The Small Business Reorganization Act (SBRA) took effect Feb. 19, marking one of the most significant changes in bankruptcy law since 2005.
The SBRA attempts to create a simplified and expedited process for small business debtors to propose, confirm and complete a reorganization plan. A debtor may elect to proceed under the new framework of the SBRA if the debtor is engaged in “commercial or business activities” (except for a person whose primary activity is the business of owning single asset real estate) with noncontingent liquidated debts under an established debt limit. At least half of this debt must be based on the commercial or business activities of the small business debtor.
The SBRA appears to present noteworthy benefits for debtors electing to have their cases administered under the new provisions; however, it is yet to be determined how the new framework will practically effect and/or benefit a small business debtor.
Notably, the SBRA eliminates certain requirements that were considered expensive and burdensome for small business debtors. One of the key barriers preventing small businesses from filing or completing successful reorganization plans was the “absolute priority rule,” which precludes retention of equity ownership unless creditors consent. This in effect could result in a loss of ownership for shareholders or small-businesses owners, many of whom were the founders or managers of the business.
With the SBRA, a business can confirm a reorganization plan, even over creditor objection, by dedicating three to five years of net operating income in payments to its creditors, and the absolute priority rule will not apply. A small-business debtor can also receive its discharge at the time of plan confirmation if it’s able to file a consensual plan, or after three to five years of payments, regardless of whether additional payments are required by the plan, if the plan is confirmed over objection.
Significantly for lenders, the SBRA permits the modification of secured creditors’ rights, even when a creditor’s claim is secured by the debtor’s principal residence. An SBRA debtor’s plan may modify the rights of a creditor’s claim if the claim is secured only by a mortgage on the debtor’s principal residence, and if the loan was not used “primarily to acquire” the property and was instead “used primarily in connection” with the debtor’s business.
This is a departure from the anti-modification provisions found in Chapters 11 and 13 of the bankruptcy code, which generally allow a plan to modify the rights of holders of secured claims, except for claims secured only by the debtor’s principal residence. Under the new provisions, a small business debtor may be able to modify the claim of a creditor holding a mortgage on a principal residence (if loan proceeds were used primarily in connection with the small business) by proposing a lower interest rate, extending maturity or even cramming down the loan to the value of the secured claim. It’s unclear whether this will apply when a small-business debtor grants a security interest in the principal residence as additional collateral but did not receive new value.
As small business debtors proceed under the new provisions of the SBRA, courts will be tasked with answering a number of questions involving interpretation of the law, as well as practical issues that may develop with implementation.
Lindsey Emerson Raines is an associate at Friday Eldredge & Clark. Her practice focuses on business litigation, creditors’ rights and bankruptcy. You can email her here.
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