The Examiners: Code Shouldn’t Hinder Small Business Restructurings

If you could make one change to the bankruptcy code, what would it be?

In the not-too-recent past, Chapter 11 was a tool available for small portfolio companies or family-owned businesses hoping to shed debt, restructure their capital structure and fix their business operations in a cost-efficient manner. However, the ever-increasing cost of the Chapter 11 process, combined with new and short deadlines to deal with certain important operational issues, conflict with the goal of allowing small businesses to fix themselves and has made Chapter 11 less available for those that might need it most. Chapter 11 should be revised to allow for cost-effective and less time-constrained restructurings for smaller businesses.

To start, the bankruptcy code should be amended to allow “sweat equity,” as opposed to only new money, to satisfy the so-called absolute priority rule. This change would allow family businesses and small portfolio companies a better opportunity to retain at least some ownership interest in the company after exiting Chapter 11 without having to, in essence, buy back their businesses for cash if they cannot afford to pay 100% to creditors. Currently, the so-called absolute priority rule requires that if an impaired class of unsecured creditors fails to consent or agree to their treatment under a plan of reorganization, junior creditors and equity holders may not receive or retain any property. The “new value” exception to the absolute priority rule enables equity holders to retain their equity interests if they offer “new value” in the form of cash to the reorganized debtor. If family businesses or small portfolio companies could use “sweat equity” contributions as “new value,” it would significantly increase their likelihood of retaining an equity interest in a successful reorganization.

Similarly, recent amendments to the bankruptcy code shortened the time periods within which a debtor has to make vital strategic decisions, such as limiting the time a debtor has the exclusive right to file a plan of reorganization and to decide whether to keep or reject its real estate leases. Therefore, a small distressed company generally faces liquidation before it has the opportunity to work through its operational business issues. This makes Chapter 11 virtually unavailable for businesses where the equity owners would like to try to fix, and then keep, their business.

Further, there are numerous so-called first-day motions a Chapter 11 debtor must file at the start of its case to keep operating, including paying insurance, taxes, utilities, payroll and other employee benefits, to name a few. While these motions are usually approved by the court without much adversarial scrutiny, they are time-consuming and costly to prepare. Streamlining the first-day process to reduce or eliminate this information gathering would help already overworked managers and would reduce the cost of seeking Chapter 11 relief.

Given the entrepreneurial nature of our economy, it is important to provide small-business owners with access to Chapter 11 so they may restructure without the current barriers to a successful exit from bankruptcy.

Sharon Levine is vice chair of Lowenstein Sandler LLP’s national bankruptcy, financial reorganization and creditors’ rights practice. Follow her on Twitter at @LevineSharon