Insolvency professionals have limited options to consider when counseling small business clients in financial distress who wish to continue operating their business. On the federal level, practitioners may choose to file a traditional chapter 11 reorganization or a small business bankruptcy under subchapter V. But these options are often cost-prohibitive for many small businesses, even with their significant benefits.[3] Meanwhile, state law options such as liquidating receiverships or assignments for the benefit of creditors rarely provide clients the option to maintain control over their business. With the adverse effects to small businesses resulting from the COVID-19 pandemic, insolvency professionals must examine new options to assist their small business clients. This article introduces an innovative new option for businesses negatively affected by the COVID-19 pandemic.
The COVID-19 pandemic has devastated a large number of small businesses around the country. Many of these “mom and pop” businesses have been operating locally for generations. But now, small businesses, particularly within the retail and service industries, are in an untenable position. Their revenues have dramatically decreased due to stay-at-home orders, capacity restrictions and customers affected by COVID-19.[4] And while some businesses have received funding under federal, state or local programs, in many cases this assistance only relieves their pressure for a short period of time, as their revenues have not returned to pre-pandemic levels.[5] Without this assistance, these small business owners do not have the revenue to pay employees, lease obligations and vendor invoices. Consequently, many of these businesses have closed, even though they might have recovered after the pandemic.
Historically, state receivership laws have long provided flexible and accessible forums in which to address the wind-down of insolvent small businesses. These laws provide that a court-appointed fiduciary liquidate a company’s assets for payment to creditors.[6] This is generally either accomplished by (1) liquidating the assets through public auction or private sale, or (2) selling the business assets as a going concern to a third-party buyer. In addition to statutory receiverships, in extraordinary circumstances state courts may use their powers in equity to appoint a nonliquidating receiver.[7]
The impact of the COVID-19 pandemic necessitated an innovative, structured and low-cost state option for small business owners to continue operating. Emulating the words of Justice Brandeis that “[s]tate[s] may … serve as a laboratory; and try novel social and economic experiments…,”[8] Rhode Island created its Business Recovery Plan (BRP).[9] As a result of the extraordinary circumstances caused by the pandemic, the BRP authorized courts to use their equitable powers to appoint a nonliquidating receiver.[10] Rhode Island was the first state to implement such a temporary court measure in response to the pandemic.[11][12]
The BRP authorizes any business experiencing more than a 20% decrease in revenue, and not in material default of its obligations before the pandemic, to submit a petition under the BRP. If granted, the business owner would continue operating the business under the supervision of a court fiduciary.[13]
Moreover, if the petition is granted, a temporary order is issued.[14] The order includes the following: (1) an injunction prohibiting commencement or continuation of any action against the business’s property; (2) appointment of a nonliquidating receiver; (3) permission for the business management to continue operating in the ordinary course of business; (4) notice to creditors and interested parties; (5) authorization to develop a plan; and (6) scheduling of a hearing for approval of the plan.
Similar to the automatic stay, the injunction is a critical component of the BRP. However, unlike in a traditional chapter 11, the BRP petition is not triggered by operation of law.[15] Nonetheless, the court will generally grant an injunction when the business is accepted into the program. The injunction permits the business and its advisors to focus on developing, negotiating and implementing the plan.
Furthermore, within 10 days of the petition’s approval, the business must submit a proposed plan to the nonliquidating receiver.[16] The process of creating this plan functions similarly to a prepackaged chapter 11 bankruptcy.[17] Like in a prepackaged chapter 11, under the BRP, the business and its creditors work together to create a reorganization plan to ultimately submit to the court. Notably, the plan generally requires all participating creditors to consent to the plan — a key difference from a chapter 11 bankruptcy. In other words, creditors must consent to the plan before its authorization.
Meanwhile, the nonliquidating receiver oversees the business and ensures that the business operates in the ordinary course of business. Similar to a chapter 11, added restrictions exist for non-ordinary-course transactions. In a nonliquidating receivership, the court must determine whether the business can dispose of assets or mortgage assets, or incur expenditures outside the ordinary course of business.[18]
Violations of the BRP order, or default under the operating plan, may result in the court converting the nonliquidating receivership to a traditional liquidating receivership.[19] This is similar to converting a chapter 11 to a chapter 7 bankruptcy where conversion is under the complete discretion of the court.[20]
Ultimately, the option of the BRP is not appropriate for every small business insolvency. By its design, the BRP cannot force creditors to involuntarily consent to a restructured payment of debt or accept less than the amount owed.[21] Nonetheless, the BRP provides an opportunity for small businesses to work with its creditors, in good faith, to remedy the financial hardships they are facing during the COVID-19 pandemic. In many cases, the BRP would allow the creditors to be in a better position than under a traditional bankruptcy or receivership.[22] The BRP is one more “arrow in the quiver”[23] for the insolvency professional to use under the appropriate circumstances.
[1] Judge Brian P. Stern is an associate justice of the Rhode Island Superior Court and presides over the State Business Calendar. Judge Stern is a member of the board of directors of the Roger Williams University School of Law, the American College of Business Court Judges and a member of the National Center for State Courts, Post-Pandemic Civil Working Group.
[2] Andrew F. Stern, student at Boston College School of Law.
[3] 5 Collier Bankruptcy Practice Guide ¶ 84.02 (2020).
[4] Nat’l Ctr. for State Courts, Rhode Island Business Recovery Plan: A Reference Guide 1 (2020), available at https://www.ncsc.org/__data/assets/pdf_file/0015/54015/RI-BRP-Reference… (hereinafter “Reference Guide”) (citing Emily Flitter, “‘I Can’t Keep Doing This:’ Small-Business Owners Are Giving Up,” New York Times (July 13, 2020), available at https://www.nytimes.com/2020/07/13/business/small-businesses-coronaviru…); Madeleine Ngo, “Small Businesses Are Dying by the Thousands — And No One Is Tracking the Carnage,” Bloomberg, Aug. 11, 2020, available at https://www.bloomberg.com/news/articles/2020-08-11/small-firms-die-quie….
[5] Allan Patricof, “PPP Delayed the Day of Reckoning for Small Business. Now, Time Is Almost Up,” Barrons, (May 22, 2020), available at https://www.barrons.com/articles/ppp-delayed-the-day-of-reckoning-for-small-business-its-almost-here-51590102090).
[6] Stern, Brian P. & Fragomeni, Christopher J., The Triage and Treatment of Healthcare Institutions in Distress: How to Involve State Regulators in Healthcare Bankruptcies and Receiverships, 22 Roger Williams U. L. Rev. 147 (2017).
[7] Levine v. Bess Eaton Donut Flour Co., 705 A.2d 980 (R.I. 1998).
[8] See New State Ice Co. v. Liebmann, 285 U.S. 262, 311, 52 S. Ct. 371 (1932).
[9] See Superior Court: Business Recovery Plan, Rhode Island Judiciary, available at https://www.courts.ri.gov/Courts/SuperiorCourt/Pages/BusinessRecoveryPl…; see also R.I. Super. Ct., Admin. Order No. 2020-04 at 1 (Mar. 31, 2020).
[10] Id.
[11] On March 31, just 45 days after Rhode Island’s first reported COVID-19 case, Rhode Island became the first state to implement a temporary court measure targeting small businesses in response to the pandemic. Since then a similar program has been adopted by the Philadelphia Commerce Court. This relief may also be possible in states that permit equitable nonliquidating receiverships.
[12] See R.I. Sup. Ct., Executive Order 2020-08 (Apr. 5, 2020), available at https://www.courts.ri.gov/Courts/SupremeCourt/SupremeExecOrders/20-08.pdf; see also Associate Justice Brian P. Stern, Attorney Training Remote Proceedings RI Superior Court, YouTube (Apr. 28, 2020), available at https://www.youtube.com/watch?v=p4J1XGQMv60&feature=youtu.be.
[13] Id.
[14] Id.
[15] See Collier Bankruptcy Practice Guide ¶ 38.02 (2020).
[16] Note 12, supra.
[17] See 1 Collier Bankruptcy Practice Guide ¶ 4.02 (2020).
[18] 2 Collier Bankruptcy Practice Guide ¶ 43.02 (2020).
[19] Note 12, supra.
[20] 2 Collier Bankruptcy Practice Guide ¶ 37.15 (2020).
[21] Note 12, supra.
[22] Collier Bankruptcy Practice Guide, supra, note 3.
[23] In most uses of this idiomatic phrase, the speaker is talking about the need to have diverse resources or strategies to handle a challenge or any obstacles to an objective.