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Small business bankruptcy

On Behalf of | Nov 25, 2019 | Firm News

In August President Trump signed a law that significantly reforms Chapter 11 for individuals and small businesses. The law become effective on February 19, 2020.

When an individual or small business wanted or needed to restructure debt, there were two options. Chapter 13 was the preferred option, but it was not always available. It has a debt limit which can affect some debtors. It is also limited to individuals. If a corporation or LLC was owned by an individual or married couple we would treat it as a sole proprietorship. However, this approach had both tax ad and liability issues.

If Chapter 13 was not a viable option, the alternative was Chapter 11. Chapter 11 is not friendly to individuals or small businesses. It is expensive and paper intensive. It requires disclosure statement that must be preapproved by the judge before a reorganization plan can be sent to creditors. There may be multiple classes of creditors and at least one class has to vote in favor of the plan. To add salt to the wound, if anyone objects to the plan, all assets belong to the estate, rather than the debtor, until all creditors are paid in full. This is called the Absolute Priority Rule. The exception requires the debtor to find a third party to buy out the case at an approved lump sum in the future.

Chapter 11, subchapter 5, will relieve individuals and small businesses of many of these burdens. It really is a hybrid between Chapter 11 and 13. The court appoints a trustee to oversee the establishment and implementation of a reorganization plan. The debtor remains in charge. The Absolute Priority Rule is abolished in Chapter 11, subchapter 5. When the debtor fulfills the obligations f the plan the debtor receives a discharge and retains all assets.

An additional benefit for small business debtors is a cram down provision for junior mortgages taken out against the family home to fund the business. In essence, a secured business loan can be reduced and interest rate modified, depending upon the value of the home, relative to the senior mortgages.

Although the law was passed, the implementation requires new rules and forms. There will be a learning curve for those practitioners who venture into this area of bankruptcy. However, this new Chapter offers a promise of real relief for those who would otherwise be tied to the traditional bankruptcy remedies.