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The Role of Chapter 11 Bankruptcy in Addressing the Consequences of COVID19.

posted by Jay Lawrence Westbrook

Many businesses may require bankruptcy proceedings to assist in recovery from the CV Recession. In my view, the best legal approach to any Chapter 11 reforms necessitated by the emerging CV-induced economic crisis lies in building up from the Small Business Reorganization Act (SBRA) to cover more Small and Medium Enterprises (SME), rather than trying to adjust the general provisions of Chapter 11, the home of bankruptcies like General Motors and American Airlines. Our database at the Business Bankruptcy Project shows that in 2018 more than half of the businesses that filed in Chapter 11 in the Southern District of New York would fall under the temporary SBRA cap, $7.5 million.

Most immediately, the recently voted funds for small business must be available in bankruptcy reorganization cases. We must remove any barrier to using them in that way. I start the study of Chapter 11 by reminding students that the clerk at the bankruptcy court does not hand out money. Bankruptcy does not produce funding, although it can help facilitate it in important ways. Thus there is no legal reform that will avoid the need for very substantial financing with implications far beyond reorganization procedures. Bankruptcy cannot help unless it can be used in connection with rescue funding.

To the extent we can see forward, the most serious failures will come from a) the bad luck of being part of an especially hard-hit region (e.g. New York) or an especially hard-hit industry (e.g. travel); or b) the business being over-leveraged with debt even prior to the CV crisis, creating a fragile financial structure; or c) some combination of the two. For both, Chapter 11 buys time to adjust business models and methods (e.g., curbside pickup) and secure financing. Ideally, Congress would adopt a standstill on all debt collections for 30-60 days, but so far there has not been the will to do that. That makes the bankruptcy stay necessary in many cases where just a brief moratorium might be enough. As it is, traditional Chapter 11 proceedings, even those with substantial sales, are expensive and time-consuming and thus a poor fit for many smaller companies.

A number of large businesses will require bankruptcy. For the most part the bankruptcy system should be able to accommodate them, although temporary bankruptcy judges or some legislation permitting magistrate-helpers for the bankruptcy courts will be required. See, e.g., Edward R. Morrison and Andrea C. Saavedra, Bankruptcy’s Role in the COVID-19 Crisis SSRN #3567127. (One of my favorite bankruptcy stories is Judge Caroline Dineen King of the Fifth Circuit volunteering to act temporarily as a bankruptcy judge during the great economic crisis of the mid-Eighties in Texas because of the avalanche of bankruptcies; in doing that she emulated another great judge, Learned Hand, much earlier in the Twentieth Century.)

The basic structure of Chapter 11 will work for those large companies. Adoption of permanent changes or additions to the provisions that govern large corporate reorganizations should be postponed for more careful examination. At most, adjustments thought necessary to get through the crisis should be temporary.

Where help will be needed is for SMEs. By a wonderful stroke of luck, in February, 2020, the Small Business Reorganization Act (SBRA) took effect just in time for CV, permitting a fast, cheap Chapter 11 procedure for small businesses, defined as those with up to $2.75 million in debt. See, e.g., Bob Lawless/ Ted Janger, Credit Slips March 15, 2020; Jessica Ljustina, Coronavirus Aid, Relief, and Economic Security Act Expands Scope of Small Business Reorganization Act (Harvard Round Table). The CARES Act, responding to the helpful recommendations of the National Bankruptcy Conference (3/22/20), included a temporary increase in the cap to $7.5 million in light of the economic crisis.

SBRA (Subchapter V) is a form of Chapter 11 bankruptcy permitting a small business—as an individual person or incorporated—to get court approval of a plan that reduces and postpones debt and permits it to be paid over three years or more—just what so many small businesses will need. In some ways, it is a radical reform, but it is limited in its scope. It eliminates most of the time-consuming and expensive requirements of Chapter 11 and permits paying the lawyers over time. It encourages agreement between the business owner and creditors, but permits court approval without agreement if the court finds the plan fair and even-handed. It also imposes a trustee who can act as a guide to the debtor, a protector of creditors and other interests, and an advisor to the court. It can also permit a business person to save his/her home. It may result in a return to the bifurcated structure of reorganization as originally adopted and successfully used before 1978, with specialized provisions for private, less-than-colossal companies. It is potentially a godsend in this emergency.

Even the temporary $7.5 million cap may be too small for SME that need only limited help, but need it quickly and cheaply. We can add larger companies by starting with the sensible provisions already approved by Congress in SBRA and consider what, if any, protections (and related delay and expense) might need to be added for those larger companies where the risk of abuse and injury to creditors might be more likely. We would need fast and knowledgeable factual research to fix a new cap—or maybe a series of caps, with added protections as one moves up the scale in size. Generally, debt is the best metric for bankruptcy procedures (for obvious reasons), but as size increases other tests might be appropriate as well, if they can be kept simple and easy to apply. Companies that have publicly traded debt should not be eligible, just as they are not allowed to use SBRA.

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