Even as companies continue to grow in size in the Portland area, small businesses continue to be a major part of the economy in the region and throughout Maine. Anyone who runs a small business knows that it’s not easy, and sometimes it can be hard to make ends meet. If you happen to be a small business owner here in Maine who is struggling financially, there is help on the way.
The Small Business Reorganization Act of 2019 will make Chapter 11 bankruptcy faster and less expensive. Signed into law this past August, the legislation takes effect on February 19 of the next year. Here’s a basic overview of how bankruptcy currently works and how this bill will improve the process for struggling small business owners.
Basics of Bankruptcy Reorganization
There are various forms of bankruptcy filing, but perhaps the most common is Chapter 11. While individuals can technically use Chapter 11, it most often applies to businesses with less than $2,725,625 of debt. With Chapter 11 bankruptcy, a business is allowed to continue operating while it reorganizes its debt.
The bankruptcy process starts with a petition to the bankruptcy court. This is either done voluntarily by the debtor or involuntarily by creditors after certain conditions have been met.
However the process is initiated, the business usually has four months to develop a reorganization plan (though in certain cases this can be extended up to 18 months). The goal is for the business to emerge from bankruptcy in better financial shape. This is often done by restructuring these kinds of debts:
Priority tax debts
Chapter 11 may be used to continue operations while you reorganize your business’ past due income, payroll and property taxes. While most tax obligations are usually paid off during a five-year period, Chapter 11 allows you to renegotiate the repayment terms with the appropriate taxation authorities and reach a mutually beneficial agreement.
It’s possible for a business owner filing for Chapter 11 relief to seek payments on the current value of collateral — such as real estate, business equipment and vehicles — opposed to what’s owed on it.
For example, say your business owns $250,000 worth of equipment, but you still owe the bank $500,000 from the purchase of it. You can ask the court to approve paying only the current value of $250,000 — enabling your business to reduce monthly operating expenses.
When a business is just starting out, it often takes on significant credit card charges or other unsecured loans to cover operating costs. With Chapter 11, a business can restructure this debt and pay it off in either a lump sum or over several years.
Ideally, your business and unsecured creditors will agree on payment terms. But if you can’t come to an agreement, the bankruptcy judge will decide on the terms.
Leases and contract debts
With Chapter 11 relief, a business can choose to accept or decline certain leases and contracts. For example, suppose your business previously contracted with a security service for a three-year period. Then you find a comparable service at a considerably lower price. If you can demonstrate that this contract would contribute to the profitability of the business, the judge may grant a replacement request.
Relief Coming Soon
Historically, small business owners have found it difficult and expensive to seek Chapter 11 bankruptcy protection. But with the passing of the Small Business Reorganization Act, more small business owners will be able to access Chapter 11 through a new subchapter created specifically for this group of debtors.
While the qualifying debt threshold remains the same ($2,725,625), this new subchapter includes provisions for the following key improvements:
The new law will facilitate small business reorganizations by eliminating some significant procedural requirements and reducing costs, including:
- No one except the business debtor will be able to propose a plan of reorganization.
- The debtor won’t be required to obtain approval or solicit votes for plan confirmation.
- Absent a court order, there will be no unsecured creditor committees.
- The court is required to hold a status conference within 60 days of the petition filing, giving the debtor 90 days to file its plan.
New value rule
Currently, equity holders of the small business debtor are required to provide “new value” to keep their interest without paying off creditors. When the new legislation takes effect, the reorganization plan must be nondiscriminatory and “fair and equitable.” Also, like Chapter 13, the debtor’s entire projected disposable income must be applied to payments or the value of property to be distributed can’t amount to less than the debtor’s projected disposable income.
With the new law, a standing trustee will be appointed to serve as the trustee for the bankruptcy estate. It also allows the trustee to preside over the reorganization and monitor its progress.
Administrative expense claims
As it currently stands, a debtor must pay any administrative expense claims on the start date of the effective plan. This includes claims incurred by the debtor for goods and services after a petition has been filed, which can significantly add to the cost of the process for a business already suffering from financial hardship. But under the new law, the debtor can now pay those expenses over the term of the plan, which is more manageable for small business owners going through bankruptcy.
The new law eliminates the prohibition against small business debtors modifying their residential mortgages. The debtor will have more leeway if the underlying loan wasn’t used to acquire the residence and was used primarily for the debtor’s small business. Otherwise, secured lenders will continue to have the same protections as in other Chapter 11 cases.
Under the new law, the court must grant the debtor a discharge within three years after completing payments (or a longer period of up to five years established by the judge). Except for amounts due after the last payment date and certain non-dischargeable debts, this will relieve the debtor of personal liability for all debts under the plan
Additionally, the exceptions to discharge contained in Section 523(a) of the bankruptcy code will apply to the small business debtor. Currently, a Chapter 11 bankruptcy features limited discharge exceptions.
Right for Your Business?
If your small business is struggling financially, your options were somewhat limited. Lack of size or resources likely prevented you from pursuing Chapter 11 bankruptcy. But with these updates coming into effect, that soon may not be the case.
If you think your small business could be saved with a financial reorganization, don’t hesitate to contact us at Filler and Associates.