(This story originally appeared in the Philadelphia Inquirer)
It may come as a surprise that, despite the pandemic, bankruptcy filings have significantly fallen over the past year: As of March 2022, annual bankruptcy filings totaled 395,373, compared with 473,349 cases in the previous year, according to statistics recently released by the Administrative Office of the U.S. Courts. That’s a 16.5% decrease.
Government relief programs and an historic rise in household wealth fueled by a strong stock market and higher real estate prices are among the reasons to explain this trend. But unfortunately, many experts believe that this trend will reverse, and bankruptcies will soon be on the rise.
Why? Because higher inflation, supply chain woes, a slowdown in global output and rising interest rates are contributing toa growing concern that the U.S. economy could be entering into a recession sometime this year. If that happens, then small businesses, some still reeling from the pandemic, may see a drop-off in demand and a pressure on profits that may force them into making some hard decisions about whether or not to declare bankruptcy.
Brad Sadek, a bankruptcy attorney based in Philadelphia, says that many small businesses tend to file for bankruptcy, not during financial distress, but in the aftermath of the financial distress.
“If a business wasn’t able to get their Paycheck Protection Program loans forgiven, or if they’re having trouble paying back other debt because of a downturn, then bankruptcies are going to increase,” he says. “A lot of business owners may have their assets at risk, too, particularly if the real estate market continues its downturn and property values decrease. Bankruptcy numbers are going to go up.”
All of this sounds grim. But there is some good news. That’s because 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 the existing law.
The legislation — called Subchapter 5 by those in the know — streamlines the reorganization process for small business. For example, it allows a financially troubled business owner to propose a plan of reorganization to an appointed trustee without having to obtain approval or solicit votes from its unsecured creditors, which is the case under Chapter 11. The legislation also setsthe filing deadline for a reorganization plan at 90 days, which helps business owners get back on their feet quicker, instead of letting the process drag on without firm deadlines.
There are other benefits.
Rather than requiring a business owner to come up with more capital in order to retain their stake — a condition that creditors often impose — the legislation only asks that the reorganization plan is “fair and equitable” and ensures that the business owner’s projected payments or the value of property to be distributed under the plan is not less than the owner’s projected disposable income. In many cases the business owner’s personal residence may also be protected. An extended period is also allowed to pay for administrative expenses, and a business owner can potentially be discharged from bankruptcy faster than under Chapter 11.
While the Small Business Reorganization Act established these streamlined bankruptcy procedures to help small business owners keep their companies afloat and preserve jobs it was limited only to businesses that had debts of up to $2.7 million. The CARES Act of 2020 temporarily allowed more small businesses to qualify for these benefits by increasing the upper debt limit for small businesses from $2.7 million to $7.5 million. Unfortunately, that increase expired on March 27, 2022.
New bipartisan legislation, called the Bankruptcy Threshold Adjustment and Technical Corrections Act, aims to fix this problem. The bill, which passed both the House and Senate earlier this month and awaits President Biden’s signature, will provide a two-year extension to the CARES Act increase to $7.5 million, 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 individuals the opportunity to try to save their homes from foreclosure.
Sen. Chuck Grassley (R-Iowa) was one of the primary sponsors of the new bill and believes that it could help as many as 40% more businesses facing bankruptcy survive because of its streamlined rules.
“Maybe a local restaurant won’t be passed on from one generation to the other,” he told me recently. “But there’s a lot of small manufacturing firms that do, and so this legislation will also help businesses continue for successive generations of a family.”
Let’s hope that your small business never has to consider bankruptcy. But if you find yourself in that situation, and you’re eligible, then the extension of the Subchapter 5 rules may be pivotal for your survival. If you feel like this is a possibility, it’s important to talk to a bankruptcy expert as soon as possible.
“The new legislation is a very good thing for companies facing financial troubles” Sadek says. “And I think it’s going to be utilized by more small businesses here as time goes on.”