Just in time for what is almost certainly going to be a rush of bankruptcies in the trucking sector, two changes in federal bankruptcy law are set to potentially keep more companies alive that might have faced liquidation in the past.
The changes, discussed last week on the Drilling Deep podcast with attorney Matt Ferris of the law firm of Haynes & Boone, were rolled out in February in a fortuitous piece of timing: just as the COVID-19 pandemic raised the prospect of pushing a likely enormous number of companies, including trucking firms, into liquidation under Chapter 7 of the Federal Bankruptcy Act.
But the Small Business Reorganization Act (SBRA), passed last year in a rare display of bipartisanship and signed by President Donald Trump, went into effect Feb. 19. Soon after, as Congress passed and the president signed the CARES Act for pandemic relief, the provisions in the SBRA suddenly were opened to an even larger number of troubled companies.
What the SBRA does is make the Chapter 11 process in bankruptcy law easier, cheaper and available to smaller companies. And what the expansion in the CARES Act did was allow companies with an even bigger debt load than what was in the original SBRA law to seek relief under its provisions.
Under the original SBRA, a company could use its provisions if it had a debt load up to $2.7 million. (Debt above that threshold would bring a company into the usual provisions of Chapter 11.) Under the expansion of SBRA provisions, that number goes up to $7.5 million.
(A piece about the new law in the National Law Journal noted that the higher ceiling allowed by CARES is only good for a year before it reverts back to its approximately $2.7 million level).
“SBRA is aimed at simplifying the bankruptcy process for small businesses by increasing efficiency, lowering costs, and easing the plan confirmation process,” Scott Ugell, a New York state-based attorney, wrote of the changes in a recent issue of the Rockland County Business Journal. “It could mean the difference between weathering the storm or having to close one’s doors and liquidate one’s assets. This statute was a great idea before the economic tsunami we are experiencing but now it is a real blessing.”
Companies that are looking for protection under SBRA are actually filing under Chapter 11. Chapter 11 is designed to reorganize a company with the agreement of its debtors and allow it to continue in a new corporate structure that can take a wide variety of forms.
But Chapter 11 has always been expensive and complicated. For a smaller company, that usually means a trip through bankruptcy court and liquidation under Chapter 7. A smaller trucking company would fit that description.
“The cost of the process can be prohibitive for companies of a certain size,” Ferris said in his Drilling Deep interview. “The practical result is that many companies are forced to go the Chapter 7 route, which means they have to liquidate their assets and cease operations.”
Ferris said the SBRA cuts a lot of costs in the process and therefore opens the door to a Chapter 11 process in place of the more company-killing Chapter 7. “The act makes it possible for companies that would not otherwise have been able to avail themselves of Chapter 11 to actually go in and reorganize and be operating their business once they emerge from bankruptcy,” he said.
The consensus among attorneys who have written about the SBRA is that the elimination of a creditors’ committee for smaller companies filing under the law is a significant boost.
In a chapter 11 action, a creditors’ committee is formed to represent the debtor’s unsecured creditors. It will then hire advisers and lawyers and incur other costs. All those costs are billed to the debtor.
Joseph Ammar of the law firm of Miller Canfield, writing in the Michigan Bankruptcy Journal last year, said that as a result of that change, “costs and procedural burdens should be reduced with no creditors’ committee.” He also cited the law’s elimination of a requirement for a debtor to post a “disclosure statement,” which requires a significant amount of data.
Ferris, describing the changes in the law, said another of the most significant changes under SBRA is that companies filing under it will avoid the “absolute priority rule.” Under current practice in Chapter 11, “as you move down the capital stack, the lowest rung can’t keep anything under a plan unless the rung above that is getting paid in full.”
At the bottom of most Chapter 11 filings are the equity holders, who in the bankruptcy of a publicly traded corporation would be shareholders.
“So what that means in a lot of small companies, the owner of the company who built this into a meaningful business is not able to keep the company through Chapter 11 unless they can come up with a new capital contribution,” Ferris said.
That is often impossible. But Ferris said that under the new law, “this rule doesn’t exist, so even if unsecured creditors are not getting paid in full, the equity owner can keep their equity.”
The question arises: Why would a company not take advantage of the provisions under SBRA instead of going the Chapter 7 liquidation route?
The SBRA option may be chosen if “the reduction in costs makes Chapter 11 a possibility,” Ferris said. But some companies, even after a restructuring, won’t be able to make the business work.
“Chapter 11 helps fix the balance sheet issues,” he said. “But it doesn’t necessarily fix the revenue side. So it has to be a business you can salvage for Chapter 11 to make sense.”
Ferris said he was unaware of any companies thus far that have pursued the SBRA route to a revised Chapter 11. It’s only been in effect since February and the higher limits were added only in the passage of the CARES Act in late March.
A lot of companies may be waiting until the dust settles before they take any action. “It may seem counterintuitive but as this economy begins to reopen you may see an increase in the number of filings, because people can then begin projecting accurately whether there is a business to restructure,” Ferris said.