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Coronavirus Aid, Relief and Economic Security Act (CARES Act)

3.25.20:   On March 25, 2020, in a 96-0 vote, the Senate passed the Coronavirus Aid, Relief and Economic Security Act (CARES Act).  A primary purpose of the CARES Act is to provide financially distressed consumers and small businesses swifter access to bankruptcy relief.  This legislation goes to the House, where it is anticipated to be approved Friday, March 27, and signed shortly after passage by President Trump.

A key provision of the CARES Act amends the Small Business Reorganization Act of 2019 (SBRA), which went into effect on February 19, 2020. This Act created Subchapter V of Chapter 11 of the U.S. Bankruptcy Code. Specifically, the CARES Act increases the eligibility threshold for a Subchapter V reorganization from $2,725,625 of debt to $7,500,000.  After one year, the eligibility threshold will return to $2,725,625.

Subchapter V provides many advantages to small business debtors over a traditional Chapter 11 filing.  Those advantages include:

  • Elimination of the Absolute Priority Rule:  This Rule prevents a debtor from retaining any ownership interest in its assets unless all creditor claims are paid in full.
  • Administrative claims:  Subchapter V eliminates the requirement that all administrative claims (which generally include reclamation claims and claims that accrue post-petition) be paid as a condition of confirmation.  Subchapter V allows those claims to be paid over time.
  • Modification of Loans Secured by the Principal Residence:  Previously, loans secured by a debtor’s principal residence were not modified under Chapter 11. Under Subchapter V, however, if proceeds of the loan were used to finance a debtor’s business, the loan may be modified.  First position loans used to purchase the debtor’s residence, continue to have the same protection under Subchapter V as they do under Chapter 11.  Only non-first position loans used to finance a debtor’s business may be modified.
  • Appointment of Trustee:  A trustee will be appointed in all Subchapter V cases, but the role is different in a Subchapter V and the trustee’s powers are not as broad.  A Subchapter V trustee will not have possession of the debtor’s assets or the ability to sell those assets.  Rather, the trustee’s initial and primary duty is to facilitate the development of a consensual reorganization plan.  A Subchapter V trustee will act as a mediator between the debtor and the competing claims of creditors.  Ideally, the trustee will also be able to provide some guidance, between the stakeholders, to develop a consensual and feasible plan.  A Subchapter V trustee will appear at major hearings for the case and supervise the debtor’s plan payments.
  • Creditors Committee:  Unlike a traditional Chapter 11 bankruptcy, there is no automatic formation of a creditors committee.  A creditors committee will only be formed in a Subchapter V bankruptcy when ordered by the court.
  • The Plan:  Subchapter V plans vary in multiple ways from Chapter 11 plans, including:

 

    • Subchapter V only allows the debtor to file a plan.  In a Chapter 11, after a debtor’s exclusivity period, creditors or other parities who have an interest, may file a plan.
    • Subchapter V plans are to be filed within 90-days after the order for relief, subject to extensions under limited circumstances.
    • The term of a Subchapter V plan is consistent with current practices in Chapter 13 cases, generally between three to five (3-5) years.
    • A Subchapter V plan can be confirmed so long as it is deemed “fair and equitable” for each class of claims.  Unlike a Chapter 11 plan, it is unnecessary that at least one impaired class accept the plan in order to be confirmable.
    • And probably, the most cost effective part of a Subchapter V bankruptcy compared to a traditional Chapter 11 case, is that no disclosure statement is required.  This saves both time and significant expense.  A debtor is required, however, to include some disclosure as part of its plan.  Necessary disclosures include a short statement of its history, a liquidation analysis, and financial projections regarding the feasibility of its plan.

 

  • Discharge:  If the plan is consensual, a debtor is entitled to discharge on confirmation.  If, however, the confirmed plan is not consensual, the debtor must make all plan payments for three (3) years before obtaining the discharge.  This discharge provision, in my opinion, is an element of Subchapter V that provides incentives for both creditors and debtors to negotiate in good faith.

Additional bankruptcy related impacts of the CARES Act include:

  • Excluding coronavirus-related federal government payments, from being treated as “income” for purposes of filing bankruptcy under Chapters 7 and 13 of the Bankruptcy Code.
  • Clarifying that the calculation of disposable income, for purposes of confirming a Chapter 13 plan, shall not include coronavirus-related payments.
  • Explicitly permitting individuals and families currently in Chapter 13 to seek payment plan modifications.  This will apply to families experiencing a material financial hardship, due to the coronavirus pandemic, including extension of payments for up to seven (7) years after their initial payment was due.
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