The Small Business Reorganization Act – A New Subchapter for Small BusinessesSince the 2005 amendments to the Bankruptcy Code, small business debtors have continued to struggle to reorganize effectively under Chapter 11 of the Bankruptcy Code. On Friday, August 23, 2019, President Trump signed the Small Business Reorganization Act of 2019 into law in an effort to address some of these issues.

The act aims to make small business bankruptcies faster and less expensive by creating a new subchapter of Chapter 11 of the Bankruptcy Code specific to small businesses. At this time, the act only applies to business debtors with secured and unsecured debts, subject to certain qualifications, less than $2,725,625. The act includes the following provisions:

  • Appointment of a Trustee. The act provides that a standing trustee will serve as the trustee for the small business’s bankruptcy estate. Similar to Chapter 12 family farmer and fisherman bankruptcies, the act provides that the trustee shall facilitate the small business debtor’s reorganization and monitor the debtor’s consummation of its plan of reorganization.
  • Streamlining the Reorganization Process. The act streamlines small business reorganizations and removes procedural burdens and costs associated with typical corporate reorganizations. Notably, only the debtor can propose a plan of reorganization. Small business debtors do not have to obtain approval of a separate disclosure statement or solicit votes to confirm a plan. Unless the court orders otherwise, there are no unsecured creditors’ committees. The act further requires that the court hold a status conference within 60 days of the petition date and that the debtor file its plan within 90 days of the petition date.
  • Elimination of the New Value Rule. The act removes the requirement that equity holders of the small business debtor provide “new value” to retain their equity interest in the debtor without paying creditors in full. For plan confirmation, the act instead only requires that the plan does not discriminate unfairly, is fair and equitable, and, similar to Chapter 13, provides that all of the debtor’s projected disposable income will be applied to payments under the plan or the value of property to be distributed under the plan is not less than the projected disposable income of the debtor.
  • Modification of Certain Residential Mortgages. Notably, the act also removes the categorical prohibition against individual small business debtor’s modifying their residential mortgages. The act now allows a small business debtor to modify a mortgage secured by a residence if the underlying loan was not used to acquire the residence and was primarily used in connection with the small business of the debtor. Otherwise, secured lenders have the same protections as in other Chapter 11 cases.
  • Delayed Payment of Administrative Expense Claims. The act removes the requirement that the debtor pay administrative expense claims – including those claims incurred by the debtor for post-petition goods and services – on the effective date of the plan. Unlike a typical Chapter 11, a small business debtor may now stretch payment of administrative expense claims out over the term of the plan.
  • Discharge Limitations. The court must grant the debtor a discharge after completion of all payments due within the first three years of the plan, or such longer period as the court may fix (not to exceed five years). The discharge relieves the debtor of personal liability for all debts provided under the plan except any debt: (1) on which the last payment is due after the first three years of the plan, or such other time as fixed by the court (not to exceed five years); or (2) that is otherwise non-dischargeable. All exceptions to discharge in Section 523(a) of the Bankruptcy Code apply to the small business debtor. This is a departure from a typical corporate Chapter 11 which has limited exceptions to discharge set forth in section 1141.

The benefits of Chapter 11 reorganization have been elusive to small business debtors given their size and limited financial resources. The act attempts to remedy many of these obstacles to successful small business reorganizations. If the act proves to be beneficial to small business debtors, there may be a legislative push to increase the debt limitations and provide even more businesses access to the new subchapter.

The act takes effect in February 2020. Small business and consumer lenders should be prepared to protect their interests in this new subchapter of the Bankruptcy Code. Bradley attorneys are experienced in all aspects of bankruptcy, and will continue to monitor the development of the law and bankruptcy practice under the act.

 

Republished with permission. This blog post was originally published on Bradley’s Financial Services Perspectives blog on August 27, 2019.

Proposed Tax Regulations Eliminate Possibility of Clawback of Lifetime Gifts for Estate Tax PurposesAs previously posted, the Tax Cuts and Jobs Act signed into law in December 2017 (the “2017 Act”) made significant changes to the federal wealth transfer system with respect to gift and estate tax transfers during the calendar years 2018 through 2025. One of these changes was increasing the basic exemption amount that can be transferred free of gift, estate and generation skipping transfer (GST) taxes. Prior to the enactment of the 2017 Act, the exemption amount was $5 million (as adjusted for inflation in years after 2011). Under the 2017 Act, the exemption amount was doubled to $10 million, which, after being adjusted for inflation, is now $11.4 million in 2019 (or $22.8 million for a married couple). However, the increased exemption amount is scheduled to “sunset” on January 1, 2026, to the 2017 levels, as adjusted for inflation.

One recommendation included in our earlier blog post was for individuals to consider using their increased exemption amounts to make significant gifts to family members. While almost any asset can be used for making gifts, interests in closely held businesses can be an attractive asset to use for a number of reasons, including business succession and tax valuation reasons.  This can be especially true if such significant gifts are combined with other estate planning strategies, such as gifts to intentionally defective grantor trusts. However, there are always a number of tax considerations that need to be taken into account in making significant gifts, including whether such gifts are made efficiently from an income tax perspective. In any event, an advantage of making such significant gifts would be to use the increased exemption amounts prior to their sunset in the year 2026, or earlier if the tax laws are changed by Congress before such time. This is similar to estate planning that occurred in late 2012, when the exemption amount was scheduled to be reduced from $5 million per person to $1 million per person.

One concern of making such lifetime gifts prior to the sunset of the increased exemption amounts is whether the IRS would try to “clawback” such gifts into someone’s taxable estate when he or she later died, if the amount of such person’s lifetime gifts exceeded the exemption amount at the time of that person’s death. For example, if someone makes a $10 million gift in 2019 (when the exemption amount is $11.4 million) and then dies 10 years when the exemption amount has been decreased to $5 million (as adjusted by inflation), would the IRS take the position that estate taxes are owed at the time of that person’s death? This has been a concern because the gift and estate tax system is “unified,” and the amount of lifetime gifts is taken into account in calculating estate taxes in a decedent’s estate.

In November 2018, the Treasury Department issued proposed regulations stating that in such a situation, the credit to be applied in computing estate tax in a decedent’s estate would be based upon the higher exemption amount in effect at the time of the gift. Thus, there would be no clawback of lifetime gifts that later exceeded the exemption amount at a decedent’s death, if the exemption amount is decreased due to the sunset of the increased exemption amount in the 2017 Act or other changes by Congress.

Please feel free to reach out to any of Bradley’s trust and estate attorneys if you would like to discuss the possibility of making gifts to take advantage of the increased exemption amount. As gift and estate tax laws change (either due to the sunset of the increased exemption amounts or potential changes by Congress), we will update the Family Business Advocates blog to inform clients and others of such changes, and the advisability of making lifetime gifts in connection with such changes.

Avoiding Risk when Serving as an Advisory Board MemberI am a fan of advisory boards when family-owned companies are transitioning from a board of directors consisting solely of family members. It is a good way to test the waters before moving to a board of directors that includes independent (non-family) members in a fiduciary capacity. I am also a fan of individuals who are willing to serve as members of advisory boards. They play an important role in the life of a family-owned company by bringing new perspective and business expertise. Typically, advisory board members find the work rewarding. However, the role is not without risk.

Although a member of a corporation’s advisory board does not owe statutory fiduciary duties to the corporation or its shareholders, she may unintentionally adopt such duties if, by her actions, she becomes a de facto director of the corporation. In addition, if the corporation and advisory board adopt an engagement letter that spells out the advisory board’s functions, members of the advisory board may be subject to liability if they stray from the boundaries set out in the engagement letter.

If an advisory board member begins to act as a member of the board of directors, she will be considered a “de facto” director. A de facto director’s actions are binding on the corporation so far as third persons are concerned and, thus, an advisory board member who becomes a de facto director would likely owe fiduciary duties like those of an actual director. In order to avoid the danger of an advisory board member becoming a de facto director, each member of the advisory board should take care to avoid taking on responsibilities and performing functions reserved for the board of directors.

If a corporation and its advisory board wish to shield the advisory board members from the various fiduciary duties and potential liabilities of a legal board of directors they should adopt an engagement letter that clearly delineates the advisory board’s roles and the standards by which those roles are to be performed. The letter should also make clear that the advisory board is not to perform roles reserved for the board of directors. The letter should require that the advisory board keep certain legal matters confidential. Lastly, while any indemnification provision included in a corporation’s certificate of incorporation typically does not cover the advisory board, the corporation may (and should) contract to provide indemnification to advisory board members for liability that may arise from their service.

The following is a suggested list of provisions to be included in the engagement letter:

  • The advisory board should not be referred to as a “board” but instead an “advisory committee” or other appropriate title.
  • The advisory board does not have decision-making powers or voting authority.
  • The recommendations of the advisory board are not binding and are subject to review by the corporation’s board of directors.
  • The advisory board should hold meetings separate from the board of directors.
  • Advisory board members should not be counted in determining whether a quorum is present at board of director meetings.

In addition to adopting an engagement letter, the corporation and its advisory board may wish to adopt certain behavioral safeguards. For example, advisory board members should not be informally referred to as “directors” or “the board,” but as “advisors” or another appropriate term. Also, when decisions are made by the board of directors after discussion with the advisory board, resolutions should be adopted by the directors and the meeting minutes should reflect that the advisory board members did not participate in the vote. These suggestions can help ensure that the advisory board remains in a purely advisory role without any semblance to the contrary.