Bankruptcy

The Disappearing Small Businesses (Designation) in Bankruptcy

By Bob Lawless

The 2005 bankruptcy law was not just about consumers. It made a number of changes to businesses bankruptcies, including the expansion of safe harbors for derivative claimants about which Stephen Lubben has written extensively (e.g., here). Other changes were to small business bankruptcies--not to make it easier for small businesses to get through chapter 11 but to make it more difficult. Small business bankruptcy filers got new duties and extensive new reporting requirements, both of which can lead to dismissal for debtors who fail to meet them. As I was preparing to teach these requirements this year, I came across a little surprise about the difference between this law on the books and the law on the ground that I thought I would share.

As I wrote a few years ago:

In addition to Mom and apple pie, there was always at least one other subject that members of Congress would support and that was small business. The 2005 bankruptcy law, however, was affirmatively hostile to small business, making it more difficult for small businesses and their owners to get bankruptcy relief. Although Congress passes many laws that advantage large business and often at the expense of the large businesses? smaller counterparts, the 2005 bankruptcy law is the only example of which this author knows that expressly singles out small business for harsher treatment than a similar large business. Perhaps Mom and apple pie need to hire a lobbyist to prevent the same from happening to them.

("Small Business and the 2005 Bankruptcy Law: Should Mom & Apple Pie Be Worried?," 31 S. Illinois. Univ. L.J. 585 (2007)).

Congress designated a "small business debtor" as any debtor with less than $2,190,000 in total secured and unsecured debts and for which there is no active creditors' committee. (There are more details such as the requirement that the debts be noncontingent and liquidated and that the limits gets inflation adjusted every three years.)

To get a handle on how exactly how many chapter 11 cases each year meet this definition, I pulled down the 2007 bankruptcy petition integrated database, and what I found just did not seem right. According to these data, there were 2,299 chapter 11s filed in 2007 where (i) the debtor was not an individual, (ii) said they had predominately business debts, and (iii) where the total liabilities were between $50,000 and $1,000,000. Because very few small chapter 11 cases have creditors' committees, almost every one of these 2,299 cases should have identified as small business debtor, but only 36.8% did so. I pulled the docket on one of the cases, and it was a manufacturer that said it had about $800,000 in debt and yet did not identify as a small-business debtor.

In theory, the small-business provisions of chapter 11 are self-executing, but I suspect in practice they often are not. If a debtor does not designate as a small business, it might fly under the radar and avoid having to meet the new reporting requirements. One practitioner suggested to me that that the reason for the low compliance rate was inattentiveness: the software the attorneys used to complete the forms did not adequately draw their attention to the small-business box. Other practitioners pointed out that the definition requires that no creditors committee is active, and the appointment of a committee is up to the U.S. Trustee. Thus, until the U.S. Trustee files a notice that it will not appoint a committee in a case, it is not a small business case. Whatever the reason, the low rate of small-business designations is another example of how "law on the ground" often adapts and changes the "law on the books."

Full post as published by Credit Slips on April 30, 2010 (boomark / email).