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Updated: April 30, 2020 Experts Corner

How to navigate Congress’ bankruptcy-code changes

The U.S. Capitol building in Washington, D.C.

The last several weeks have brought limited relief to businesses grappling with an immediate economic downturn from the coronavirus pandemic. 

However, some businesses will require more help than short-term loans 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 Ch. 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.

Key aspects of a streamlined small business Ch. 11 case include the following.

You stay in control during the case. Like a traditional Ch. 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 Ch. 11 case, only the company seeking to reorganize can file a reorganization plan, the key document that a bankruptcy court must approve to allow a company to exit Ch. 11. This helps to keep the company in control. 

You can remain in control after the case. In a traditional Ch. 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 Ch. 11 plan. 

This rule does not apply in a small business case. Instead, a company must make payments under a Ch. 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. Ch. 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 Ch. 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 Ch. 11 plan. 

You can stretch out payments for the cost of running the case. In a traditional Ch. 11 case, all the costs of running a Ch. 11 case, including any accounts payable open at the time a reorganization plan is approved, must be paid in full immediately. 

A small business debtor can spread these expenses out over a period of several years.

You don’t have to pay unnecessary fees to the federal government. In a traditional Ch. 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.

Andrew C. Helman is an attorney and partner at Murray, Plumb & Murray in Portland, Maine.

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