The New Bankruptcy Law and Small Business

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 was signed into law on April 20, 2005 with an effective date of October 17, 2005 for most provisions.  This law affects individuals (consumers), small businesses, and businesses in general with its many changes to existing bankruptcy laws.

A “small business” for the purposes of this legislation and Chapter 11 filing is a business debtor which is engaged in commercial or business activities (not related to property ownership or activities incidental to property ownership) and has a total non-contingent liquidated debt of not more than $2 million dollars as of the date of the filing for relief.  The debt total excludes debts owed to affiliates or insiders.

A small business may be excluded from this category of bankruptcy filings if it has established a creditors’ committee that is active and representative of the creditors of the business and that committee provides oversight on the operations of the business.  This committee may be formed after the initial bankruptcy filing and classification as a small business.  If such a committee is formed subsequent to the filing, the business may be reclassified outside of the small business category.

Why does it matter if you are a “small business” or a “large business”?  The major reason is that small businesses are given only six months to file a reorganization plan, while large businesses are given 18 months.  The six-month time restriction, if not met, moves a small business from reorganization (Chapter 11) to liquidation (Chapter 7). So understanding that the clock is ticking and that a plan needs to be developed and filed is critical to a small business’ viability.

Small business debtors (Chapter 11) are required (effective date of requirement is to be determined) to file periodic financial statements and other reports regarding:

-          Profitability (the amount of money that has been earned or lost during the current and recent fiscal periods

-          Forecasts or reasonable approximations of projected cash flows over a “reasonable” period

-          Comparative reports on actual cash flow versus projected cash flows

-          Statements/verification as to whether the debtor is in compliance with all post-petition requirements, including timely filing of tax returns and other governmental filings, as well as payment of taxes and other administrative expenses

In instances where the debtor is not in compliance, an explanation of why, how, and at what cost the debtor intends to remedy the situation.

As part of Chapter 11 the debtor files a reorganization plan (and possibly other disclosure statements) that is expected to provide adequate information on how business will be done and how each debt holder claim or interest will be handled.  The court must approve this plan.  The plan is expected to achieve a balance between the interests and needs of

-          The court

-          The United States Trustees

-          Creditors

-          Other parties with interest in the information

-          The Small Business Debtor

At this time, no agency has been designated to ensure the “adequacy” of information requirement is met.

The Small Business Debtors (or an appointed trustee) are expected to perform certain duties in a small business case:

1. Provide the most recent set of complete financial statements, income tax returns, or a statement that no such documents have been prepared or filed
2. Attend meetings scheduled by the court and the US Trustee (this requirement may be waived under extraordinary and compelling circumstances)
3. Make timely filings of schedules and statements related to financial affairs
4. File all post-petition financial and other reports
5. Maintain insurance
6. File timely tax returns and payments
7. Allow inspection of books and records upon receipt of reasonable notice by the United States Trustee or designated representative

The information above is just a small part of the changes and requirements that small businesses face if they find it necessary to apply for reorganization or liquidation bankruptcy.  Many attorneys and business advisors have recommended that any business contemplating bankruptcy of any type should consider making those filings before October 17, 2005 if it is an “inevitable” event.

What all businesses need to keep in mind is that most creditors would prefer that the customer contact them to negotiate new terms if the financial situation is at a critical point.  Creditors prefer receiving all of the money owed over a longer period of time rather than the possibility of getting little or no money.

This new legislation has proponents and opponents with both sides saying why it is good or bad for business (and individuals).  That is true of any legislation, and once it is passed, we must live with it.

For instance, current bankruptcy laws allowed the courts to go back to vendors and creditors who had been paid in the 90 day period prior to bankruptcy filing to “reclaim” the funds paid.  These funds were often viewed as “preference” payments.  As such the vendor who was conducting business as usual suddenly finds the account that was current is now unpaid and they have to get in line with the other creditors in the bankruptcy proceeding.

If your business (large or small) or you as an individual have been contemplating a bankruptcy filing, the best strategy may be to set up appointments with tax advisors, attorneys, and accountants to get a clear picture of your situation today versus what happens after October 17, 2005.  Understanding the options and timing could be critical to how successfully you can address your financial situation.

Copyright ©2005 F.O.C.U.S. Resource, Inc.