Changes to the Bankruptcy Code Take Effect in 2020

Bruce W. Akerly - Partner
Jan 20 2020

On August 23, 2019, President Trump signed the Small Business Reorganization Act of 2019, P.L. 116-54 (the “SBRA”). The SBRA made significant changes to small business bankruptcies under Chapter 11 of the Bankruptcy Code. As with any legislation, additional changes, that are not necessarily the focus of the principal legislation, are address by Congress.

 

Preference Actions.  Section 547 of the Bankruptcy Code, 11 U.S.C. § 547, deals with the avoidance of preferential transfers. The third section of H.R. 3311 also creates one new and immediate revision to the Bankruptcy Code, universally applicable to all chapters and not just the new subchapter 5. Section 547(b) of the Bankruptcy Code shall be amended to include a due diligence requirement upon the filing party of a preference action.


Venue In Preference Action.  The SBRA also amends the venue provision of 28 U.S.C. § 1409(b) to increase the minimum limit for a trustee to bring a case against a non-insider in a district other than where the non-insider defendant resides from $12,850 to $25,000. This venue provision is also effective immediately and directly applicable to preference and avoidance actions under the Bankruptcy Code.


Family Farmer Relief Act of 2019 (H.R. 2336)The Family Farmer Relief Act revises section 101(18) of the Bankruptcy Code to define the term “family farmer” as an individual or individual and spouse engaged in a farming operation whose aggregate debts do not exceed $10,000,000. This revision doubles the debt limit for debtors eligible to file for protection under chapter 12 and allows chapter 12 to remain relevant by accounting for the technological advancements made in the farming industry and farming equipment since chapter 12 was originally enacted in 1986.


Small Business Reorganizations Under Chapter 11.  The SBRA is an amendment to the Bankruptcy Code’s existing provisions with respect to reorganization of small businesses. It is expected to have a significant impact on struggling small businesses, according to a commentary in the Philadelphia Inquirer. The SBRA is designed to fill a gap in the current bankruptcy laws by providing a framework for small businesses to successfully reorganize in bankruptcy court, according to a recent commentary in the National Law Review.


The SBRA establishes a new subchapter V for Chapter 11 reorganizations for small business debtors.  Subchapter V applies in any Chapter 11 case of a small business debtor that elects to have it apply.  See Code § 103(i) as added by the SBRA § 4(a)(2). The SBRA also amends or otherwise affects many other provisions of the Bankruptcy Code, including by declaring about two dozen sections and subsections of Chapter 11 to be inapplicable in small business bankruptcy cases, a half-dozen of which may become re-applicable if the court so orders “for cause.” 11 U.S.C. § 1181(a).

The most significant changes under the SBRA are:

·      The SBRA defines a small business debtor as an entity with an aggregate of noncontingent, liquidated secured and unsecured debt of not more than $2,725,625.

·     The SBRA eliminates the absolute priority rule which, in ordinary Chapter 11 cases would preclude an owner of a business from continuing to own the business when unsecured creditors vote to reject the Chapter 11 plan that provides for less than full payment of their claims and the owner fails to put up sufficient new value to retain ownership. Under the SBRA, there is a new way for determining the owners’ and creditors’ equity interests, based on what is “fair and equitable.” Most significant, according to the recent commentary, the SBRA will allow small businesses to confirm a plan over the objection of creditors, a significant change to existing law and a guaranteed enhancement of the success rate for small business reorganizations. Under the SBRA, debts will no longer be required to be paid in full for the business owner to retain ownership of a company. Instead, the owner will have to abide by a new formula for payback that projects disposable income over a period of three to five years. The small business Chapter 11 plan must provide for the debtor’s distribution to unsecured creditors of all projected disposable income earned over the three- to five-year period following court approval of the plan.

·      A trustee will be appointed in every small business case similar to a Chapter 12 or 13 trustee. Ordinarily, such a trustee will act as a fiduciary for creditors, usually in lieu of the appointment of a creditors’ committee. There will be no creditor committee in small business bankruptcy cases under the SBRA. However, in a small business bankruptcy case, unlike the appointment of a Chapter 11 trustee in ordinary Chapter 11 reorganizations, the trustee would not operate the business of the small business debtor. See 11 U.S.C. §§ 1183-84.

·       Only the small business debtor may file a plan of reorganization,[1] and it must do so within 90 days after the order for relief (which may be extended by the court “if the need for the extension is attributable to circumstances for which the debtor should not justly be held accountable”). 11 U.S.C. § 1189.

·      The rules for the contents of a small business bankruptcy plan of reorganization are more debtor-friendly than under existing Chapter 11. Most notably, a loan secured by the principal residence of the debtor may be modified by the plan if the proceeds of the loan were used for the small business. 11 U.S.C. § 1190.  Modification of such a loan is not generally permitted under Chapter 11. See 11 U.S.C. § 1123(b)(5).

·      The requirements to confirm a plan are more debtor-friendly than under existing Chapter 11, particularly the rules for confirming a plan over the opposition of an impaired class of creditors. 11 U.S.C. § 1191.

·      It will also be much harder for creditors to take away certain personal assets of the business owner, such as a home or place of residence.

·      The SBRA provides for changes to the preference statute (section 547 of the Bankruptcy Code) that may benefit trade creditors.  While not specifically applicable to small business debtors, trade creditors will benefit from this provision. A trustee/debtor-in-possession bringing a preference action must, as part of his or her burden of proof, now show that the trustee has conducted “reasonable due diligence in the circumstances of the case and taking into account a party’s known or reasonably knowable affirmative defenses under Section 547(c).”  This change will hopefully discourage the practice of trustees basing their preference claim on payments indicated in the debtor’s check or other payment records.  SBRA increases from $13,650 to $25,000 the minimum amount of claims where a trustee/debtor must commence a lawsuit against non-insider creditors in the venue where the defendant “resides” and not where the bankruptcy case is pending. This could apply to preference and other avoidance claims and will hopefully discourage the commencement of lawsuits to collect small preference claims.

·      Finally, the SBRA also allows for an extension of the time period for the payment of administrative expenses, altering the current priority payment scheme. In an ordinary Chapter 11 case, post-petition trade creditors or lenders must be paid when the debts are due or on the effective date of the plan of reorganization. In a small business case, the debtor may stretch out the payment of administrative claims over the life of the Chapter 11 plan.


[1] Cf. 11 U.S.C. § 1121(c) which permits any “party in interest” to file a plan at certain times and under certain circumstances