When “Small” is Still Too Big: The Small Business Reorganization Act

By Donald L. Swanson

The Small Business Reorganization Act is now law!

• The House of Representatives passed it on July 25, 2019;
• The Senate passed it on August 1, 2019; and
• The President signed it on August 23, 2019.

This Act is much-needed and long overdue. It provides Chapter 12-type relief for small businesses within Chapter 11. Kudos to everyone for getting it passed!

But there is a catch: to qualify for relief under this new Act, a small business must have less than $2.725 million of total debt. This debt limit is exceedingly small. While it should cover most Mom & Pop shops and most start-ups, it excludes most formerly-successful entrepreneurs and their businesses.

By formerly-successful, I mean businesses that had at least a decade of success, during which they expanded substantially. These businesses and their entrepreneurs will rarely meet the $2.725 million debt limit.

Why Not Increase The Limit?

Here’s the problem: Congress despises formerly-successful entrepreneurs. It really does! And it always has!

Congress loves small businesses and successful entrepreneurs. Politicians love to extol them as crucial to our economy.

But when successful businesses fail, Congress turns on their entrepreneurs fast and hard. It makes no difference to Congress that failure might come from the economy going south or a product becoming obsolete or an industry going in the tank or the entrepreneur’s failing health. Formerly-successful entrepreneurs are on Congress’s list of most-despised people. Seriously!

This most-despised status has always been true—though it’s improving over time. In a 1930’s bankruptcy opinion, for example, the U.S. Supreme Court explained some U.S. history on antagonism toward debtors:

• The 1800 Bankruptcy Act was “exclusively in the interest of the creditor” and presumed the debtor’s dishonesty;
• Beginning in 1841, an individual could finally file a voluntary bankruptcy to liquidate and obtain a discharge—until then, an “honest but unfortunate” debtor had no opportunity for a “fresh start”; and
• In 1874, a debtor could, for the first time, reorganize—but only with the consent of creditors.

Antagonism toward individual debtors is a historical reality. But over time, that antagonism has softened toward many. In fact, Congress has provided effective bankruptcy relief for everyone but formerly successful entrepreneurs. Such provisions are in the form of:

1. Consumer relief under Chapters 7 and 13;
2. Municipality relief under Chapter 9;
3. Large business relief under Chapter 11; and
4. Now, relief for truly-small businesses under the Small Business Reorganization Act.

Bankruptcy Still Does Not Help Formerly-Successful Entrepreneurs

Yet, there is still no viable bankruptcy relief for a formerly-successful entrepreneur.
Consider the plight of a formerly-successful entrepreneur in this hypothetical:

• Entrepreneur’s business provides goods and services to a high-tech world. The business prospers mightily, with dozens of employees and tens of millions of dollars of sales each year . . . for more than a decade. But obsolescence sets in. The business cannot adjust, and it fails.
• Meanwhile, Entrepreneur (i) takes a personal income from the business that is substantial, but not huge—nearly-all profits are poured back into the business, (ii) builds a nice (not high-end) home, (iii) drives a used Lexus SUV, (iv) takes cool vacations—but does so rarely, because of work demands, and (v) in all other respects, leads a comfortable-but-modest lifestyle.
• When the business fails, Entrepreneur (a forty-something) has a personal net worth of a couple million dollars, without counting guaranteed business debts that exceed $5 million after liquidation of the business; and flow-through tax liability from liquidation of business assets (held in an LLC) exceeds $2 million.
• Following liquidation of the business, Entrepreneur is working for a different high-tech business and is receiving a good salary.

This Entrepreneur is who Congress truly despises.

I’ll try to explain.

You’d think Congress would be eager to protect this Entrepreneur from financial devastation. Why? Because our economy needs to have entrepreneurs make business investments and take entrepreneurial risks. Protecting them from the down-side of such risks is one way to encourage their efforts.

But, no. Congress has always gone the opposite direction. They want to punish an entrepreneur’s failure. Apparently, they’re still stuck in the 1800’s presumption of dishonesty?

Consider the bankruptcy options for our Entrepreneur discussed above:

1. Reorganization under Chapter 13 is not available because Chapter 13 is designed for consumers: no one with more than $1,257,850 of secured debt or $419,275 of unsecured debt is eligible for Chapter 13 relief.
2. A discharge is not possible under Chapter 7 because Entrepreneur is young and capable of earning a substantial income in the future and is, therefore, ineligible for Chapter 7 relief and must file Chapter 11 instead.
3. Creditors hold a veto over confirmation of Entrepreneur’s Chapter 11 plan (except in the Ninth Circuit, perhaps), and Entrepreneur cannot get a Chapter 11 plan confirmed.
4. Entrepreneur is ineligible for the small-business relief, newly enacted into law, because total debts exceed $2.725 million.

In other words, Entrepreneur has no viable opportunity for bankruptcy relief.  None (except in the Ninth Circuit, perhaps).  This is not right!

A Companion Law

At the same time the Small Business Reorganization Act became law, a companion bill also became law: the Family Farmer Relief Act. This Act increases family farm eligibility for Chapter 12 relief from total debts of $4.4 million to $10 million. Ten million dollars sound large-farm-friendly, doesn’t it? In a way, yes. But the Act actually retains the despised-group reality. Here’s how:

• Chapter 12 contains various standards for qualifying as a “family farmer” (e.g., the farming operation must be owned or operated by an individual and spouse, if one exists, or by one family and its relatives).
• So, what Congress is actually saying in the $10 million eligibility limit is this: we want to help family farms . . . but not large family farms.

Conclusion

Here’s hoping Congress will act soon to include formerly-successful entrepreneurs in the relief provided by the Small Business Reorganization Act.

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