How the new bankruptcy law will affect small business

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How the new bankruptcy law will affect small businesses

By Thomas D. Goldberg and Mary Weil Tufaga

Mr. Goldberg is a partner in the Stamford office of Day, Berry & Howard LLP. Ms. Tufaga is an associate in the firm’s Hartford office.

President Bush in April signed the Bankruptcy Abuse Prevention and Con-sumer Protection Act of 2005. The act, which applies (with some exceptions) to all bankruptcy cases filed on or after Oct. 17, 2005, represents the first major congressional overhaul of bankruptcy law in more than 25 years.

The law primarily intends to make it more difficult for consumers to file for bankruptcy. Thus, the most publicized changes target consumer bankruptcy proceedings. But the act also incorporates changes affecting small businesses, both as debtors and creditors. Here are a few of the most significant changes.

1. The act streamlines the procedure for a small-business debtor seeking to confirm a plan of reorganization. A qualifying “small business” debtor generally is one whose aggregate noncontingent liquidated debts do not exceed $2 million.

Currently, a debtor must prepare a disclosure statement tailored to the specific case; submit the disclosure statement for formal court approval; and, after obtaining court approval, solicit creditor votes in favor of a proposed plan of reorganization.

Under revised section 1125(f) of the Bankruptcy Code, the process for small-business debtors will be considerably easier and less expensive. For example, a court may determine that a plan of reorganization provides creditors with “adequate information,” thereby obviating the need for a disclosure statement. When a plan of reorganization lacks the detail necessary to double as a disclosure statement, a small-business debtor may use a disclosure statement on standard forms approved by the court or adopted under 28 U.S.C. § 2075. And a small-business debtor may solicit acceptances of a plan prior to final approval of the plan, so long as the court has “conditionally” approved the disclosure statement and the disclosure statement has been mailed at least 25 days prior to the confirmation hearing. The disclosure statement hearing and the confirmation hearing may be combined.

2. The new law will help assure small-business representation on creditors’ committees in larger cases. Under the current law, creditors’ committees typically comprise a debtor’s seven largest creditors willing to serve on the committee. Under revised section 1102(a)(4), the court may order a trustee to increase the size of the committee to include a small business if the court determines that the small business holds claims of the kind represented by the committee and that the aggregate amount of the claims is disproportion-ately large in comparison with the creditor’s annual gross revenues.

3. Revised section 546 of the Bankruptcy Code permits vendors to “reclaim” goods provided to a debtor during the 45 days preceding the start of the debtor’s case (up from the current 10-day look-back period) as well as during the 20 days following the bankruptcy filing. Current law permits debtors to offer vendors an administrative claim (which has priority over general unsecured claims) in place of returned goods. Under revised section 546, however, the debtor must return the goods or their cash equivalent. As a result, the often cash-strapped debtor may have to look to its post-petition lender to finance its reclamation obligations. The revised provision codifies the majority view of courts that a vendor’s reclamation rights are subordinate to the rights of a pre-petition lender that holds a blanket lien on the debtor’s assets.

4. Commercial real estate lessors will benefit from an amendment shortening the period during which a debtor may assume or reject a commercial lease that the parties entered into before the bankruptcy filing. Under revised section 365(d)(4), the debtor must assume or reject a commercial lease of real property within the first 120 days of the case. The Bankruptcy Code provides for one 90-day extension for cause; further extensions must be approved by the landlord in writing. The provisions are likely to have particular significance in retail cases, forcing debtors to analyze the cost-effectiveness of their operations at the outset of the case, or even prior to filing, in order to avoid making ill-informed decisions that may affect the debtor’s ability to emerge from bankruptcy as a viable entity.

5. The act includes several amendments to the preference provisions. (These provisions permit the bankruptcy trustee to recover certain payments made by the debtor to creditors in the 90 days before the bankruptcy filing.) One amendment precludes claims by a commercial debtor when the aggregate value of the transfer is less than $5,000. Another affects the “ordinary course of business” defense to a claim to recover preferential transfers. Under current section 547(c)(2), the creditor has the burden to show both that the transfers were made in the ordinary course of business or financial affairs of the debtor and creditor (the so-called “subjective” test) and that the transfers were made according to ordinary business terms (the “objective” test). The latter often requires costly expert testimony regarding general industry practice, which is impracticable in all but the largest cases.

Revised section 547(c)(2) eases the creditor’s burden by permitting the creditor to prove either that the transfer was made in the ordinary course of business between the debtor and the creditor, or that it was made according to industry standards.