AIRA

June 17, 2020

So You’re Telling Me There’s a Chance?

--A Review of the Small Business Reorganization Act & the

Opportunity at Rehabilitation for Businesses

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SBRA Overview The Small Business Reorganization Act

Enacted August 23, 2019, took effect February 19, 2020

Amends Bankruptcy Code in numerous places and creates new Subchapter V to Chapter 11

Purpose: provide relief to business and individual debtors whose debts exceed limitations of chapter 13, but are too small to undergo a full-on chapter 11 restructuring

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SBRA Overview Subchapter V: 11 U.S.C. §§ 1181-95

§ 1181 sets out sections of the Bankruptcy Code that do not apply in the context of an SBRA case

Generally speaking (with some key exceptions), provisions that are inappliacable to Sub-V cases are replaced by SBRA provisions

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Sub-V Eligibility As Enacted:

Debtor must be a “small business debtor,” as defined by § 103(i) of the Bankruptcy Code, with aggregate noncontingent, liquidated, secured and unsecured debts totaling less than $2,725,625

As Amended by 2020 CARES Act (March 2020)*:Debt limit increased to $7.5 million

*CARES Act amendment sunsets March 2021

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Early Case Law – Debtor Eligibility In re Ventura, 18-77193, 2020 BL 134496, 2020 WL

1867898 (Bankr. E.D.N.Y. April 10, 2020)

Debtor amended petition to elect Sub-V treatment after passage of Sub-V case deadlines (status conference, plan filing)

Court allows amendment, citing (1) fact that debtor’s initial filing for chapter 11 was before SBRA took effect; and (2) Bankruptcy Code provisions at issue allowed for extending deadlines

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Early Case Law – Debtor Eligibility In re Twin Pines LLC, Case No. 19-10295 (Bankr. D.N.M.

April 30, 2020)

corporate debtor filed small business petition under chapter 11 February 2019

Secured lender seeks dismissal of case, debtor has no way to confirm chapter 11 plan

SBRA takes effect February 19, 2020 – debtor amends petition 9 days later to elect Sub-V treatment

Court allows case to move forward with extended deadlines under SBRA to conduct status conference & file plan

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Electing Sub-V Treatment

Sub-V treatment is not automatic for eligible debtors

Debtor must elect to proceed under Subchapter V at time of filing petition or by amending petition

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Electing Sub-V Treatment

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Rights & Duties of Sub-V Debtor Section 1184 grants debtor right to remain as debtor-in-possession

Additional reporting requirements for Sub-V debtors:

Must file most recent balance sheet, cash flow statement, & statement of operations within 7 days of filing;

Debtor must still file operating reports

Debtor must attend mandatory status conference before the Bankruptcy Court within 60 days after filing (§ 1188)

Debtor must file and serve report on all parties detailing efforts undertaken/to undertake to propose and confirm consensual reorganization plan

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(Almost) No Committees in Sub-V Cases SBRA § 1181(a) eliminates automatic appointment

of a creditors’ committees in Sub-V cases.

Committee may still be appointed for cause under § 1102(a)(3)

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The Sub-V Trustee Trustees appointed by U.S. Trustee’s Office for every Sub-V

case

Sub-V Trustee’s role more similar to Chapter 12 or 13 Trustee, or chapter 11 examiner, as opposed to traditional chapter 11 trustee

General role: supervise & monitor the case, and participate in plan development & confirmation

If a Sub-V debtor is removed as debtor-in-possession, Sub-V Trustee is responsible for operating the debtor’s business as called for under §1183(b)(5)

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The Sub-V Trustee Unique duty for Sub-V Trustees under § 1183(b)(7):

Trustee has duty to “facilitate the development of a consensual plan of reorganization.” 11 U.S.C. §1183(b)(7)

Inclusion of this language in SBRA suggests role of Trustee to act as a mediator between all parties to propose a consensual plan

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The Sub-V Trustee Additional duties under § 1183(b), analogous to duties of chapter 7

trustees including:

(1) accountable for all property received (see § 704(a)(2))

(2) examining proofs of claim and objecting to claims if a purpose would be served (see §704(a)(5))

(3) opposing discharge of the debtor, if advisable (see § 704(a)(6))

(4) furnishing information concerning estate and estate’s administration requested by party in interest requests, unless the court orders otherwise (see § 704(a)(7))

(5) make and file a final report with the court (see § 704(a)(9))

(6) ensuring debtor commences timely payments under confirmed plan (see §§ 1202(b)(4), 1302(b)(5))

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Property of the Estate Under Sub-V Property of the estate modified under § 1186 to

include property acquired after Petition Date in the event a debtor’s plan is confirmed through Sub-V cramdown process

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Additional Sub-V Features Changes to § 327 disinterestedness for debtors’

professionals

lawyers and accountants may hold claims against debtor totaling up to $10,000

No U.S. Trustee Fees

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Modified Sub-V Plan Process SBRA makes several significant changes to chapter

11 plan process intended to benefit small business debtors, including: Only the debtor may file a plan

Timeline for filing plan shortened to 90 days

No need to prepare/seek approval of disclosure statement

No absolute priority rule

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Sub-V Plan Requirements Sub-V plans must include:

Brief history of the business operations of the debtor

Liquidation analysis

Projections with respect to debtor’s ability to make plan payments

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Sub-V Plan Requirements Sub-V debtors must propose a plan that:

Provides all of debtor’s projected “disposable income” received during 3 years after first plan payment is due

3 year period may be extended up to 5 years

Alternatively: plan may provide that value of property to be distributed under the plan within the plan payment period is not less than debtor’s projected disposable income

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Plan Confirmation in Sub-V Cases Consensual plan confirmation under § 1129(a) still

applies to Sub-V cases, with one notable exception:

Section 1191(a) states that § 1129(a)(15) not applicable for consensual plan confirmation

Section 1129(a)(15) addresses projected disposable income requirement for individual chapter 11 debtors, but only in event a creditor invokes this requirement

Cramdown in Sub-V cases is significantly different from traditional chapter 11 cases

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Hypothetical Case Study:Jon’s Corner StoreJon’s Corner Store Assets Summary

Total assets under $1 million, generally include inventory, FF&E Specifically includes commercial refrigeration equipment that needs to be

replaced within 2 years Debt Summary

Bank holds blanket lien on all assets, $2.6 million outstanding Personally guarantied by Jon, the business owner/sole shareholder

1 PMSI lender for vehicle used in debtor’s business, $35,000 outstanding Landlord owed $25,000 in unpaid rent obligations Undisputed unsecured trade claims totaling $150,000

1 claimant (“BigGUC”) is owed the vast majority of trade debts Insider claim of sole shareholder for $100,000 personal loan made to business Personal Injury lawsuit scheduled as C/U/D; damages claimed are $1.0 million

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Hypothetical Case Study:Jon’s Corner Store Is Debtor eligible to file under Subchapter V?

DebtIncluded for Sub-V

Eligibility? Included Amount Excluded Amount

Bank Debt – Sr. Secured Yes $ 2,600,000.00 $ 0.00

PMSI Secured Lender Yes $ 35,000.00 $ 0.00

Rent Claim Yes $ 25,000.00 $ 0.00

Unsecured Trade Claims Yes $ 150,000.00 $ 0.00

Insider Claim No $ 0.00 $ 100,000.00

Personal Injury Claim No $ 0.00 $ 1,000,000.00

Total $ 2,810,000.00 $ 1,100,000.00

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Hypothetical Case Study:Jon’s Corner Store Plan Summary

Debtor proposes 3-year plan, with payments funded by projected disposable income of debtor calculated as income net of:

Payroll, utilities, rent, insurance, taxes, and other ordinary business expenses, plus

Cash reserves totaling $10,000, built up over first 2 years of plan so Debtor can acquire new refrigeration equipment in year 3

Remedies in event of plan default include provision for liquidating certain of Debtor’s assets

3 relevant classes: Secured

• Impaired, but secured creditors retain liens in collateral + 10-year note at market interest rate; no § 1111(b) election

General Unsecured• Impaired, estimated distributions of 10% (approx. $15,000) to allowed GUCs

Equity• Retains interest in Debtor

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Hypothetical Case Study:Jon’s Corner Store Confirmation Issues GUC class is only non-accepting class at confirmation,

failing to meet 1129(a)(8) requirement that all classes accept plan Debtor seeks to cramdown under § 1191(b)

Assume debtor meets § 1129(b)(2)(A) cramdown requirements Largest GUC objects to confirmation on basis that plan does

not treat GUCs on a fair & equitable basis in violation of § 1191(c) because:

• Debtor has not committed all of its projected disposable income to make plan payments to GUCs, by including cash reserve provisions to acquire new equipment in year 3

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Cramdown in Sub-V Cases Under § 1181(a) of Sub-V, § 1129(b) cramdown requirements do not apply to Sub-V

cases (with one notable exception)

Instead, § 1191(b) governs cramdown in Sub-V cases

11 U.S.C. § 1191(b) Exception.Notwithstanding section 510(a) of this title, if all of the applicable requirements of section 1129(a) of this title, other thanparagraphs (8), (10), and (15) of that section, are met . . . the court . . . shall confirm the plan notwithstanding therequirements of such paragraphs if the plan does not discriminate unfairly, and is fair and equitable, with respect to each classof claimsor interests that is impaired under, and has not accepted, the plan.

Notable exception to applicability of § 1129(b):

New § 1191(c)(1) expressly reincorporates cramdown standard applicable to secured claims under § 1129(b)(2)(A)

No material changes to unfair discrimination definition

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Cramdown in Sub-V Cases: No Absolute Priority Rule SBRA expressly eliminates § 1129(b)(2)(B)(ii) “absolute

priority rule,” to cramdown plan for confirmation (see 11 U.S.C. § 1181(a))

Effect: Sub-V plan can provide for equity to retain interest in debtor even if unsecured creditors are not paid in full under plan

Instead, plan must only treat creditors on a “fair and equitable,” basis under § 1191(c)

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Cramdown in Sub-V Cases: Redefining “Fair & Equitable” Section 1191(c) states new rule of construction for determining

whether plan is “fair & equitable,” & requires that plan:

Meet requirements of § 1129(b)(2)(A) (cramdown for secured classes)

As of the effective date of the plan—

Provide that all of the projected disposable income of the debtor be paid to creditors over life of plan; or

value of the property to be distributed under the plan is not lessthan debtor’s projected disposable income

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Cramdown in Sub-V Cases: Redefining “Fair & Equitable” Section 1191(c) “fair & equitable,” standard also

requires that:

Debtor must show ability to make all payments under plan, or reasonable likelihood of ability to make all payments; and

Plan must provide appropriate remedies (may include liquidation of nonexempt assets) to protect creditors in event plan payments are not made

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Cramdown in Sub-V Cases: Defining Projected Disposable Income

AKA “best efforts” test

Section 1191(d) defines disposable income as income received by the debtor, and that is not “reasonably necessary to be expended” for:

maintenance or support of debtor or dependent of the debtor, or domestic support obligation first payable after petition date; or

payment of expenditures necessary for the continuation, preservation, or operation of the business of the debtor

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Cramdown in Sub-V Cases: Defining Projected Disposable Income Determining potential expenses that can be deducted under plan and

counted as necessary to continue/preserve/operate the debtor’s business likely to be source of conflict for parties in Sub-V

Necessary deductions likely to at least include: Payroll Utilities Rent Insurance Taxes Inventory/Raw Material acquisition costs Other ordinary course expenses

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Cramdown in Sub-V Cases So if all Sub-V Cramdown requirements are met, debtor does not have

to comply with:

§ 1129(a)(8) – requirement that all classes accept plan

§ 1129(a)(10) – requirement that at least one impaired class accept plan; and

§ 1129(a)(15) – projected disposable income test for individual debtors (replaced by Sub-V regardless)

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Cramdown in Traditional Chapter 11 If all requirements of § 1129(a) are met except §

1129(a)(8) (requiring acceptance of plan by all impaired classes), then plan may still be confirmed as a cramdown under § 1129(b)

Section 1129(b)(1) permits cramdown as long as plan is “fair & equitable,” and does not unfairly discriminate against creditor classes that have not accepted plan

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Cramdown in Traditional Chapter 11 Section 1129(b)(2) Defines “fair and equitable,”

treatment in traditional chapter 11

Section 1129(b)(2)(B) – Absolute Priority Rule Prohibits equity holders from retaining interests in reorganized

debtor unless unsecured creditors receive full payment (subject to the new value exception), in event an unsecured creditor class does not accept the plan

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Postconfirmation Matters for Sub-V Debtors

Discharge not granted until debtor makes: All payments due within first 3 years following plan

confirmation or longer period set by court (not to exceed 5 years)

Sub-V Trustee remains in place until plan is substantially consummated

So You’re Telling Me There’s a Chance?�--�A Review of the Small Business Reorganization Act & the Opportunity at Rehabilitation for BusinessesSBRA OverviewSBRA OverviewSub-V EligibilityEarly Case Law – Debtor EligibilityEarly Case Law – Debtor EligibilityElecting Sub-V TreatmentElecting Sub-V TreatmentRights & Duties of Sub-V Debtor(Almost) No Committees in Sub-V CasesThe Sub-V TrusteeThe Sub-V TrusteeThe Sub-V TrusteeProperty of the Estate Under Sub-VAdditional Sub-V FeaturesModified Sub-V Plan ProcessSub-V Plan RequirementsSub-V Plan RequirementsPlan Confirmation in Sub-V CasesHypothetical Case Study:�Jon’s Corner StoreHypothetical Case Study:�Jon’s Corner StoreHypothetical Case Study:�Jon’s Corner StoreHypothetical Case Study:�Jon’s Corner StoreCramdown in Sub-V CasesCramdown in Sub-V Cases: No Absolute Priority RuleCramdown in Sub-V Cases: Redefining “Fair & Equitable”Cramdown in Sub-V Cases: Redefining “Fair & Equitable”Cramdown in Sub-V Cases: Defining Projected Disposable IncomeCramdown in Sub-V Cases: Defining Projected Disposable IncomeCramdown in Sub-V CasesCramdown in Traditional Chapter 11Cramdown in Traditional Chapter 11Postconfirmation Matters for Sub-V Debtors