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Chapter 11 bankruptcy became easier just in time for the COVID-19 fallout

Andrew Walker, JD | August 2020 Footnote

Editor's note: Updated July 28, 2020

The Small Business Reorganization Act (SBRA) is a newly added subchapter of Chapter 11 bankruptcy that makes it feasible and beneficial for your small-business clients to benefit from Chapter 11 in ways not possible just one year ago.

Chapter 11 is a very powerful tool for large companies or wealthy individuals to restructure debt and emerge competitive. In the past, it has been too expensive for smaller Main Street businesses to consider this path. This changed in late 2019, when Congress passed the Small Business Reorganization Act (SBRA) to make a more streamlined and cheaper version of Chapter 11 — just in time to keep some of your smaller clients in business.

Detailed financial reports are required at filing and during any type of Chapter 11 case, and CPA services will be in demand to produce these reports. And for CPAs in industry, knowing any and all tools available to you and your companies can be the difference between a prosperous future or not.

The economic harm of the COVID-19 pandemic is likely to fall disproportionately on mom and pop small businesses like restaurants, dry cleaners, lawyers, massage studios, barbers, small retailers and cafes. Many of these companies are viable but just need time for consumer demand to return, and maybe to pay less for long-term loans and leases. These companies are likely already asking you about options to weather the storm.

As of mid-July, approximately 500 cases were filed nationally under SBRA, which means there is not a large body of experience to fall back on, but the law has many favorable provisions for businesses with debts under $7.5 million1.

Benefits of SBRA to your clients’ businesses

1. Owners retain their interest in the business

In a traditional Chapter 11, the shares lose all value and the owners of the company stop owning the company. Because the SBRA is designed for owners who also run their companies, Congress decided that the owner should continue to own the company afterwards.

2. Discharge unsecured debts without forgiveness of debt income

At the end of a successful plan, the company’s unsecured debts are discharged. Discharged means that the company or proprietor no longer owes the debts. PPP (Paycheck Protection Program) loans and EIDL (Economic Injury Disaster Loans) loans are also discharged in bankruptcy. This discharge is excluded from taxable income. The exclusion from taxable income alone is a great reason why a floundering business might prefer bankruptcy to other sorts of debt workout.

An LLC or corporation filing for Chapter 11 does not relieve the owners, employees, officers or board members of any personal guarantees. Sometimes they can negotiate with creditors or file a personal bankruptcy themselves to remove the personal guarantee.

3. Lower the principal balance of secured loans to the value of the collateral

A company with secured loans, such as SBA loans or other business loans, may lower the principal balance of these loans to the value of the collateral. Oftentimes, the equipment, inventory and accounts receivable of the company have depreciated and have a resale value of less than the secured loans against them.

In an SBRA case, the company can pay only the current resale value of the collateral in a plan that lasts approximately five years. The company gets a lien release and discharge of the unpaid balance when they complete the five-year plan. The interest rate can often be negotiated lower than the loan, too. The SBRA also, for the first time in Chapter 11, provides options to do this with business loans attached to the owner’s personal home.

An EIDL loan will be secured against the equipment, inventory and accounts of the company, and because these loans can be much greater in balance than the value of the collateral, the SBRA will help companies that will struggle with them in the future.

4. Renegotiate or break leases

In the new work-from-home environment, a lease for a lot of space can be a drain on a company’s cash flow. An SBRA case allows the company to break the lease without paying or negotiating lower payments.

Knowledge is power

Now is a difficult time for business leaders large and small. Make sure you and/or your clients are equipped with all the best information to make the wisest choice for your businesses or your clients’ businesses. Many lawyers offer a free consultation to explore the client’s business and see if bankruptcy, under the SBRA or another chapter, would be beneficial.

Andrew Walker is a Minneapolis lawyer practicing since 2011 and is a managing partner at Walker & Walker Law Offices, PLLC. He helps Minnesota individuals and small businesses reorganize and move on from unsustainable debt loads. You may reach him at andrew@bankruptcytruth.com.