Thirty-Second Annual Southeastern Bankruptcy Law Institute April 6-8, 2006 Atlanta, Georgia

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1 Thirty-Second Annual Southeastern Bankruptcy Law Institute April 6-8, 2006 Atlanta, Georgia Small Business Provisions and Single Asset Real Estate Provisions in Chapter 11 Bankruptcy: Update and Analysis Mary Jo Wiggins, Professor of Law, The University of San Diego School of Law and Of Counsel, Procopio, Cory, Hargreaves & Savitch, LLP., San Diego, California Copyrighted Materials. Please do not cite or quote without permission of the author.

2 General Background: The 2005 Amendments to the Bankruptcy Code contain substantial changes to the rules and practices that are intended to govern small business bankruptcies. The stated purpose of these changes is to [institute] a variety of time frames and enforcement mechanisms designed to weed out small business debtors who are not likely to reorganize. 1 The intent of these materials is to provide an update and tentative analysis of these changes. Obviously, since these amendments are new, the implications and potential consequences of these sections are difficult to state with absolute certainty. However, to the extent that these new sections impose enhanced duties and reporting requirements on small business debtors, those who counsel such debtors should be aware of both the requirements and the consequences for failing to adhere to them. A few other general observations appear at the end of these materials. 1 H.R. Rep. No , p. 1 at 19 (2005). 2

3 I. Small Business Provisions: Qualifying As A Small Business A. Section 101(51C) Small Business Case The definitions governing small business cases have been revised and expanded. Section 101(51C) now defines a small business case as, a case filed under chapter 11 of this title in which the debtor is a small business debtor. B. Section 101(51D) Small Business Debtor The 2005 Amendments define small business debtor as a debtor: engaged in commercial or business activities, including an affiliate of the debtor that is also in bankruptcy, but excluding any debtor whose primary activity is the business of owning or operating real estate, who has non-contingent, liquidated, secured, and unsecured debts that, in the aggregate, do not exceed $2 million on the date of bankruptcy, excluding debts owed to 1 or more affiliates or insiders of the debtor, and The UST has not appointed an unsecured creditors committee under 1102 or the court has determined that such committee is not sufficiently active and representative to provide effective oversight of the debtor. If a creditors committee has been appointed and is active in the case, the debtor is not a small business debtor, regardless of the aggregate amount of the debts. 3

4 Section 101(51D)(B) specifies that a small business debtor does not include, any member of a group of affiliated debtors that has aggregate non-contingent liquidated secured and unsecured debts in an amount greater than $2 million (excluding debt owed to 1 or more affiliates or insiders). The significance of this revised definition is two-fold. First, the emphasis on the existence and/or role of the creditor s committee is new. That was not a consideration under the old definition. Congress has apparently determined that where a creditors committee exists or where such a committee is active and representative, such a case is not a good candidate for the streamlined provisions of small business reorganizations. Second, the definition now makes explicit reference to how debts owed to affiliates or insiders should be treated in calculating the debt limit. It is also interesting to note that, due to the language of the definition, the determination of who is or is not a small business debtor might not occur until the bankruptcy is well under way. Although Interim Bankruptcy Rule 1020(a) limits this possibility in certain 4

5 respects, it does not eliminate it entirely. 2 A court might determine that a debtor does not belong in a small business case and thus that the special provisions do not apply to them until a much later stage in the case. In the interim, it would seem prudent to assume that such provisions apply to a case that seems to fit within in the language of the statute (and thus to comply with these special provisions) until a court determines otherwise. II. Revised Provisions For Submission And Consideration of Information Provided In Connection With The Small Business Bankruptcy Case A. Flexible Rules for Disclosure Statements 1. Section 1125(a) - This section has been amended to provide that in all chapter 11 cases, both large and small, the court shall consider the complexity of the case, the benefit of additional information to parties in interest, and the cost of providing additional information whenever the court is determining whether a 2 Interim Federal Rule of Bankruptcy Procedure 1020(a). 5

6 disclosure statement provides adequate information. 2. Section 1125(f) - This section has been amended to provide that, in a small business case, the court may determine that the plan itself provides adequate information and that a separate disclosure statement is not necessary. The court may also approve a disclosure statement submitted on a standard form as an official form Section 1125(f) - This section has been amended to provide that a court has authority to conditionally approve a disclosure statement in a small business case. The conditional approval is subject to final approval after notice and a hearing. 3 The 2005 Amendments direct the Judicial Conference to develop standard forms for small business cases. See S. 256, Section 433 (directing the Conference to prescribe official forms for a disclosure statement and plan for small business cases, with the goal of achieving a practical balance between reasonable needs of the courts and parties and reasonably complete information, as well as economy and simplicity for debtors.); See S. 256, Section 435 (directing the Conference to promulgate rules and forms requiring small business debtors to file periodic financial and other reports containing information about the debtor s profitability and cash receipts and disbursements, and whether the debtor is timely filing tax returns and paying taxes and other administrative expenses). 6

7 These sections are designed to reduce the costs and complexity of small business cases. This might be accomplished in at least three ways. First, bankruptcy courts are directed to take into consideration an explicit set of sensible policies in determining whether a disclosure statement provides adequate information. Second, a separate disclosure statement might not always be required in such a case. Third, conditional approval of a disclosure statement might be granted. This is intended to have the effect of facilitating the chapter 11 reorganization process in small business cases. B. Uniform Reporting Requirements for Small Business Debtors 1. New Section A new section of the Code requires small business debtors to file periodic and other reports that contain the following information: the debtor s profitability; 7

8 reasonable approximation of projected cash receipts and disbursements over a reasonable period; comparisons of actual cash receipts and disbursements with projections in prior reports; whether the debtor is in compliance with post-petition requirements imposed by the Code or the Rules, and whether the debtor has been timely filing tax returns and other governmental filings and paying taxes and other administrative expenses when due; if the debtor is not in compliance with such post-petition requirements or is not filing tax returns and other governmental filings or paying taxes and other administrative expenses when due, information of what the failures are and on how they will be remedied; information on such other matters as are in the best interests of the debtors and creditors, and in the public interest in fair and efficient chapter 11 procedures. 4 This section provides a uniform list of materials and reports that debtors must file in all small business cases. Most of this material is fairly standard, although actual compliance levels are likely to vary since small business debtors that end up in bankruptcy might have difficulty obtaining the required information on a 4 These requirements become effective 60 days after the promulgation of federal rules of bankruptcy procedure to establish forms to be used to comply with the new section

9 prompt and cost-effective basis. However, to the extent that the Code now contains these requirements, small business debtors must make every effort to comply. The last requirement is quite vague and could be troublesome. Who determines what material/information is in the best interests of parties in interest and in the public interest? When is that determination made? C. New Duties of DIP or Trustee in Small Business Cases 1. New Section This section lists the duties of a small business debtor in possession or trustee, including the duty to: append to its petition the most recent balance sheet, statement of operations, cash-flow statement, and federal income tax return; attend meetings scheduled by the court or UST; timely file schedules and statements of financial affairs; 5 5 With extensions that cannot exceed 30 days after the order for relief unless compelling circumstances justifying an extension. 9

10 file post-petition reports as required by the federal rules of bankruptcy procedure or local rules; maintain customary insurance; timely file tax returns and other required governmental filings, and timely pay taxes entitled to administrative expenses priority; allow the UST to inspect the debtor s business premises, books, and records. The effect of failing to adhere to the requirements in section 1116 can be devastating to a small business debtor. These effects can include dismissal, conversion of the case, appointment of a trustee, and loss of the automatic stay. 6 III. Time for Filing Plans and Disclosure Statements and Plan Confirmation Deadlines in Small Business Cases A. Time for Filing Plan and Disclosure Statement in Small Business Cases 1. New Section 1121(e) - This section makes it clear that only the debtor may file a plan within 180 days after the order for relief. In addition, a plan and disclosure statement must be filed within 300 days after the order for relief, 6 See Sections 1112 and 362(n) and the commentary on those sections in these materials. 10

11 regardless of who files them. These time periods may be extended for cause only if the debtor demonstrates that it is more likely than not that the court will confirm a plan within a reasonable period of time, a new deadline is imposed when the time is extended, and the order extending the time is signed before the existing deadline has expired. 2. New Section 1129(e) - This section provides that if a plan is timely filed in a small business case, the court must confirm the plan within 45 days after it is filed. The court may extend this time but only if it determines that it is more likely than not that the court will confirm a plan within a reasonable time, a new deadline is imposed at time the extension, and order extending the deadline is signed before the existing deadline has expired. The basic idea here is to give the debtor in a small business case more 11

12 control over the early dynamics of a chapter 11 case. The section is also designed to promote the expeditious handling of small business cases so that they are less likely to lag in the system. IV. The Special Role of the United States trustee in Small Business Cases A. Section 586 of Title 28 - This section imposes new duties on the UST in small business cases. These duties include the obligation to conduct an initial debtor interview early in the case. At that time, the U.S. trustee must begin to investigate the debtor s viability, inquire about the business plan, explain the debtor s obligations to file monthly operating reports, and perform other informational and administrative tasks. 7 If it is determined to be appropriate and advisable, the U.S. trustee must also do the following: 7 The House Report on S. 256 states as follows: Most Chapter 11 cases are filed by small business debtors. Although the Bankruptcy Code envisions that creditors should play a major role in the oversight of chapter 11 cases, this often does not occur with respect to small business debtors The resulting lack of creditor oversight creates a greater need for the United States trustee to monitor these cases closely. H.R. Rep. No , pt. 1, at 19 (2005). 12

13 1. Visit the debtor s business premises. 2. Ascertain the state of the debtor s books and records. 3. Verify that the debtor has filed tax returns. The U.S. trustee must also review and monitor the debtor s activities to determine whether the debtor will be unable to confirm a plan. The U.S. trustee must move to dismiss or convert a case under section if the trustee finds material grounds for that relief. The U.S. trustee, already given a significant number of new and enhanced responsibilities under the 2005 Act, now has even more. V. New Provisions Governing Serial Small Business Filers A. Section 362(n) - Amendments to the Automatic Stay 1. Section 362(n) provides that the automatic stay does not apply if the debtor: 8 Section 1112 has also been amended in very significant ways. These revised provisions apply both in small business cases and in all other Chapter 11 cases. 13

14 is a debtor in another small business case that is pending when the petition is filed; was a debtor in a small business case that was dismissed for any reason within the previous two years; or was a debtor in a small business case in which a plan was confirmed within the past two years. 2. If a debtor had acquired substantially all the assets or business of a small business debtor that fits the above description, the automatic stay does not apply unless the debtor establishes that it made the acquisition in good faith and not for an evasive purpose. 3. These amendments to section 362(n) do not apply in the following circumstances: in a non-collusive involuntary case, or; in a voluntary case if the debtor establishes that the filing resulted from circumstances beyond the debtor s control not foreseeable at the time of the commencement of the case, and confirmation of a feasible reorganization plan is likely within a reasonable time. 14

15 VI. New Provisions Governing Single Asset Real Estate Cases A. Section 101(51B) - This provision eliminates the monetary cap from the single asset real estate definition. B. Section 362(d)(3) - This provision permits continuation of the automatic stay against a creditor with a claim secured by a mortgage on single-asset real estate. This continuation is allowed only if certain interest payments are made. This provision has been modified to make it clear that nondefault contract rate of interest is the relevant variable for determining the amount of interest payments that must be made in order for the stay to continue. VII. General Conclusions Only time will tell whether these provisions, especially those involving small business cases, will achieve their desired result. However, there is reason for skepticism. As previously stated, the objective of the legislation is to weed out non-viable 15

16 small business reorganizations. However, previous law arguably contained sufficient measures to accomplish this goal and it is not clear, as an empirical matter, that such measures were not doing the job. What these provisions might end up doing is the opposite of what was intended. They might actually increase the time and complexity of small business cases by instituting new reporting requirements (even if they are supposedly uniform) and increasing the role of the already greatly-burdened U.S. trustee in small business cases. In that event, it is unlikely that small businesses will have any enhanced incentives to seek relief under the Code. In the meantime, it is recommended that attorneys who represent small business corporate debtors comply with the new provisions as non-compliance brings with it some increased risks, including dismissal, conversion and collateral seizure. 16