Bankruptcies have fallen, but economic pressures could send more small businesses looking for cover
It may come as a surprise that, despite the pandemic, bankruptcy filings have dropped significantly over the past year: in March, annual bankruptcy filings stood at 395,373, compared to 473,349 cases in 2021, according to recently published statistics by the US Courts Administrative Office. It’s a 16.5% lessen.
Government assistance programs and a historic rise in household wealth fueled by a strong stock market and higher house prices are among the reasons for this trend. But unfortunately, many experts believe that this trend will reverse and bankruptcies will soon increase.
Why? Because higher inflation, supply chain issues, slowing global production and rising interest rates are contributing to growing concern that the US economy could enter a recession this year. If that happens, small businesses, some of which are still reeling from the pandemic, could see lower demand and pressure on earnings that could force them to make tough decisions about whether or not to declare bankruptcy.
Brad Sadek, a bankruptcy lawyer based in Philadelphia, says that many small businesses tend to file for bankruptcy, not in the event of financial difficulties, but as a result of financial difficulties.
“If a business has been unable to get its Paycheck Protection Program loans forgiven, or if it is struggling to repay other debts due to a downturn, bankruptcies will increase,” he said. “Many business owners may also see their assets at risk, particularly if the real estate market continues to slow and property values decline. The number of bankruptcies will increase.
It all sounds grim. But there is good news. Indeed, in 2019, a bill called the Small Business Reorganization Act was passed to help small businesses take advantage of Chapter 11 bankruptcy rules without incurring the high costs and regulations required by applicable law.
The legislation – called subchapter 5 by those in the know – streamlines the process of reorganizing small businesses. For example, it allows a business owner in financial difficulty to propose a plan of reorganization to an appointed trustee without having to obtain the approval or solicit the votes of his unsecured creditors, which is the case under the chapter 11. The law also establishes the 90-day deadline for filing a plan of reorganization, which helps business owners get back on their feet faster, instead of letting the process drag on without firm deadlines.
There are other advantages.
Rather than requiring a business owner to provide more capital in order to retain their stake — a condition that creditors often impose — the legislation only requires that the plan of reorganization be “fair and equitable” and ensure that the business owner’s projected payments or the value of assets to be distributed under the plan is not less than the owner’s projected disposable income. In many cases, the personal residence of the business owner can also be protected. An extended period is also allowed to pay administrative expenses, and a business owner can potentially be released from bankruptcy faster than under Chapter 11.
While the Small Business Reorganization Act established these simplified bankruptcy procedures to help small business owners keep their business afloat and preserve jobs, it was limited only to businesses that had debts of up to $2.7 million. The 2020 CARES Act temporarily allowed more small businesses to receive these benefits by increasing the small business debt limit from $2.7 million to $7.5 million. Unfortunately, this increase expired on March 27.
New bipartisan legislation, called the Bankruptcy Threshold Adjustment and Technical Corrections Act, aims to address this problem. The bill, which was signed into law by President Joe Biden on Tuesday after Congress passed it earlier this month, provides for a two-year extension of the CARES Act increase to 7.5 million dollars and makes minor technical fixes to the Small Business Reorganization Act. It also increases the debt limit for individuals to qualify for Chapter 13 personal bankruptcy for two years, allowing more people to try to save their homes from foreclosure.
Sen. Chuck Grassley (R., Iowa) was a key sponsor of the bill and estimates it could help up to 40% more businesses facing bankruptcy survive with its simplified rules.
“Maybe a local restaurant won’t be passed down from generation to generation,” he told me recently. “But there are a lot of small manufacturing businesses that do, and so this legislation will also help businesses continue for successive generations of a family.”
Hopefully your small business will never have to face bankruptcy. But if you find yourself in this situation and you qualify, then extending the rules of subchapter 5 can be crucial for your survival. If you think this is a possibility, it is important to speak to a bankruptcy expert as soon as possible.
“The new legislation is a very good thing for companies facing financial difficulties,” says Sadek. “And I think that’s going to be used by more small businesses here over time.”
Gene Marks is a Chartered Accountant and owner of Marks Group, a technology and financial management consultancy firm in Bala Cynwyd.