Several well-known corporations such as Nieman Marcus, Hertz, Pizza Hut, 24 Hour Fitness and Chesapeake Energy have already sought Chapter 11 bankruptcy protection due to the Covid-19 crisis. Edward I. Altman, creator of the Z Score, a key performing indicator that measures a company’s likelihood of going bankrupt, predicts a record number of filings by companies with a billion or more in debt. Whether small to mid-sized bankruptcies grow to record levels, however, only time will tell.
Small to mid-sized bankruptcies will likely be higher in certain industries and geographic locations, as restaurants, bars, retailers, airlines, hospitality, movie theaters, the oil & gas industry and metropolitan regions like the Greater New York – New Jersey area, for example, have been particularly hard hit.
Because of support provided by the CARES ACT, federal stimulus payments, unemployment insurance enhancements, and mandated mortgage and consumer loan forbearance, year-to-date bankruptcy filings are actually down by 27% so far this year, but the American Bankruptcy Institute (ABI) predicts a future surge in bankruptcy filings, pointing to a 48% year-over-year increase in Chapter 11 filings back in May.
Most people struggle to pay their bills for two to five years before declaring bankruptcy following an economic downturn, so, typically, the timeframe for bankruptcies following a crisis is long and slow. Filings for Chapter 13 and 11 bankruptcy protection are the option individuals with an ability to pay off creditors over time select (Chapter 11 reorganizations are required for debts greater than $1,184,200 and unsecured debts of $394,725.) A Chapter 7 filing, the option for businesses that cannot pay creditors, on the other hand, releases debtor claims and is final. If the economy takes time to bounce back and unemployment persists, this could mean more Chapter 7 bankruptcy filings.
The historic peak of bankruptcies occurred when the Bankruptcy Abuse Prevention and Consumer Protection Act — which was viewed as much less favorable to borrowers — became law on October 17, 2005. In 2006, filings dropped significantly and would not peak again until 2010, three years following the housing bubble, but filings in 2010 fell short of the 2.1 million filings in 2005. Despite a consistent wave of natural and man-made disaster from 2011 through 2019, bankruptcies again trended down.
Corporate insolvencies in the US are forecasted to increase 27% in 2021, but bankruptcy researcher and professor at the University of Illinois College of Law, Robert Lawless maintains that while bankruptcies will increase in the US in 2021, he is more optimistic about Covid’s impact. As Professor Lawless points out, economic downturns and bankruptcies do not necessarily correlate. For instance, the last peak in bankruptcies before 2005 occurred in the 1990’s, a decade of significant economic growth.
While federal law governs most bankruptcies, state law, which can vary significantly from state to state, decides how much of a borrower’s assets creditors can go after. Bankruptcy attorneys and consumer advocates see 2021 as a year of possible additional reforms that could favor debtors. Professor Lawless agrees that some bankruptcy laws are outdated and that debt ceilings today do not account for inflation.
Albeit there already is some good news for struggling small to mid-sized businesses. The Small Business Reorganization Act (SBRA) of 2019, which was passed last summer and enacted into law in February when the Covid-19 pandemic began, amended the Chapter 11 bankruptcy code. SBRA modifies or eliminates many traditional Chapter 11 requirements while also providing small business debtors with substantial benefits and creditor protections. Subchapter V now allows small businesses to pause their obligations so they can renegotiate with lenders, landlords and other creditors, and enables debtors to reduce monthly payments and amounts owed to creditors while also enabling creditors to recoup more than they would during a liquidation. Subchapter V, furthermore, reduces financial and administrative expenses associated with bankruptcy protection for qualifying businesses.
In addition to modifying or eliminating many of the traditional Chapter 11 requirements and making it easier for small businesses to confirm their reorganization plan and retain control of their equity and the process, Subchapter V does not discriminate and is fair and equitable to all parties. It is believed that Subchapter V will provide small businesses with a better chance to successfully restructure their debt accumulated because of the current crisis, and that should preserve more businesses and save more jobs.
James J. Talerico, Jr., CMC ©
About the Author
A nationally recognized small to mid-sized business (SMB) expert, Jim Talerico has consistently ranked among the “top small business consultants followed on Twitter.” With more than thirty – (30) years of diversified business experience, Jim has a solid track record helping thousands of business owners across the US and in Canada tackle tough business problems and improve their organizational performance.
A regular guest on the “Price of Business” on Bloomberg Talk Radio, Jim’s client success stories have been highlighted in the Wall St. Journal, Dallas Business Journal, Chicago Daily Herald, and on MSNBC’s Your Business, and he is regularly quoted in publications like the New York Times, Dallas Morning News, Philadelphia Inquirer, and on INC.com, in addition to numerous, other industry publications, radio broadcasts, business books, and Internet media.
Jim Talerico is also a Certified Management Consultant CMC©, an honor bestowed on only 1% of all consultants worldwide.
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