Chapter 11 Not Suited for Small Business, Senate Panel Told

By Daniel Gill

Chapter 11 works well for large companies with complex debt structures but is inefficient and less effective for small and medium sized businesses, bankruptcy professionals told a Senate committee March. 7.

Witnesses appearing before the Judiciary oversight subcommittee discussed proposals to revise the Bankruptcy Code to better facilitate Chapter 11 reorganization for small and medium-sized enterprises or SMEs.

“There is a strong consensus in the bankruptcy community that the Bankruptcy Code in its current form is ill-suited for small business,” Craig Goldblatt, a bankruptcy lawyer and conferee of the National Bankruptcy Conference, said.

Chapter 11 works well “in the context for which it was designed—addressing financial distress faced by large corporations with complex capital structuresm,” he said in written remarks.

Robert J. Keach, a bankruptcy lawyer and co-chair of the American Bankruptcy Institute’s Commission to Study the Reform of Chapter 11, agreed.

Because of the expenses involved, “most financially troubled SMEs simply avoid chapter 11 altogether,” he said at the hearing.

Edward Janger, David M. Barse Professor of Law at Brooklyn Law School in New York, testified along with the others that the bankruptcy code required a legislative fix to address SME reorganizations.

Two proposals had been submitted to the subcommittee.

The National Bankruptcy Conference proposal, prepared years ago, aims to create a system where small business debtors would be treated more like debtors in Chapter 13 or 12, for individuals or family farmers and fishermen, respectively, Goldblatt said.

The proposal would apply to business debtors with less than $7.5 million debt. Under that model, a creditors committee wouldn’t be appointed, and creditors wouldn’t vote to approve a plan.

The plan would also propose a revision to the “absolute priority rule” in bankruptcy that allows business owners to retain companies even if all creditors aren’t paid in full.

These businesses typically depend on the individual or family entrepreneur owner-operators, Goldblatt said in his prepared statement. Without these individuals, the businesses wouldn’t survive, he said.

The current problem affects a significant number of bankruptcy filers.

The ABI proposal “would apply to approximately 90 percent of all business filers by number,” Keach said.

Key provisions of the ABI proposal include:

  •  Removing unrealistic and artificial deadlines and allowing SMEs to establish sensible restructuring timelines
  •  Reducing the amount of information that an SME debtor must provide when filing a Chapter 11 case
  •  Reducing the reporting requirements imposed on SMEs
  •  Not requiring the U.S. trustee to appoint a committee of unsecured creditors in an SME case, unless requested by a creditor or needed for other reasons
  •  Allowing a party to request the appointment of a professional (an “estate neutral") with skills tailored to particular problems facing that debtor
  •  Reducing or controlling the costs of a Chapter 11 case by streamlining the plan of reorganization process
  •  Providing a plan of reorganization option that allows an SME owner to maintain some ownership interest in the company
Responding to the subcommittee’s top Democrat, Sen. Richard Blumenthal (D-Conn.), Keach said that “we should be concerned” about current trends of small businesses seeking debt relief outside of bankruptcy. This includes state court receiverships or assignments for the benefit of creditors, or ABCs.

Receivership and ABC are just a route to liquidation, and ABCs are often conducted without any judicial supervision, he said.

Janger said that there were three things necessary to fix the problem.

He said there should be a chapter specifically for SMEs and that a fiduciary or an “estate neutral” should be appointed to preside in the case, perhaps similar to a Chapter 12 or 13 trustee. There also should also be a form plan applicable to SMEs, he said.

To contact the reporter on this story: Daniel Gill in Washington at dgill@bloomberglaw.com

To contact the editor responsible for this story: Jay Horowitz at jhorowitz@bloomberglaw.com

Copyright © 2018 The Bureau of National Affairs, Inc. All Rights Reserved.