Buried in the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, which is expected to be passed by Congress and signed by the President today, are revisions to the Bankruptcy Code that are relevant to creditors dealing with distressed debtors. Most notably, the bill will impact the recently-enacted Small Business Reorganization Act of 2019 (the “SBRA”) by increasing the potential pool of qualified debtors.

The SBRA, which just went into effect in mid-February, adds to the Bankruptcy Code a subchapter V, which allows small business owners certain advantages to reorganize their debt. The current debt limit for eligibility for cases under the new subchapter V is $2,725,625. The CARES Act will increase the eligibility threshold to $7.5 million in total debt, but only for one year, at which time it will revert back to the present limit.

Along with an increase in the filing of new subdivision V cases, this modification to the SBRA will likely see an surge in existing chapter 11 cases being converted to subchapter V through the filing of an amended petition under Bankruptcy Rule 1009. Since the SBRA was enacted a month ago, debtors in pending small business chapter 11 cases have been successful in converting or “re-designating” their cases to subdivision V. Specifically, bankruptcy courts reviewing re-designation requests have “found no legal reason to restrict a pending chapter 11 case to re-designate to a Subchapter V case.”  See In re Progressive Solutions, Inc., 2020 Bankr. LEXIS 467, at *13 (Bankr. C.D. Cal. Feb. 21, 2020); In re Moore Props. of Person Cty., LLC, 2020 Bankr. LEXIS 550, *17 (Bankr. M.D.N.C. Feb. 28, 2020) (finding that a small business debtor “was entitled to make the election to have subchapter V apply”); In re Body Transit, 2020 Bankr. LEXIS 740, *15 (Bankr. E.D. Pa. 2020 March 24, 2020).

In reaching its decision, the Body Transit court “consider[ed] the extent to which parties in interest have invested in the case and whether the court has entered orders that create sufficient vested property interests or post-petition expectations such that the application of subdivision V to those rights or expectations would offend ‘elementary considerations of fairness.’” Body Transit, 2020 Bankr. LEXIS 740, at *14-15 (quoting Moore Properties). Further, in determining whether re-designation was appropriate, the Body Transit court considered “whether the amendment is made in bad faith or would unduly prejudice a party.”  Id. at 15. The court placed the burden of showing prejudice on the party objecting to the re-designation, which was the senior secured creditor.

Many debtors in pending chapter 11 cases will believe that they will benefit from the conversion of a case to subchapter V, because a conversion could eliminate the appointment of a creditors committee and the requirement of filing a disclosure statement with a plan of reorganization. Further, a subchapter V plan need not comply with the absolute priority rule, so that a debtor could retain an ownership interest in its assets even where all creditor claims are not paid in full. For these reasons, the CARES act potentially makes a subchapter V case a more attractive option for a larger group of distressed small business borrowers.

The CARES bill also provides for other temporary changes to the Bankruptcy Code in response to the COVID-19 outbreak, more focused on the individual consumer than small business. For a one year period, the definition of “income” in chapter 7 and 13 cases will exclude coronavirus-related payments received from the government. It is unclear if this includes any federally mandated or funded furlough or unemployment payments. It also allows chapter 13 debtors with confirmed plans to seek modifications to their plans if they experience a material financial hardship due to the present pandemic.  Both of these modifications are debtor-friendly, and could impact the rights of lenders.

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