Changes to federal bankruptcy law will make it easier and less expensive for small businesses and family farmers to restructure or shed their debt.
COVID-19 continues to rattle the global economy. New numbers from the U.S. Commerce Department show gross domestic product fell 9.5% for the second quarter of the year. By the end of July, new unemployment claims had topped 1 million for 19 straight weeks.
In Michigan, bankruptcy filings for Chapters 7 and 13 rose 17% in July, outpacing the national increase of 6%. Nationally, Chapter 11 filings for commercial reorganizations were up 79% for the first half of the year compared with 2020.
While we might be fatigued by the overuse of “unprecedented,” it’s clear these are unprecedented times. Starting in March, Michigan small businesses were required to shut down or to service only their essential customers. Some sectors remain closed. Others have been forced to operate at 50% of capacity or less, although they face the same – or increasing – fixed costs.
Many small businesses and family farms are drowning in their operations. While federal loan and grant programs have been extremely helpful, they won’t be enough for businesses that have been shut down for an extended period of time. Many will not be able to recover without restructuring or reducing their debt.
The same is true of family farmers, particularly dairy farmers, who were already suffering before the pandemic began. The expenses of milking and maintaining their herds continue even as the national shutdown of schools dried up demand for their product, forcing them to dump milk.
As we head into fall, a time when bankruptcy filings traditionally increase in Michigan, we are expecting a significant increase in new filings. Changes to bankruptcy law prompted by the coronavirus will make the restructuring process simpler and easier for both small businesses and family farms.
Changes to Chapters 11, 12
For decades, small businesses looking to restructure their operations and debt had the same requirements under Chapter 11 that a mega case had. Bankruptcy was expensive for small business owners, which made filing for Chapter 11 an unrealistic option.
The addition of Subchapter V, or SBRA, to Chapter 11 provides significant changes that will expand the number of small businesses eligible, streamline the process and make it easier for owners to retain equity. Prior to COVID-19, a company could have no more than $2.7 million in unsecured debt to be eligible to file under small business rules. The CARES Act has raised the debt limitation to $7.5 million, adding a sunset provision of March 2021.
Similar but not identical changes have been made to Chapter 12, which covers restructurings for family farms. The debt limitation here went from $4 million pre-coronavirus to $10 million now, which encompasses a larger percentage of family farms.
While small businesses and farms still must adhere to many provisions of the bankruptcy code, such as opening new accounts and filing monthly financial statements, significant changes have been made to Chapters 11 and 12. These include:
- Eliminating the creditors’ committee in favor of a single trustee who does not operate the business or farm of the debtor, unless there is a finding of fraud or mismanagement. The trustee is paid to oversee the process and ensure the debtor adheres to the rules, unlike a creditors’ committee that typically works to maximize the plan for creditors.
- Enabling only the debtor to file a reorganization plan. No creditor or competing plan may be filed. There’s also no longer a need for a disclosure statement, unless required by the court, making the plan document simpler and less expensive to develop.
- Eliminating the absolute priority rule, which indicates that no junior interest can retain or receive property unless all interests of a higher level have been paid in full. In many cases, a creditor may have a secured claim that is a small fraction of the total debt, enabling that one creditor to preclude a reorganization plan from being confirmed. This change enables shareholders to retain stock in the business and smooths the path to confirmation.
- Enabling administrative expenses to be paid over the life of plan. In a regular filing, expenses have to be paid on confirmation of the plan, but these can now be stretched three to five years, which gives the debtor additional breathing space.
There are numerous other changes to both Chapter 11 and Chapter 12 that are designed to benefit small business owners and family farmers. We now have a window that offers the ability to reorganize less expensively and more easily.
Sue Cook and Rozanne Giunta are partners in the law firm Warner Norcross + Judd LLP who concentrate their practices in bankruptcy and restructuring. They can be reached at email@example.com and firstname.lastname@example.org.