How Small Business Can Use Bankruptcy to Survive Coronavirus
04/13/2020By Daniel Wotman
The coronavirus and the sweeping government response to contain it are hitting our local small businesses extremely hard. Small businesses are the backbone of our economy here in New York City and Long Island, and we must use every tool available to us to try to save them. A recent change in the United States Bankruptcy Laws – specifically enacted for small businesses – may help to blunt the effects of the sudden shutdown on these once profitable enterprises due to COVID-19. Under the protection of the United States Bankruptcy Court, these new changes in the law may enable many small businesses to remain viable during the recovery period. Once the COVID-19 lockdown restrictions are lifted and consumer spending begins to loosen up — fueling positive cash flow — small businesses could emerge from bankruptcy protection as profitable business entities once again.
The Small Business Reorganization Act of 2019, which took effect just this past February, originally provided that any small business that has a total of secured and unsecured debt in an amount that is less than $2,725,625 is eligible to elect to be a small business debtor under Chapter 11. Congress, in the Coronavirus Aid, Relief and Economic Security Act or the CARES Act enacted on March 27, 2020, increased temporarily for one (1) year the debt limit from $2,725,625 to an amount that is less than $7,500,000 to elect to be a business debtor under Chapter 11.
A recent decision by the United States Bankruptcy Court for the Eastern District of New York in Central Islip has made it perfectly clear that the United States Bankruptcy Court will apply The Small Business Reorganization Act of 2019 to assist small business in their efforts to survive this economic and health crisis of epic proportion that has so adversely affected small business. United States Bankruptcy Court Judge Robert E. Grossman in a 35 page decision issued on April 10, 2020 in a Chapter 11 case entitled In re Deirdre Ventura, Case No. 8-18-77193-reg, pending in the United States Bankruptcy Court for the Eastern District of New York upheld a Debtor’s right to change her designation in an existing case to a small business debtor to take advantage of the debtor friendly provisions of the new Small Business Reorganization Act of 2019, including the right to seek a modification of her mortgage on her primary residence that she operates as a bed and breakfast in a historic home on Long Island’s North Shore. Prior to the enactment of the Small Business Reorganization Act of 2019 the Debtor could not modify in her Chapter 11 business case the mortgage on the property because it was used as her residence.
“Had Congress been given a crystal ball with the power to see what the world is facing today, including the severe disruption to our Nation’s economy and its impact on small businesses, Congress likely could not have drafted a more effective set of mechanisms to help these businesses reorganize and hopefully survive.”
—United States Bankruptcy Judge Robert E. Grossman
Now under The Small Business Reorganization Act of 2019 a debtor can seek to modify a mortgage on his or her primary residence where the lender’s funds were not used primarily to acquire the property and were used primarily in connection with the small business of the debtor.
United States Bankruptcy Judge Grossman in In re Deirdre Ventura stated: “Had Congress been given a crystal ball with the power to see what the world is facing today, including the severe disruption to our Nation’s economy and its impact on small businesses, Congress likely could not have drafted a more effective set of mechanisms to help these businesses reorganize and hopefully survive.” The Court further stated: “The SBRA merely amends the definition of small business debtor to ensure that certain debtors can avail themselves of a less costly and time-consuming path to reorganization that befits the family–owned businesses and other ‘Main Street’ businesses that are currently in such dire need of relief.” … These types of debtors who are willing to risk everything to start and maintain their own businesses should not be penalized, rather, they should be applauded.”
The Small Business Reorganization Act of 2019 streamlines small business Chapter 11 reorganizations. It makes them far less expensive and provides small businesses with a greater chance for success when emerging from Chapter 11 reorganization. Chapter 11 protection can provide a cash-strapped small business with critical breathing room, allowing time for the pandemic’s curve to flatten out to the point when consumers will once again feel comfortable venturing out of their homes to start spending again locally.
Congress has significantly reduced administrative costs for small businesses during the Chapter 11 process. They eliminated creditors’ committees and creditors’ committee attorney fees in Chapter 11 cases for small businesses. Disclosure statements to creditors for Chapter 11 proposed plans of reorganization are no longer required. Early input from the Bankruptcy Court and a qualified Trustee with extensive experience in Chapter 11 cases will be provided to small businesses to help them along the hopeful path to recovery.
“Small business owners are put in the driver’s seat in working out a plan to repay a portion of what is owed to vendors and suppliers at reduced amounts, and to restructure loans with lenders…[and] small business debtors are no longer at the mercy of their creditors to approve a plan of reorganization as those in large Chapter 11 cases.”
It is important to know that small businesses must make sure that their books and records are in good order prior to filing a Chapter 11 petition. Financial Projections will need to be prepared, and a reduced repayment plan of 3 to 5 years duration — to be paid out of earnings — will have to be proposed.
Small business owners are put in the driver’s seat in working out a plan to repay a portion of what is owed to vendors and suppliers at reduced amounts, and to restructure loans with lenders. Creditors are encouraged to arrive at a consensual plan of reorganization with the small business debtor early on. On the other hand, small business debtors are no longer at the mercy of their creditors to approve a plan of reorganization as those in large Chapter 11 cases. If the creditors don’t approve the debtor’s plan, the small business owner can propose its own nonconsensual plan to the court. The nonconsensual plan must provide sound financial projections that there will be enough earnings to repay a portion of the total debt over 3 to 5 years.
There's also a new way for determining the owners' and creditors equity interests, based on what is “fair and equitable,” with greater opportunities for owners to keep a stake in their businesses, even if all debts can't be paid off. Certain personal assets — like homes and residences — are also now protected.
Management of the debtor’s affairs in a small business case is left to the owner of that business. A small business debtor may include corporations, partnerships or individuals.
A small business debtor has the protection of the automatic stay where it cannot be sued by any of its creditors in state court. The small business owner has the right to use, sell or lease property. It can reject leases of real property it no longer needs or cancel long term contracts that are too expensive. The small business owner can borrow money, operate its own business and modify loans with its banks.
With Court approval, during the Chapter 11 case, critical suppliers of products and services essential to a small business’s core operations can be paid what they were owed prior to the bankruptcy so that the small business may continue to receive the critical supplies it needs to remain in business. Payments to lenders and other secured creditors may be eligible to be put on hold for a period of time until the business becomes profitable again and is in a position to start paying again. No bank wants to see a client go out of business because its impatience forced the collection of cash whereby the lender would receive only pennies on the dollar for “secured equipment” that cannot be sold for market value. Court orders can also be obtained prohibiting utility companies from altering, refusing or discontinuing services if they are provided with adequate protection. And, if there is equity in hard assets (such as real estate, account receivables, etc.) either an existing or new lender can loan immediate cash where such lender will be granted a priority lien on all assets to the small business that would allow it to immediately begin operations again. With the Court’s permission, unpaid salaries earned within 90 days of the bankruptcy filing can also be paid.
“Courts are still accepting Bankruptcy Petitions and related documents that can be filed electronically. Necessary court hearings are being held over the phone.”
This new small business Chapter 11 law can greatly benefit businesses that may have been thriving just a month ago, such as restaurants, bed and breakfast, retail stores, hair salons, and many others. These businesses, who employ countless local residents, pay taxes, and contribute to the character of our communities, are absolutely vital to New York City and Long Island communities. They shouldn’t be forced into liquidation because their suppliers now refuse to deliver services and supplies, or from threat of eviction from landlords.
It is important to know that you don’t need to wait to get help. Even though the Bankruptcy Courts are physically closed due to COVID-19, the Courts are still accepting Bankruptcy Petitions and related documents that can be filed electronically. Necessary court hearings are being held over the phone.
The Small Business Reorganization Act will benefit small local businesses which are now struggling to stay afloat and suffering from a drastic reduction or total elimination of income. Let’s move quickly and use all of the available tools to shield them from the worst, so that we can all look forward to the days when these businesses will reopen and continue to serve as the living heartbeat of our towns.