The CARES Act – A Bankruptcy Lifeline to Small Businesses

On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Action (the “CARES Act”) was signed into law. The CARES Act made important changes to Chapter 11 of the Bankruptcy Code, the most significant of which is that bankruptcy relief is now accessible to more small businesses. The importance of small businesses cannot be underestimated – such businesses make up an estimated 44% of economic activity in the United States.

The primary amendment to the Bankruptcy Code for businesses under the CARES Act is to subchapter V of Chapter 11 of the Bankruptcy Code. That subchapter is known as the Small Business Reorganization Act (the “SBRA”) and became effective on February 19, 2020. Prior to the enactment of the SBRA, small businesses hoping to reorganize were limited to Chapter 11 bankruptcy relief which is costly and time consuming, often resulting in the debtor either dismissing its Chapter 11 case or converting to a Chapter 7 liquidation. The SBRA was Congress’ effort to remedy that problem, giving small businesses an opportunity to reorganize their obligations and continue as going concerns.

The SBRA made critical changes to Chapter 11, the most notable of which is the appointment of a subchapter V trustee. The trustee’s main function is to assist the debtor in developing a consensual plan of reorganization. The SBRA eliminates many costs associated with a larger Chapter 11 case. Some of the cost savings are achieved through the following:

  • Eliminating the costly process of preparing and seeking approval of a disclosure statement;
  • Eliminating the appointment of a committee of unsecured creditors which under a larger Chapter 11 case, is paid for by the debtor;
  • Granting the debtor the exclusive right to file a plan, meaning that the debtor will no longer face competing plans;
  • Permitting the modification of debt on residential property used as collateral for business loans;
  • Eliminating the absolute priority rule, which means that the debtor’s owners may keep their equity even if higher priority classes are not paid in full;
  • Eliminating the requirement that at least one impaired class accept the plan of reorganization;
  • Eliminating the requirement to pay quarterly fees to the Office of the United States Trustee;
  • Permitting the payment of administrative claims over the life of the plan as opposed to full payment on the plan effective date.

A significant limitation of the SBRA as originally enacted, however, was the $2,725,625 debt ceiling which meant that a small business could not have more than the approximate $2.7 million in debt to be able to file bankruptcy under subchapter V. The new CARES Act raised this ceiling to $7.5 million. The $7.5 million debt ceiling applies only to bankruptcies that are filed before March 27, 2021 – following such date, the limit will return to the $2,725,625 amount. For the time being, however, the higher debt limit will enable a much larger number of small businesses to take advantage of the less costly subchapter V process. This increase will provide many small businesses with much needed access to the SBRA and will give them a less expensive reorganization path. Small businesses now have a fighting chance to stay in business and reorganize.