What Do Struggling Small Businesses Need Most? Time – and Bankruptcy Can Provide It

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 Perhaps I am out of date, but I have not heard of much/any debtor-in-possession financing being available to little enterprises.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.

As bankruptcy scholars, we believe there’s a way to fix this.

Job Creators

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.

Respite Needed

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.

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  1. dougie

    Yves, your take on this issue is spot on. As a small business owner facing some of the challenges you mention in your analysis, I believe the fastest way to trainwreck your entire life would be to go the bankruptcy route.

    1. Bob Hertz

      Can you expand on the last comment about ‘trainwrecking your entire life’?

      My own experience is only with personal bankruptcy, which for me actually improved my life. I want to know more about the business implications,

      1. dougie

        As Yves mentioned, business BK would most assuredly involve personal BK given the high level of personal guarantees involved. In my case, it would jeopardize four income streams related to the core business. Those income streams are important due to the fact that personal savings and retirement planning went out the window, once I opened a small business in 2003. Along with the (very) low 6 figure IRA that kept the business open during the 2008 troubles. Plus the home refinance that took years to repay.

        I went “all in” with my business, and it is in a position to repay us handsomely, should we continue to weather the storm. Thank Dog that our business, auto repair, is deemed essential, and is rebounding nicely at the moment. Currently, we are able to manage the debt load. We are feeding 9 families livable wages, and damned proud of that.

        But, I digress…..A business BK would leave us trying to live on Social Security and a big garden. Little else, given our lack of time to rebuild any sort of financial life. I would also disrupt the lives of our employees, who will one day own the business, when we step aside.

  2. Mark

    Businesses do need time. But I don’t see traditional bankruptcy as the solution. Landlords in particular need to realise that these are not normal times and that that taking a share the losses is essential. The alternative of kicking out tenants and leaving properties vacant doesn’t benefit anybody.

    I think the Australian approach has had some successes regarding commercial tenancies.. Right now the Australian economy is looking deceptively rosey and the approach has been far from perfect. There will be dead wood in the system that is expected to float to the surface once the six months is up.


    What does the Scheme provide?

    For commercial tenants and landlords, the Scheme provides the following support:

    A six-month moratorium on commercial tenancy evictions for the non-payment of rent for small to medium enterprises with an annual turnover under $50 million that have experienced a minimum 30 per cent reduction in turnover due to coronavirus (COVID-19), commencing from 29 March 2020

    A freeze on rent increases during the moratorium for commercial tenants

    A rental payment waiver or deferral taking into account the commercial tenants’ income reduction due to coronavirus (COVID-19), to be negotiated between the tenant and landlord

    A free mediation service for commercial tenants and landlords, accessed through the VSBC, to support fair tenancy negotiations

    1. NotTimothyGeithner

      Absent a vaccine and a mass hiring program, many businesses will shut down or need to rescale six months out, so addressing bankruptcy rules is a must to deal with the deadwood. I mean I think gyms are disgusting normally, but how many won’t survive? Bars, restaurants, entertainment venues, ad even stores dependent on a reasonable amount of local prosperity. The local paper had a bit about sign shops with booming businesses as everyone is signing up, but what happens next month?

      There needs to be a plan for dealing with the deadwood because we aren’t going back for many places, or even older small business owners who were nearing retirement. Providing an exit might be necessary. Despite the hubbub about sports leagues, how many are going to restart? What about businesses near the stadiums?

  3. meadows

    Not sure how comparable small business debt is with student debt, but I think the best solution to my daughter in law’s crippling med school debt is bankruptcy… or straight up debt forgiveness since she works for a local Native American Nation and the Feds pay her salary. Their dental care is free.

    When will the indebted ever get a break?

    My Dad went personally bankrupt in the late 1970’s but due completely to his own mismanagement. How does one determine just cause? Does it matter? Many of us are in different stages of drowning in debt… business owner, student, householder, retiree.

    I remember Dad’s credit was wrecked… better for him to not have easy access to money. My family is trying to get a small business going, we call it “Hudson Yard,” (ha!)… Getting loans locally practically impossible and many hoops to jump through, while across the street a huge “student housing” project is going up, plenty of dough and tax breaks for this mega-project. Private equity REIT…

  4. Susan the other

    Well, hey. Where are all the high-flying masterminds of creative finance when you need them?? Just think of the possibilities… maybe set up an International Bank of Negative Money which will come in handy for countries whose profligate central banks have bonded for way too much emergency finance and need to balance their books pronto to protect their currencies – what better than purchasing a lot of Negative Money from the IBNM? Voila, no more devaluation problems! Or, let PE do it: Allow small business to write off all their debt, poof, with a bankruptcy resolution document which PE can purchase, syndicate into investment vehicles that rich people need to offset the gargantuan back taxes they owe society. Or just do what the Fed does, set up two sets of books for the small business, one for the good business and one for the bad business; let the good business thrive with a clean slate and let the bad business run it’s written down obligations right off the books, gradually over a 10 year period so the economy can absorb the losses. And etc. Just do whatever is clever, you oh-so-smart financiers.

  5. k teh

    Physical cash in general circulation. Folks are coming here from all over the world, desperate to get away from the cash deserts, not realizing that our banks are slowly turning the screw as well, on order from the Fed (at least that is their stated reason).

    The point of imperialism is that enslaving people is easier, more stable and more profitable with money than by force. Communism, socialism or capitalism – it’s all feudalism for the 10%. How is it that China printed all that money, maintained pegs, and bought large swaths of the US economy?

    Small business serving small business is the only offramp from thousands of years of imperialism. Voters vote for the flavor of imperialism and support looting and burning of small businesses, for a lottery ticket called a university degree. If anyone thinks Congress is going to help small business get in on the bankruptcy racket, they haven’t looked at the records of the presidential candidates.

    They print the money, and have you compete for it to exploit natural resources to their end. Win-win for them and lose-lose for you. And someone is surprised that growing income inequality has only been accelerated?

    “We burn down our own small businesses because that’s the only way we can get attention.” Congrads.

    And neither is it a surprise that unions beholden to government employer landlords are corrupt. That the police protect and serve the 10%, and do the best they can for the rest, should not be a surprise.

  6. Edward

    Instead of giving trillions to Wall Street, the money could have been used to support these businesses. What I think is needed, personally, is to try to determine what the chances are for the Covid-19 transmission in different circumstances, and then try to devise rules for businesses to operate which keep these transmission rates acceptably low.

  7. John Rose

    Masks Masks Masks
    Japan started with a mask-wearing culture, increased it and did little else. Very little Covid.

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