What Small Businesses Need Most Is A Little More Time

By Brook Gotberg (University of Missouri Law School; Chair, Small Business Committee of the Bankruptcy & COVID-19 Working Group)

Brook Gotberg

In the wake of the national shutdown of most commercial activity in response to the COVID-19 pandemic, many small businesses are struggling with financial disruption, restrictions on reopening, and uncertainty regarding future business prospects.  Small businesses make up the vast majority of private firms in the United States, and provide nearly two-thirds of all new jobs.  These businesses have been the most visible economic casualties of the global pandemic, with many already closing for good, and many others reevaluating their prospects.  Certain industries, particularly dining and entertainment, have been particularly hard-hit, and could face large-scale obliteration.

A group of interdisciplinary scholars, the Small Business Committee of the Bankruptcy & COVID-19 Working Group, has been meeting regularly since March to discuss policy proposals for bankruptcy that would best protect viable small businesses from unnecessary death.  Although bankruptcy serves as a method to discharge debt, it also operates to stop collection efforts, which may be essential even for companies with little to no debt.  We fear that many formerly profitable small businesses will unnecessarily fail in the face of the current constraints on bankruptcy protection – constraints which assume a functioning economy, not the current reality.  Moreover, a mass filing of bankruptcies could overwhelm the bankruptcy system itself, particularly in light of the accelerated time frames currently designated for small businesses under the Bankruptcy Code.

We therefore recommend that the Code be temporarily adjusted to put a six-month freeze on most typical deadlines, affording debtors additional time to propose a plan of reorganization.  Furthermore, we recommend that debtors be allowed an amortized schedule to repay past-due rent.

Our reasoning for this proposal is simple.  While bankruptcy law in normal times can distinguish viable companies from non-viable companies and recommend reorganization or liquidation accordingly, these are not normal times.  Baseline assumptions for the value of businesses depend on revenues, which are now artificially constrained.  Creditors, trustees, and judges cannot make informed decisions on the viability of a given enterprise based on the recent past, and that uncertainty is unlikely to be resolved in the near future.  It is therefore essential to allow bankrupt firms more time to take advantage of the automatic stay while reassessing options for reorganization.

Furthermore, the hit to revenues will likely create debt overhang for otherwise profitable businesses that could prove impossible to overcome in the short run. This is particularly true for rental obligations.  For many small businesses, past-due rent is likely to be the primary obligation, but the law does not permit debtors to repay past-due rent over time, as is permitted for other forms of debt.  Current bankruptcy rules require a debtor to commit to its outstanding rental agreements within 60 days of filing, and then to repay all past-due rental obligations “promptly” (see 11 U.S.C. § 365(b) and (d)(4)(A)).  Our policy recommendation would permit small business debtors to repay rental obligations over the life of the plan – three to five years, under the Small Business Reorganization Act (SBRA).

Similarly, we also recommend that interest accumulated on oversecured collateral after the date of the national emergency proclamation, March 13, 2020, be disallowed in an effort to preserve the respective positions of all creditors.

Recognizing the burden placed on landlords and secured creditors by these recommendations, our proposed changes to deadlines do not interfere with swift cash collateral motions and motions to obtain alternative financing.  We also recommend that, although most motions to lift the stay would not be permitted, creditors should be allowed to lift the stay in circumstances where it can be shown that the debtor is wasting or spoiling the collateral.

A simultaneous permanent closure of small businesses would be catastrophic for the American economy, as hinted at by the surge in unemployment that followed the temporary closures.  Beyond the loss of jobs, closure of businesses would mean fewer services offered within the community, and closed storefronts would likely invite blight, particularly in already vulnerable communities.  This could erase years of hard-won economic and social progress.

The goal of the Bankruptcy & COVID-19 Working Group is to make workable policy recommendations that will have a meaningful impact in mitigating the harm caused by COVID-19 to the American economy.  The group continues to meet, gather data, and review additional policy recommendations.  The goal is to minimize the long-term damage caused by the global pandemic by exploring how bankruptcy policy can do the most good.

The full letter can be found here.

Estimating the Need for Additional Bankruptcy Judges in Light of the COVID-19 Pandemic

By Benjamin Iverson (BYU Marriott School of Business), Jared A. Ellias (University of California, Hastings College of the Law), and Mark Roe (Harvard Law School)

Ben Iverson
Jared A. Ellias
Mark Roe

We recently estimated the bankruptcy system’s ability to absorb an anticipated surge of financial distress among American consumers, businesses, and municipalities as a result of COVID-19.

An increase in the unemployment rate has historically been a leading indicator of the volume of bankruptcy filings that occur months later.  If prior trends repeat this time, the May 2020 unemployment rate of 13.3% will lead to a substantial increase in all types of bankruptcy filings.  Mitigation, governmental assistance, the unique features of the COVID-19 pandemic, and judicial triage should reduce the potential volume of bankruptcies to some extent, or make it less difficult to handle, and it is plausible that the impact of the recent unemployment spike will be smaller than history would otherwise predict. We hope this will be so.  Yet, even assuming that the worst-case scenario could be averted, our analysis suggests substantial, temporary investments in the bankruptcy system may be needed.

Our model assumes that Congress would like to have enough bankruptcy judges such that the average judge would not be pressed to work more than was the case during the last bankruptcy peak in 2010, when the bankruptcy system was pressured and the public caseload figures indicate that judges worked 50 hour weeks on average.

To keep the judiciary’s workload at 2010 levels, we project that, in the worst-case scenario, the bankruptcy system could need as many as 246 temporary judges, a very large number. But even in our most optimistic model, the bankruptcy system will still need 50 additional temporary bankruptcy judgeships, as well as the continuation of all current temporary judgeships.

Our memorandum’s conclusions were endorsed by an interdisciplinary group of academics and forwarded to Congress.

A Guide to the Small Business Reorganization Act of 2019

By Hon. Paul W. Bonapfel (U.S. Bankruptcy Judge, N.D. Ga.)

Hon. Paul W. Bonapfel

A Guide to the Small Business Reorganization Act of 2019 is a comprehensive explanation of the new subchapter V of chapter 11 of the Bankruptcy Code that qualifying debtors may elect and other changes to the Bankruptcy Code that the Small Business Reorganization Act of 2019 (“SBRA”) enacted.  The Guide also covers related changes to title 28 of the U.S. Code (Judiciary and Judicial Procedure) and the promulgation of Interim Bankruptcy Rules and revised Official Forms.

Among other things, the Guide discusses the new definition for ”small business debtor;” the role and duties of a subchapter V trustee; changes in procedures; provisions for the content and confirmation of a subchapter V plan (including elimination of the “absolute priority rule”); and new provisions for discharge after confirmation of a “cramdown” plan.

Since the distribution of earlier versions of the Guide prior to SBRA’s effective date (February 19, 2020) and its publication at 93 Amer. Bankr. L. J. 571, the paper has been revised and updated to include discussion of: the increase in the debt limits for eligibility for subchapter V under the CARES Act; how courts are implementing procedures for subchapter V cases; and early case law dealing with retroactive application of subchapter V, its availability in a chapter 11 case filed prior to its enactment, and the exception in new § 1190(3) to the antimodification rule in § 1123(b)(5), which prohibits the modification of a claim secured only by the debtor’s principal residence.

The latest Guide is available here.

Bankruptcy Venue Reform

By Nicholas Cordova (Harvard Law School)

Nick Cordova

Although the Boy Scouts of America (BSA) is headquartered in Texas, it filed for chapter 11 in Delaware in February. That was permissible under existing bankruptcy venue rules because the BSA had created an affiliate in Delaware seventh months earlier. Unsettled by this apparent forum shopping, the Attorneys General of 40 states, the District of Columbia, and Puerto Rico sent a letter to Congress expressing their support for H.R. 4421, the Bankruptcy Venue Reform Act of 2019. It would have prevented the BSA’s conduct. Ten state Attorneys General did not sign the letter: New York, Delaware, Connecticut, Florida, Kansas, New Jersey, North Carolina, Montana, Virginia, and Wyoming.

Under the Act, a corporation could only establish venue in three places. First, the district where its “principal assets” were located for the 180 days before filing. Second, the district where it maintains its “Principal Place of Business.” Third, and only for controlled subsidiaries, any district where a case concerning an entity controlling 50 percent or more of its voting stock is pending. Changes of control or in the Principal Place of Business in the year before filing or conducted “for the purpose of establishing venue” would be disregarded. Corporations could thus no longer manufacture venue in a preferred jurisdiction by simply creating an affiliate there.

H.R. 4421 would also require the Supreme Court to promulgate rules allowing “any attorney representing a governmental unit” to appear in any chapter 11 proceeding without paying a fee or hiring local counsel. This provision likely factored heavily into the Attorneys General’s support for the Act. Their support letter emphasizes that the resulting rule would help them enforcers consumer protection and environmental laws by reducing the costs of defending their states’ interests in chapter 11 cases filed in distant jurisdictions.

The letter offered two reasons why corporations should not be able to manufacture venue in districts with seemingly favorable judges just by creating an affiliate there. First, it is costly for creditors (particularly small creditors) because they must either travel long distances or forgo face-to-face participation as well as hire local counsel in expensive legal markets. Second, it may cause the public to perceive the bankruptcy system as unfairly advantaging large corporations. H.R. 4421 would solve these problems by “ensur[ing] that bankruptcies are filed in jurisdictions where debtors have the closest connections and filings will have the largest impacts.” The letter notes the Southern District of New York and the District of Delaware as two currently attractive districts. But the Attorneys General argue that other district and bankruptcy judges have similar expertise.

Academics largely agree that 28 U.S.C. § 1408’s permissive venue rules encourage competition among bankruptcy courts to attract high profile cases, but opinion is split on whether this competition improves or degrades bankruptcy law.

Lynn LoPucki and William Whitford argue that venue choice degrades bankruptcy law by pressuring judges to exercise their discretion to favor debtors and their attorneys because these are the actors who usually choose where to file. They suggest, for example, that bankruptcy judges of the Southern District of New York misuse discretion by freely granting extensions of the 120-day exclusivity period during which only the debtor may propose a reorganization plan. Debtors can then agree to move toward confirmation of a plan in exchange for concessions from creditors.

David Skeel, on the other hand, argues that at least one of the venue choices that the proposed Bankruptcy Reform Act would eliminate—the district where the entity is incorporated—improves bankruptcy law by encouraging states to compete for incorporation fees by offering increasingly efficient bankruptcy rules in the multiple areas where federal bankruptcy law defers to state law.

On April 29, 163 current and retired bankruptcy judges sent a letter to members of the House Committee on the Judiciary expressing support for H.R. 4421’s proposed reforms. The letter stresses the preference for eliminating state of incorporation as a basis for venue.

COVID-19: Rethinking Chapter 11 Bankruptcy Valuation Issues in the Crisis

By Andrew N. Goldman, George W. Shuster Jr., Benjamin W. Loveland, Lauren R. Lifland (Wilmerhale LLP)

Andrew N. Goldman
George W. Shuster Jr.
Benjamin W. Loveland
Lauren R. Lifland

 

 

 

 

 

 

 

Valuation is a critical and indispensable element of the Chapter 11 bankruptcy process. It drives many aspects of a Chapter 11 case, from petition to plan confirmation, in all circumstances. It may be obvious that the COVID-19 crisis has added a layer of complexity—and volatility—to bankruptcy valuation issues with respect to valuing assets, liabilities, and claims, both in and outside the Chapter 11 context.  But the crisis may also change the way that courts look at valuation determinations in Chapter 11—both value itself, and the way that value is measured, may be transformed by the COVID-19 crisis.  While the full extent of the pandemic’s effect on valuation issues in bankruptcy has yet to be seen, one certainty is that debtors and creditors with a nuanced and flexible approach to these issues will fare better than those who rigidly hold on to pre-crisis precedent.

The full article is available here.

Planning for an American Bankruptcy Epidemic

By Ben Iverson (Brigham Young University), Mark Roe (Harvard Law School)

Ben Iverson
Mark Roe

The COVID-19 pandemic looks likely to cause a surge in bankruptcies in the United States—conceivably a surge as rapid and as substantial as the U.S. court system has ever experienced. A significant and rapid increase in judicial capacity to manage the flood of cases is more than appropriate, we argued in a recent op-ed.

Bankruptcy filings in the United States have historically peaked several months after a surge in unemployment. And American unemployment is now rising at an unprecedented rate, with more than 30 million claims filed in the last six weeks. If historical patterns hold, the bankruptcy surge would be on track to be the largest the American bankruptcy system has experienced.

Bankruptcy works well enough and quickly enough in normal times, particularly for restructuring large public firms. But it cannot work as well, and the economy will suffer, if the bankruptcy system is overloaded. Delays in critical vendor orders, DIP loan approvals, pre-packaged bankruptcy confirmations and the like could all slow commerce unnecessarily.

The full op-ed is available HERE.

This DIP Loan Brought to You by Someone Who CARES!

By Thomas J. Salerno, Gerald Weidner, Christopher Simpson, and Susan Ebner, (Stinson LLP)

Tom Salerno
Gerald Weidner
Chris Simpson
Susan Warshaw Ebner

 

 

 

 

 

 

 

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security (CARES) Act was enacted into law. The CARES Act is reported to be “twice as large as any relief ever signed,” and will provide $2.2 trillion in relief to US businesses (with another $1 trillion being promised in the near future). While bankruptcy lawyers are aware that CARES expanded the debt limitations for eligibility for the Small Business Bankruptcy Reorganization Act, there could (and should) be another substantial implication for the brave new bankruptcy world—a new potential source of DIP financing. It is in this context that the CARES financing provisions become particularly interesting.

The authors recognize that there are established underwriting guidelines for SBA loans. Moreover, the existing regulations (and revisions in process) will come into play as to availability of these loans. Accordingly, while there is no express prohibition for some of the loans referenced herein from being accessed in a Chapter 11 proceeding, a de facto prohibition likely comes from existing underwriting guidelines. If the overarching purpose of the CARES Act is to assist businesses in weathering the economic storm while the COVID 19 virus ravages the economy, the authors argue that such underwriting guidelines can, and must, be loosened in order to allow application of some of these programs in Chapter 11 proceedings so that they can be most effectively implemented to stabilize businesses, preserve jobs, continue to keep employees and businesses on the tax rolls, etc.

In this way the stimulus funds will be used where they can be most effectively deployed. If not, those funds will be the equivalent of the federal government sending rubber rafts to a drought stricken area—a sign that the government cares, perhaps, but of certainly no real use to address the problem at hand. The full article is available here.

Coronavirus Aid, Relief, and Economic Security Act Expands the Scope of the Small Business Reorganization Act

By Jessica Ljustina (Harvard Law School)

Jessica Ljustina

Congress passed the Small Business Reorganization Act of 2019 (“SBRA”) to streamline and reduce the cost of bankruptcy for small businesses; it went into effect on February 19, 2020.

As originally enacted, the Act allowed certain small businesses with no more than approximately $2.7 million of debt to file for bankruptcy under a new subchapter V of chapter 11 of the Bankruptcy Code.

The recently enacted Coronavirus Aid, Relief, and Economic Security (“CARES”) Act has temporarily increased the debt limit to $7.5 million for cases commenced in the next year. That may greatly expand the SBRA’s scope, as Professor Robert Lawless has estimated that over 50% of businesses that filed under chapter 11 between 2013 and 2017 had debt below $7.5 million.

The full article is available here.

The Italian Insolvency Law Reform

By Andrea Zorzi (University of Florence)

Andrea Zorzi

On January 12, 2019, a new ‘Code of enterprise crisis and of insolvency’ was adopted in Italy.

The qualifying aspect of the new law is its emphasis on early intervention. The early warning system is based on enhanced internal monitoring and a ‘duty to scream’ imposed on public creditors, if the company is delinquent on VAT or social security contributions. All business entities must set up adequate ‘organisational, management and accounting’ systems that allow early detection of a crisis and timely dealing with it. The law also creates a public office that should help debtors to find an agreement with creditors or induce them to file for a proper reorganisation procedure.

There are incentives for debtors and directors who tackle the crisis early (and for auditors who take the appropriate steps). On the other hand, undue delay is addressed in various ways. Among them, a new presumption regarding the quantification of damages in case of directors’ trading after the moment when the company is deemed dissolved, that will make it easier for trustees to hold directors liable.

The reform also brings in updates on international jurisdiction, now entirely based on centre of main interest (COMI) (however, there is no general cooperation obligation with regard to cross-border insolvency), and a comprehensive set of rules on group crisis (seemingly compliant with the UNCITRAL principles).

Finally, the law makes relevant changes regarding two of the three available restructuring instruments, while there is nothing new with regard to the very peculiar reading of the absolute priority rule (APR) according to Italian insolvency law.

The law broadens the scope of the cramming down on dissenting creditors (subject to a 75% supermajority in the relevant class) in out-of-court, but court-confirmed debt restructuring agreements: once restricted to financial creditors only, they are now available with respect to all creditors. The confirmation of the plan, which envisages only intra-class cram down, is possible irrespective of compliance with any priority rule (absolute or relative), with the only backstop of a ‘best-interest test’, now based on a comparison with a liquidation scenario. This makes the Italian ‘scheme of arrangement’ a very flexible and effective tool (confirmation rates are also very high, in practice).

Regarding judicial composition with creditors (concordato preventivo), the law confirms the controversial requirement (introduced in 2015) that a minimum 20% payment of unsecured creditors is ensured when a liquidation plan is proposed, and adds the requirement of some form of ‘external’ financial input. By contrast, there is no such a threshold when the business is due to continue under the plan: however, ‘business continuation’ is now defined more narrowly than in the past – it is such only if creditors are paid mainly out of proceeds of the ongoing business, rather than from asset sales, or, under a statutory definition, if the continued business employs at least one-half of the previous workforce. This requirement may exceedingly restrict access to reorganisation or transfer wealth from creditors to employees.

As mentioned, the APR conundrum – the matter is domain of case law – is not solved by the new law. While the discussion regarding APR among creditors is confined mainly to what constitutes ‘new value’ (thus evading the APR waterfall), APR still seems not to apply to equity holders, in case of business continuation.

Finally, the new law introduces very minor tweaks to ‘plain’ insolvent liquidation proceedings, solving some interpretive issues but without an innovative approach, and makes the ‘certified reorganisation plan’, an out-of-court restructuring framework, somewhat more stable in case things don’t work out and the debtor ends up insolvent.

Certain new measures are already in force, but the whole new Code will come into force on 15 August 2020. It should be noted that the new law fully applies – as the law it supersedes – only to enterprises with less than 200 employees. Enterprises exceeding that threshold are deemed ‘large’ and, while being able to access ordinary restructuring tools, if insolvent they are subject to ‘extraordinary administration’, a special going-concern liquidation regime that provides for broad discretion for governmental authorities and the pursuit of business continuity even at the expenses of creditors’ rights.

The paper offers a comprehensive review of the main features of the new law, setting it in the context of the current Italian insolvency law framework.

The full article is available here.

For previous Roundtable posts on Relative and Absolute Priority Default Rules in EU, see Jonathan Seymour and Steven L. Schwarcz, Corporate Restructuring under Relative and Absolute Priority Default Rules: A Comparative Assessment.

China Continues to Issue New Rules Promoting Corporate Rescue Culture, Facilitation of Bankruptcy Proceedings

By Xiao Ma (Reorg | Harvard Law School)

Xiao Ma

Coupled with continued efforts in financial deleveraging and industrial reorganization, China delivered a number of changes to its bankruptcy law in 2019 in an effort to further accommodate smooth market exits for non-profitable businesses and to provide greater opportunities for viable businesses that experience temporary liquidity issues to be restructured as going concerns.

Currently, a lack of detailed rules and practical solutions to issues arising out of bankruptcies often deters parties from initiating such proceedings in China. The new rules will provide further clarification on extensively litigated/disputed issues and enhance transparency and consistency in the bankruptcy courts’ handling of cases. The developments encourage more usage of restructuring and compromise proceedings to find market solutions to address insolvency of Chinese companies.

“China’s bankruptcy laws and practices will be more and more market-driven,” said Xu Shengfeng, a Shenzhen-based bankruptcy and restructuring partner of Zhong Lun Law Firm, notwithstanding perceptions among foreign investors that “China’s bankruptcy regime is rather bureaucratic and administrative, with a certain level of involvement by local governments.”

“The goal is to build an institution in which the government’s role can be minimized, until its complete exit,” Xu said. “It cannot be done within a year or two, but this is certainly where things are headed.”

Market players, in particular financial institutions and asset management companies, are becoming more active and playing a greater role in leading restructuring and compromise proceedings. “Right now, many of the restructuring cases need capital injection from outside investors, and it is a great time for asset management companies,” Xu said. The recent U.S.-China Trade Deal promises to open doors for U.S. firms to obtain asset management licenses to acquire Chinese NPLs – see Article 4.5 of the US-China Economic and Trade Agreement.

Key changes to China’s restructuring regime in 2019 included:

  • establishment of specialized bankruptcy courts in Beijing, Shanghai, Shenzhen, Tianjin, Guangzhou, Wenzhou and Hangzhou;
  • Supreme People’s Court’s Judicial Interpretation III on the Enterprise Bankruptcy Law (EBL);
  • joint announcement of the Plan for Accelerating Improvement of the System for Market Entity Exits by 13 major state departments;
  • further establishment of regional bankruptcy administrator associations, including those in Beijing and Shanghai;
  • comment solicitation and final issuance of the Minutes of Conference on National Courts’ Civil and Commercial Trial Work, which devoted a section specifically for amendment of bankruptcy rules and restructuring regimes; and
  • launch of National Enterprise Bankruptcy Information Disclosure Platform, a platform for the public to access information related to bankruptcy cases and facilitate bankruptcy proceedings in terms of claim registration, notices for creditors’ meeting, publication of announcements, etc.

“It was definitely a year of highlights,” said Xu. “The professionalism of bankruptcy trial teams, the establishment of online bankruptcy information disclosure platform, the promotion of pre-packaged restructurings and so on. The Supreme People’s Court is also making headways in the areas of personal bankruptcy and cross-border bankruptcy.”

The full article is available here.

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