Section 1113 of the CARES Act amends certain provisions of the Bankruptcy Code and will apply to the year following the date on which this new law goes into effect. These changes are primarily designed to benefit small businesses and individuals who need to seek bankruptcy protection (and some who have already sought it). Creditors should be aware that the changes may make it easier for debtors to qualify for the bankruptcy cases of their choice and for Chapter 13 wage-earner debtors to confirm and modify their plans in light of federal payments that will be made to alleviate the harm of the COVID-19 pandemic and otherwise remedy the hardship it creates.
Small Business Reorganization Act Debt Limit Increased
The Small Business Reorganization Act (the “SBRA”), subchapter V of Chapter 11, will now be available to debtors with not more than $7.5 million in noncontingent liquidated debts. The prior debt limit had been $2,725,625. The capped amount includes secured and unsecured debts combined. Debts owed to insiders or affiliates are excluded from the amount. At least 50 percent of the debts must arise from the debtor’s commercial or business activities for the debtor to be eligible to proceed under the SBRA. A member of a group of affiliated debtors that owes more than $7.5 million in the aggregate is not eligible to be a debtor under the SBRA. Being subject to the Securities and Exchange Act continues to render debtors ineligible for SBRA relief. The increase in the eligibility cap is available only to debtors whose bankruptcy cases commenced on or after the date of enactment of the CARES Act, so SBRA cases commenced before then are still subject to the lower debt limit. An important feature of the SBRA is that the absolute priority rule does not apply and thus equity holders in the debtors or individuals are entitled to continue to own their assets without paying unsecured creditors in full. The increase in the debt limit may lead to an increase the number of loans that do not get paid in full while the debtors keep their property.
COVID-19 Payments Are Not Relevant to Chapter 7 Eligibility
An individual’s eligibility to file for bankruptcy under Chapter 7 of the Bankruptcy Code, when the individual has primarily consumer debts, depends on how high the individual’s current monthly income is. Current monthly income is generally the average monthly income for a six-month period before the bankruptcy case started. If the current monthly income is above the state median income for someone like that individual, then a formula is applied to determine whether it is so much that proceeding under Chapter 7 would be considered an abuse, such that the case should be dismissed or converted to a Chapter 13 individual reorganization case. The CARES Act excludes payments made by the federal government in connection with the COVID-19 national emergency, and so they do not serve to increase current monthly income, which would otherwise impair the ability to proceed under Chapter 7. This change applies to cases commenced before, on, or after the date of enactment of the CARES Act.
COVID-19 Payments Are Not Relevant to the Duration or Confirmation of Chapter 13 Plan
The duration of the Chapter 13 plan is usually either three years or five years. If the individual’s current monthly income is at least as much as the applicable median state income for someone like that individual, payments under the plan have to last five years. If the individual’s current monthly income is less than the median state income, the plan usually provides for payments for only three years. The exclusion of federal COVID-19 payments from current monthly income means that they will not be a factor to push a plan to five years that would otherwise have lasted three.
When there is an objection to confirmation of a Chapter 13 plan, to be confirmed it must provide for all of the debtor’s disposable income—which is current monthly income less certain reasonably necessary expenses—to be used to make payments to unsecured creditors. The CARES Act increases the amount that a debtor can keep and not have to pay unsecured creditors, by excluding federal COVID-19 payments from the current monthly income that is used to calculate disposable income. These changes apply to cases commenced before, on, or after the date of enactment of the CARES Act.
COVID-19 Circumstances Justify Modification of a Chapter 13 Plan so That Payments Can Be Made over Seven Years Instead of Three to Five
For a plan confirmed before the enactment of the CARES Act, the debtor can request modification of the plan on notice and hearing if the debtor is experiencing or has experienced a material financial hardship due, directly or indirectly, to the COVID-19 pandemic. While a plan may not ordinarily be modified to provide for payments for longer than five years after the first payment was due under the original plan, in a COVID-19 case, the plan can provide for payments over seven years after the first payment was due. That means a potential two-year delay on plans that were confirmed before the CARES Act came into effect, and creditors who were counting on have their claims resolved by 2025 are now looking at 2027 for completion of payments.
For further information about ongoing developments related to COVID-19, visit Miller Nash Graham & Dunn’s resource library.
