The year 2020 brought us a perfect storm of economic disaster. Covid-19 hit with a vengeance leaving many unemployed with little foreseeable relief. Businesses have faltered from the shut-down and uncertainties that came with it. The collapse of the oil industry added insult to injury. Customer orders have been cancelled and customers are not returning because their customers are likewise not returning. Businesses fortunate to receive money under the Payroll Protection Program loans have exhausted those funds or will in the not too distant future with little to no relief on the horizon. Looking forward, it is hard to see the light at the end of the tunnel. What do they do?

While I always consider bankruptcy a means of last resort for my clients with financial difficulties, a new process that became law earlier this year may just be the ticket for business owners facing what may seem like insurmountable difficulties. Until February, the only bankruptcy options for businesses were Chapter 7 and Chapter 11 of the Bankruptcy Code. For the small to midsize business, neither of those avenues offered a very attractive outcome. Chapter 7 requires liquidation and cessation of the business, and does not typically provide much relief to the owners who were required to personally guarantee company debt. Chapter 11, on the other hand, while promising the business owner that the business could “reorganize” and come out of bankruptcy with the business intact rarely delivered that outcome. The more common outcome in a Chapter 11 case involving smaller and mid-sized businesses is that the expense is overwhelming, the procedures are crippling, and if the company is successful in reorganizing the original owner is unable to retain his or her equity in the business. It is not uncommon for Chapter 11 cases to convert to Chapter 7 cases with the result that the business simply fails and is liquidated.

Enter the new “Chapter 5” bankruptcy. Early this year, the Small Business Reorganization Act (SBRA) went into effect and created a new path for the struggling small to midsize business owner. While the Covid-19 pandemic had not materialized as of the SBRA’s enactment, its enactment certainly seems fortuitous looking back. It is expected that the SBRA will provide much needed relief to a large number of businesses as money under the Payroll Protection Program runs out and Covid-19 restrictions or effects continue.

Originally designed for businesses with debts of no more than $2.7 million, Chapter 5 is intended as a streamlined reorganization process that significantly reduces the cost and improves the likelihood of success for businesses that could never survive a Chapter 11 filing. The total debt amount was increased under the CARES Act to $7.5 million for a limited time due to Covid-19. The SBRA eliminates the creditor’s committee which is often a stumbling block in Chapter 11 cases. In a Chapter 5 case, a trustee is appointed to facilitate a consensual plan among the debtor and its creditors, but the debtor retains control of the business. The trustee can, in essence, serve as an impartial third-party mediator between the debtor and its creditors which may increase the likelihood of a fair and equitable resolution of claims that enable the business to continue.

In order to keep Chapter 5 cases moving quickly, the debtor must file a plan of reorganization within 90 days after filing bankruptcy, although that can be extended by the court when circumstances warrant. In appropriate cases, the filing will occur with a “pre-packaged” plan or reorganization that is submitted for approval. If creditor approval cannot be obtained, then a motion to approve the plan can be filed, and the court can enter a “cram down” order approving it. If the plan proposes relief to the unsecured creditors that is more favorable than a liquidation under Chapter 7, then it is likely to get court approval. In no event can the plan provide unsecured creditors less relief than they would receive in a liquidation. The plan must commit to contribute all projected disposable income to making plan payments for three to five years. Ideally, the plan would allow the debtor to spread payments over time and give creditors a meaningful recovery from debtors who do not have much money on hand but who have a realistic expectation of future income.

Unfortunately, the Covid-19 pandemic, oil industry collapse, and other factors may force previously successful business owners to explore their options, including the option of bankruptcy. A Chapter 5 bankruptcy may provide them an opportunity to pause their obligations long enough to meaningfully negotiate with creditors including landlords, lenders and others, and potentially obtain a “reset” that would enable them to continue their business and ultimately survive these difficult times.