Small Businesses May Be Able to Retroactively Amend Bankruptcy Petition Under the Small Business Reorganization Act

In August 2019, President Donald Trump signed the Small Business Reorganization Act of 2019 (SBRA or “the Act”) into law in an effort to address the fact that small businesses have struggled to reorganize under Chapter 11 of the Bankruptcy Code. 11 U.S.C. §§ 1181-1195 (Subchapter V). The goal of the Act was to make these bankruptcies faster and cheaper for all the parties involved. The Act originally applied to business debtors with aggregate non-contingent liquidated secured and unsecured debts of less than $2,725,625, which means that many businesses did not qualify to be a debtor under the Act. However, the Act was amended on March 27, 2020, to raise the debt limit to $7.5 million for a period of one year as part of the CARES Act in response to COVID-19. H.R. 748, CARES Act, Public Law 116-136.

There are several reasons that a small business would want to file for bankruptcy under Subchapter V of the Bankruptcy Code (the new provisions created by the Act) rather than under the pre-existing Chapter 11 provisions. First, the Act eliminates several procedural burdens associated with typical corporate reorganization such as competing plans, disclosure statements, solicitation of votes to confirm a plan, and unsecured creditors’ committees. Perhaps most important is the elimination of the requirements that: (i) equity holders of the small business debtor provide "new value" to retain their equity interest in the debtor without paying creditors in full; and (ii) have an “impaired class” of creditors vote in favor of the reorganization plan. Instead, to achieve plan confirmation, the Act only requires that the plan does not discriminate unfairly, is "fair and equitable," and provides that, for a period of three years (or up to five years if extended by the court), all of the debtor's projected disposable income will be applied to payments under the plan, or the value of property to be distributed under the plan is not less than the projected disposable income of the debtor.

Second, the Act also helps a small business debtor handle the administrative costs of a bankruptcy by pushing the case to move quickly. To this end, there must be an initial status conference within 60 days of commencement and a debtor must file a plan within 90 days of commencement. The Act also removes the requirement that the debtor pay administrative expense claims in full—including those claims incurred by the debtor for post-petition goods and services—on the effective date of the plan. Instead, under the Act, a debtor may spread out payment of administrative expense claims over the term of the plan.

One question courts have wrestled with is whether a debtor who filed for bankruptcy without electing to proceed under Subchapter V should be allowed to retroactively amend its petition to take advantage of the benefits of Subchapter V. The majority of courts that have addressed this issue—with the exception of two cases—that have allowed for such amendment. See e.g., In re Blanchard, No. 19-12440, 2020 WL 4032411 (Bankr. E.D. La. July 16, 2020) (Chapter 11 debtor could retroactively proceed under Subchapter V after trustee filed motion to dismiss or convert case that had been pending approximately one month); In re Bonert, No. 2:19-bk-20836-ER, 2020 WL 3635869 (Bankr. C.D. Cal. June 3, 2020) (Chapter 11 debtor could retroactively proceed under Subchapter V when case had been pending approximately five months). Procedurally, in order to retroactively take advantage of the Act, debtors have relied on Rule 1009 of the Federal Rules of Bankruptcy Procedure, which gives debtors a right to amend their petitions as a matter of course at any time before the case is closed. Some courts have said that once a debtor amends its petition to elect treatment under Subchapter V, the case should automatically proceed under Subchapter V until an objection is timely filed and granted. In re Body Transit, Inc., 613 B.R. 400, 409 (Bankr. E.D. Pa. 2020) (small business Chapter 11 debtor could retroactively proceed under Subchapter V when the case had been pending 48 days). In at least one case, a court has granted a debtor’s motion to convert a Chapter 7 liquidation case to a reorganization case under Subchapter V. In re Trepetin, No. 20-11718-MMH, 2020 WL 3833015 (Bankr. D. Md. July 7, 2020).

Despite the procedural posture, almost uniformly, courts have looked at the same two factors in determining whether a debtor should be able to proceed retroactively under Subchapter V: the debtor’s good faith and the potential prejudice to creditors. At least one court has allowed a debtor to retroactively proceed under Subchapter V based on the debtor’s good faith, but incorrect belief that it was disqualified from proceeding under Subchapter V at the outset of the case since it was not conducting business at that time. In re Bonert, No. 2:19-bk-20836-ER, 2020 WL 3635869, at *5 (Bankr. C.D. Cal. June 3, 2020); see also In re Ventura, No. 8-18-77193-REG, 2020 WL 1867898 (Bankr. E.D.N.Y. April 10, 2020) (permitting conversion to Subchapter V where debtor was not able to confirm plan under other Chapter 11 provisions and Subchapter V was not available when debtor filed for bankruptcy). Even more than the debtor’s good faith though, courts have focused on what, if any, prejudice creditors will experience if a debtor’s case is allowed to proceed retroactively under Subchapter V. In the absence of a creditor asserting that its interest would be unfairly prejudiced by the debtor’s conversion to Subchapter V, several courts have allowed the conversion. See e.g., In re Blanchard, No. 19-12440, 2020 WL 4032411 (Bankr. E.D. La. July 16, 2020) (no creditors came forward with a due process argument asserting that their interest would be jeopardized by an SBRA conversion); In re Bonert, No. 2:19-bk-20836-ER, 2020 WL 3635869 (Bankr. C.D. Cal. June 3, 2020) (permitting re-designation provided that no party will be unduly prejudiced); In re Ventura, No. 8-18-77193-REG, 2020 WL 1867898 (Bankr. E.D.N.Y. April 10, 2020) (allowing conversion to SBRA because, inter alia, it would not unduly prejudice the objecting creditor; rather, creditor would maintain many of the rights he had at the inception of the case).

Lastly, the age of the case does not greatly impact the court’s analyses. So long as election into Subchapter V occurs before the court confirms a plan, a court may allow the conversion. In fact, in one recent case, the court allowed the debtor to convert to Subchapter V 15 months after the debtor filed its original petition under Chapter 11 where the other criteria was met. In re Ventura, No. 8-18-77193-REG, 2020 WL 1867898 (Bankr. E.D.N.Y. April 10, 2020). Specifically the court determined that, even though the court had previously rejected the debtor’s proposed plan and was poised to rule on whether to confirm the objecting creditor’s competing plan, the objecting creditor was not prejudiced by the conversion because: (i) a plan was not yet confirmed and (ii) the creditor would maintain many of the same rights it had at the inception of the case. The court went on to note that “[g]iven that Subchapter V was not available to the [d]ebtor on the Petition Date,…the Court will not penalize the [d]ebtor because after careful analysis by Congress the law has been amended to address the needs of debtors that engage in the type of [small] business she operates.” Id. at *18.

The majority of courts have held that the deadlines imposed by Subchapter V (i.e. status conference within 60 days and plan on file within 90 days) should not impact the debtor’s ability to retroactively proceed under Subchapter V because the Act allows courts to use their discretion in extending these deadlines. See e.g., In re Blanchard, No. 19-12440, 2020 WL 4032411 (Bankr. E.D. La. July 16, 2020) (in response to US Trustee’s arguments regarding the practicality and scheduling issues associated with an SBRA re-designation, the court noted, “there are no real bases in law or rules to prohibit a resetting or rescheduling of these procedural matters.”); In re Trepetin,No. 20-11718-MMH, 2020 WL 3833015 (Bankr. D. Md. July 7, 2020) (court granted debtor’s motion to convert and also extended the deadlines under the SBRA); In re Bonert, No. 2:19-bk-20836-ER, 2020 WL 3635869 (Bankr. C.D. Cal. June 3, 2020) (holding that it was irrelevant that deadlines under the SBRA had passed because the statute allows for extensions of such deadlines). However, at least two cases have denied a debtor’s request to retroactively amend the petition to proceed under Subchapter V where the deadlines imposed by Subchapter V had already passed. See In re Seven Stars on the Hudson Corp., No. 19-17544-SMG, 2020 WL 4558344, at *8 (Bankr. S.D. Fla. Aug. 7, 2020) (holding that debtor, who elected to proceed under Subchapter V nearly one year after filing its Chapter 11 petition, could not proceed under the SBRA because debtor’s inability to meet the statutory deadlines was due solely to the timing of debtor’s election to amend its petition after the expiration of those deadlines, as opposed to some factor outside of debtor’s control); see also In re Double H Transp. LLC, No. 19-31830-HCM, 2020 WL 2549850 (Bankr. W.D. Tex. March 5, 2020) (denying debtor’s amended petition to proceed under Subchapter V three months after case filed under regular Chapter 11 because it would create a “procedural quagmire” as the deadlines under the Act had already passed).

The take-away for debtors is that if you are not proceeding under Subchapter V and doing so would be beneficial, the option is not lost and you may be able to still opt-in to a Subchapter V reorganization proceeding and take advantage of the temporary debt-limit increase to $7.5 million. On the other hand, lenders and other creditors should note that if a borrower or contract counter-party is not proceeding under Subchapter V (and otherwise qualifies under the debt limit), it may still be able to do so and should plan for that possibility. In addition, creditors should carefully weigh whether it is economically efficient to challenge any such amendment if they can demonstrate some prejudice.

For more information on Small Business Reorganization Act, please contact your Quarles & Brady attorney or:

• Hailey Varner: (312) 715-5182 / hailey.varner@quarles.com