Yves here. Perhaps readers will disagree with me, but I have some problems with the notion that bankruptcy will come to the rescue of many small businesses. First, if Covid-19 has made a business model unworkable, a bankruptcy stay won’t solve that. Even if the operation were to emerge from bankruptcy with its liabilities wiped out, it would just drive itself back into the ditch (unless a vaccine or effective treatments emerge and are widely distributed very soon). Second, companies need cash to keep operating. Perhaps I am out of date, but I have not heard of much/any debtor-in-possession financing being available to little enterprises. A longer bankruptcy process requires more cash to get through it. Third, credit to businesses, ranging from credit cards to SBA loans, require personal guarantees; the only exception is secured lending (such mortgaging real estate owned by the business or equipment finance). So many small business owners will be reluctant to declare bankruptcy until it is absolutely unavoidable because it will trigger a personal bankruptcy as well.
Finally, I’m a bit puzzled about the call for a longer bankruptcy process. My understanding is state and Federal courts are already operating on slower timetables due to backlogs created by lockdowns. And with bankruptcy courts seeing the early edge of a tsunami of bankruptcy filings, I doubt they’ll be processing cases quickly either.
Having said that, I do know someone who declared a small business bankruptcy in the dot-bomb era. His firm was due to get a $2 million contract with United signed on September 12, 2001. He failed to downsize rapidly enough due to poor cash flow forecasting. And while his business did survive, it went from 27 employees to six, although he has rebuilt somewhat from there.
By Brook Gotberg, Associate Professor of Law, University of Missouri-Columbia and Paige Marta Skiba, Economist, Professor of Law, Vanderbilt University. Originally published at The Conversation
The coronavirus pandemic and lockdown forced nearly a thirdof all small businesses in the United States to close. Some have shut down for good – one estimate puts the percentage at almost 2%, or over 100,000 so far.
Those that remain and are gradually opening up must navigate a host of restrictions, including limits on customers, who themselves may be reluctant to get a haircut, dine out or engage in other activities that put them near others. Even in parts of the country that haven’t yet experienced a lot of COVID-19 cases, businesses have reopened to significantly smaller crowds, imperiling their survival.
What these businesses need most right now is time – breathing space that temporarily freezes expenses while letting them continue to operate and figure out a plan to keep going. In many cases, that means declaring bankruptcy.
While bankruptcy is often associated with going out of business, it’s also meant to help viable companies develop a path back to profitability. The problem is bankruptcy law doesn’t provide enough time to do this in the middle of a pandemic. Ongoing health concerns will likely subdue economic activity for who knows how long, even as bills and other costs pile up.
Small businesses – specifically, those with fewer than 20 employees, like your local restaurant, nail salon and pet sitter – make up roughly 90% of all private companies and account for nearly two-thirds of all new jobs created in the U.S.
The temporary or permanent closures of so many contributed considerably to the historic levels of unemployment experienced in April and May.
To save small businesses and the millions they employ, Congress created the Paycheck Protection Program, which can lend as much as US$659 billion. But businesses must use most of the proceeds for payroll. Companies still have to pay rent, utilities, insurance premiums and a host of other ongoing costs. While some have been able to defer these expenses, they can’t do so forever. Businesses will eventually be forced to deal with unpaid, unmet obligations.
Some businesses may have enough savings to ride out the pandemic or can access fresh capital from owners – who often wipe out their personal savings, including retirement funds, in the process. But for so many others, the crush of past-due expenses will threaten their ability to continue to operate, even if the business model is sound overall.
Bankruptcy to the Rescue
While bankruptcy usually serves as an organized way to close down permanently, it can also be used to hold off creditors while a company restructures its debts and continues operations under Chapter 11. Upon filing, an automatic stay on collection efforts goes into effect, which prevents eviction, foreclosure or repossession of inventory and equipment while the business comes up with a plan.
For many businesses struggling in the aftermath of COVID-19, however, the issue is not a backlog of debt but simply a lack of immediate revenue to make short-term obligations, especially rent and payroll. And there’s really no knowing how long revenue will remain below normal, with concerns that infection rates are soaring in parts of the country that are opening up.
Until recently, very few small businesses were able to reorganize successfully under Chapter 11, opting instead to find alternative solutions under state law or to simply go out of business altogether. Last year, Congress made it a little easier for companies with less than $2.7 million in debt to navigate bankruptcy successfully, by reducing the regulatory burdens and offering more support.
But, even after lawmakers increased the debt ceiling to $7.5 million as part of their coronavirus response, small businesses still don’t have what they need most right now: time.
In bankruptcy cases, debtors are required to adhere to extremely strict time frames, many of which are accelerated for small businesses. Upon filing, debtors are required to meet with the court quickly to present a proposed plan for how they expect to be profitable going forward. Debtors have 90 days to come up with a plan, under which they can repay most creditors slowly – over the next three to five years.
There’s an important exception, however, for rent payments. If debtors wish to retain their leases, they need to pay timely rent going forward immediately after filing – and have to repay all past-due rent in full as soon as their plan is confirmed. In other words, while there’s some wiggle room with other past-due bills, such as wages, utilities and even taxes, there’s a hard deadline with rent, which for many is the largest expense of all.
These time frames and special rules regarding rent were drafted with a normal, functioning economy in mind, and did not take into account the disruption caused by a global pandemic.
A recent proposal delivered to Congress by a group of bankruptcy scholars – including us – recommended giving small businesses affected by the global pandemic extra time during the bankruptcy process.
The proposed changes would freeze bill collection as normal, but also freeze court proceedings for the next six months – a desperately needed respite after which the long-term effects of the pandemic may be better understood.
This recommendation would encourage landlords to negotiate with debtors by providing debtors with court-mandated breathing room to escape the otherwise inflexible provisions surrounding rent.
It is our hope that this would afford such businesses the time and space they need to remain the backbone of the U.S. economy.