The Small Business Reorganization Act: An Enticing Menu Option for Restaurants in Trouble

It has been reported that in the six months from March through August 2020, a total of 32,109 restaurants have closed with 19,590 of the closures expected to be permanent.  In fact, the restaurant industry recently surpassed retail as the industry with the highest number of business closures since the onset of COVID-19.

The short-term outlook is not much better.  While all states have allowed restaurants to reopen to some extent, most states have imposed capacity limits and distance requirements.  Because restaurants typically run on thin profit margins and rely on high volume, COVID-related restrictions produce significant negative impacts, especially on small business restaurants.  Some may have stayed alive with government loans or grants, but other than the short-lived Paycheck Protection Program, which officially concluded on August 8, 2020 after dispersing approximately $525 billion, additional government assistance has not been forthcoming.  

Facing an uncertain future, many restaurants are considering bankruptcy as the solution to staying afloat financially and weathering the ongoing pandemic.  Yet, the Chapter 11 bankruptcy process can be a daunting challenge for a small business with limited financial resources.  A typical Chapter 11 case requires multiple bankruptcy court hearings, out-of-court negotiations, voluminous paperwork, and separate deals with banks, landlords, and other creditors to avoid litigation and to allow the owner to retain the equity in the business.  Restaurants on the verge of closure may lack the time and manpower required of the Chapter 11 process, let alone the cash or ability to fund a case.

However, under the Small Business Reorganization Act (“SBRA”), which went into effect just in time in February 2020, small businesses with less than $7.5 million in total debt now have the option of proceeding under a streamlined version of Chapter 11 with substantial cost-saving advantages.

Here are some of the most important features of the SBRA, also referred to as “subchapter 5” of the Bankruptcy Code:

  1. The Plan – The small business (the “debtor”) has the exclusive right to file a plan of reorganization. The plan must be filed within the first 90 days of the case.  Unlike a traditional Chapter 11 case, there is no requirement that any class of creditors approve the plan.  Even if creditors reject a plan, the bankruptcy court may approve it, so long as, among other things, the plan provides that the next three to five years of the “disposable income” (i.e., net income or profits) will be distributed to creditors.  
  2. Retention of Ownership – In a major change from prior law, the owners of the debtor may retain their full ownership of the business even if trade vendors and other unsecured creditors are not repaid in full under the plan. 
  3. A Streamlined Process – Unless the court orders otherwise, no creditors committee is appointed, creditors may not file a competing plan, and the debtor is not required to file a disclosure statement with the plan, all of which shorten and simplify the plan confirmation process.  Also, the debtor is not required to pay quarterly fees to the U.S. Trustee.
  4. The Trustee – The debtor remains in possession and control of the business and its operations.  Nonetheless, a trustee is appointed in each case to serve as a financial monitor and facilitate the development of a consensual plan of reorganization.
  5. Home Equity Loan Modification – Another unique feature of the SBRA is that it allows the small business owner to modify a home equity mortgage, if it was a loan used primarily in connection with the business.
  6. Debt Limit – Small businesses with less than $7.5 million in debt are eligible to file bankruptcy under subchapter 5 as a result of the CARES Act, which increased the limit from $2.7 million.  The debt limit increase is set to expire in March 2021 and may (or may not) be extended.

This is only a brief overview, and there may be situations where a small business should not elect to proceed under subchapter 5.  Generally speaking, however, the SBRA is favorable to small businesses and promotes speed and consensus, thereby saving valuable time, reducing costs, and enhancing the prospects of success.

For those small restaurants that are constrained by debt caused by COVID-19 but remain optimistic that they can again generate positive cash flow, a SBRA case may be the vehicle for short and long term survival.