Courtesy / Dentons
Andrew C. Helman
April 15, 2020
How to navigate Congress’ changes to the bankruptcy code
By Andrew C. Helman
The last several weeks have brought limited relief to businesses grappling with an immediate economic downturn that is the result of COVID-19 and social distancing. However, some businesses will require more help than short-term loans backed by the government can provide. They will need to restructure mortgage loans, reduce debt service, or even eliminate unsecured debt, such as trade payables.
To address this, Congress has made it easier to reorganize under Chapter 11 of the Bankruptcy Code by dramatically expanding the scope of businesses that can take advantage of a new, streamlined Chapter 11 process designed for small businesses. This streamlined process was previously only available to companies with up to about $2.7 million in debts. Now, for the next 12 months only, companies with up to $7.5 million in debts will be eligible to reorganize as small business debtors.
These businesses will be able to use powerful tools under the Bankruptcy Code to clean up their balance sheets and “right size” existing debt, while also getting breathing room and preventing creditors from seizing assets.
Key aspects of a streamlined small business Chapter 11 case include the following.
- You stay in control during the case. Like a traditional Chapter 11 case, equity or pre-bankruptcy management will remain in control of the company during the case, absent highly unusual circumstances. In contrast to a traditional Chapter 11 case, only the company seeking to reorganize can file a Chapter 11 plan, the key document that a bankruptcy court must approve to allow a company to exit Chapter 11. This helps to keep the company in control.
- You can remain in control after the case. In a traditional Chapter 11 case, unsecured creditors (such as trade vendors) can block equity from retaining ownership of a company if the company does not pay them in full under a Chapter 11 plan. This rule does not apply in a small business case. Instead, a company must make payments under a Chapter 11 plan that fit within two bookends: (A) payments must be as much as creditors would get in a hypothetical liquidation, which may be nothing for unsecured creditors if all assets are encumbered by mortgages and security interests, and (B) the payments must equal a company’s projected disposable income for a three- to five-year period after bankruptcy. “Disposable income” is akin to net income and may be very small after considering expenses to maintain the company in a manner that ensures its successful continuation (including all salaries and wages).
- You can clean your balance sheet. Chapter 11 provides very strong tools to reduce the amount of debt for your company. Typically, claims secured by mortgages can be reduced to the value of any assets pledged as collateral, with any amount above that value treated as an unsecured claim that will be satisfied by payments under a Chapter 11 plan. For example, if a company operates a hotel and a restaurant and owes $7 million but, due to Covid-19 or otherwise, the company is only worth $4 million right now, the mortgage could be restructured to $4 million, with the $3 million difference treated as an unsecured claim that will share ratably in whatever payments are made to unsecured creditors under a chapter 11 plan. This is a powerful tool to “right size” your balance sheet.
- You can stretch out payments for the cost of running the case. In a traditional Chapter 11 case, all the costs of running a Chapter 11 case, including any accounts payable open at the time a Chapter 11 plan is approved, must be paid in full immediately. A small business debtor can spread these expenses out over a period of several years, which makes exiting Chapter 11 easier.
- You don’t have to pay unnecessary fees to the federal government. In a traditional Chapter 11 case, a company must pay the federal government a fee that can be as high as 1% of total disbursements each quarter, up to a cap on the fees of $250,000. These fees do not have to be paid in a small business case.
We are all heading into a period of significant economic disruption, likely for an extended period of time until we have reliable testing, strong therapeutics, and a vaccine for the novel coronavirus causing COVID-19. In the meantime, Congress has given small businesses an important tool. It's available for the next 12 months. After that, all bets are off.
Andrew C. Helman is an attorney and a partner at Murray, Plumb & Murray in Portland. He specializes in business law, including work-outs and restructuring. He can be reached at ahelman@mpmlaw.com.
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