumed that more will be driven to close in the future, unless they receive additional assistance.

Currently the CARES Act only extends eligibility to file under the SBRA to companies with up to $7.5 million in debt until March. Given the ongoing nature of the crisis, this sunset provision should be revisited, as should the committee's recommendations, particularly those permitting businesses more time to consider whether to accept or reject their leases and allowing businesses to cure rent obligations over time.[15]

For those businesses still struggling with low revenues, debt overhang and uncertainty regarding the future, the SBRA may ultimately prove to be a vital mechanism for reorganization. Furthermore, alterations to the law may still prove decisive in the survival of many otherwise viable businesses. 

The SBRA and bankruptcy laws in general exist because they are believed to ease the pain of insolvency by creating an orderly process to repay creditors, one in which the value is preserved and waste is minimized. Surely, the mass closure of small businesses would be the worst outcome for the current crisis, particularly when those companies might be saved for future prosperity through a reorganization plan.

Based on current filing rates, small businesses are not looking to the Bankruptcy Code for relief from the economic distress caused by the pandemic, at this time. However, there may come a time when the SBRA can provide relief sufficient to justify the confidence it inspired on passage.   



Brook E. Gotberg is an associate professor at Brigham Young University's J. Reuben Clark Law School.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] See Pub. L. 116-54; 11 U.S.C. §§ 1181-1195 (2019).

[2] See 11 U.S.C. §§ 1181, 1191. Under the "cramdown" scenario, discharge will not take place until all plan payments have been made, similar to the standard in chapter 13.

[3] See Lei Lei Wang Ekvall & Timothy Evanston, The Small Business Reorganization Act: Big Changes for Small Businesses, American Bar Association (Feb. 14, 2020) at https://www.americanbar.org/groups/business_law/publications/blt/2020/02/small-business-reorg/. The SBRA is currently limited to companies with less than $7.5 million in debt, although this number is itself an extension granted under the CARES Act, as the initial debt cap was $2,725,625. See CARES Act; 11 U.S.C. § 101(51D).

[4] The Committee also included (in alphabetical order) Anthony J. Casey of University of Chicago Law School, Robin Greenwood of Harvard University Business School, Benjamin Iverson of Brigham Young University Marriott School of Business, Edward Janger of Brooklyn Law School, Song Ma of Yale University School of Management, Edward Morrison of Columbia University Law School, Katherine Waldock of Georgetown University McDonough School of Business, Jialan Wang of University of Illinois Urbana-Champaign Gies College of Business, Michelle White of University of California San Diego, and Yesha Yadav of Vanderbilt University Law School.

[5] See Letter from Small Business Committee of the Bankruptcy & COVID-19 Working Group to Nancy Pelosi, Kevin McCarthy, Mitch McConnell, and Charles Schumer, May 26, 2020, on file with the author.

[6] Id.

[7] Under current law, a debtor in chapter 11 may assume an unexpired lease on the condition that the debtor timely perform all its obligations under the lease and cure outstanding obligations "promptly." See 11 U.S.C. § 365. This may be impossible for cash-strapped businesses struggling through a period of sustained low revenues caused by the pandemic and related shutdowns.

[8] See 11 U.S.C. § 365(d).

[9] See Depreciability of Going Concern Value, 122 U. Pa. L. Rev. 484, 486-87 (1973) (defining going concern value as "a composite of several unaccounted-for or prematurely-expensed business development expenditures which contribute to future earnings").

[10] See Creola Johnson, Fight Blight: Cities Sue to Hold Lenders Responsible for the Rise in Foreclosures and Abandoned Properties, 2008 Utah L. Rev. 1169, 1187 (2008) (describing legal actions taken by cities and municipalities against lenders for the problems associated with mass foreclosures).

[11] See Stacy Cowley, Who Qualifies for a Second Round of Small-Business Relief? The New York Times (Jan. 14, 2021) at https://www.nytimes.com/2021/01/14/business/ppp-loans-questions.html.

[12] See Jonathan O'Connell, Andrew Van Dam, Aaron Gregg & Alyssa Fowers, More Than Half of Emergency Small-Business Funds Went to Larger Businesses, New Data Shows, The Washington Post (Dec. 2, 2020 at 4:55 p.m. MST) at https://www.washingtonpost.com/business/2020/12/01/ppp-sba-data/.

[13] For a particularly egregious example of firms receiving PPP funds while scoring lucrative government contracts for personal protective equipment (PPE) supplies, see Nick Penzenstadler, Josh Salman & Dak Le, Coronavirus Contractors Double-Dip Government Funds, Receiving Relief Money and Contracts, USA Today (Aug. 17, 2020 at 4:02 AM MDT) at https://www.usatoday.com/in-depth/news/investigations/2020/08/17/coronavirus-contractors-double-even-triple-dip-into-relief-funds/3346470001/.

[14] See Yelp, Local Economic Impact Report, (September 2020) at https://www.yelpeconomicaverage.com/business-closures-update-sep-2020.html.

[15] A bill introduced by Senator Thom Tillis of North Carolina seemed to move in that direction. See S. 4479, 116th Cong. (Aug. 2020).

For a reprint of this article, please contact reprints@law360.com.

Hello! I'm Law360's automated support bot.

How can I help you today?

For example, you can type:
  • I forgot my password
  • I took a free trial but didn't get a verification email
  • How do I sign up for a newsletter?
Beta
Ask a question!