Senate Majority Leader Mitch McConnell, when recently asked about the possibility of states going bankrupt in the wake of the coronavirus pandemic, said that he would “certainly be in favor of allowing states to use the bankruptcy route.”
Citing the potential for reducing or limiting pension and other entitlement costs, Mr. McConnell feels that a state bankruptcy route could make sense because “it saved some cities, and there’s no good reason for it not to be available.”
Mr. McConnell could very well be right about bankruptcy — but not just for the states.
Given the catastrophic effects of government shutdowns and quarantines related to COVID-19 on the economy, going bankrupt may be one of the better strategies for many small businesses to use, too. And going bankrupt couldn’t have come at a better time. That’s because there’s a new law — the Small Business Reorganization Act of 2019 (SBRA) — which makes it easier for a small business to file for bankruptcy and recover from the effects of this unprecedented downturn.
Up until the act went into effect, and under the prior Chapter 11 reorganization law, filing for bankruptcy was a complicated task, particularly for smaller companies. But now those small businesses that have less than $2,725,625 of secured and unsecured debt can enjoy a new subchapter of Chapter 11 that takes a lot of the complexity out of the bankruptcy process, while also providing more options.
What kind of options? For example, a business owner who wants to declare bankruptcy now has 90 days (it was previously 120) to come up with a reorganization plan and — significantly — is not required to form a “creditor’s committee” of interested parties which is the case under a typical bankruptcy filing. Instead, a single trustee can be appointed to make sure things stay on track while the business owner continues to operate as normal.
Dealing with creditors is made easier, too. Once a bankruptcy is declared the business owner will no longer have to get approval from creditors to move forward with a reorganization plan, as long as the court approves. The plan will rely on fewer factors, most importantly a three- to five-year projection of disposable income that will show how debts will be paid off.
There’s also a new way for determining the owners’ and creditors equity interests, based on what is “fair and equitable,” with greater opportunities for owners to keep a stake in their businesses, even if all debts can’t be paid off. One other major factor is that certain personal assets — like homes and residences — are also now protected.
Of course, no small business owner wants to fail and regardless of how you spin it, bankruptcy is a failure. But consider the alternatives. Mounting debts. Week after week of declining revenues due to social distancing, customer hesitancy and economic uncertainty as well as the pressures of keeping people employed and not enough government relief to help pay for all this. For many small businesses, the next six to 12 months looks bleak and, according to a recent report from the Associated Press, a “flood” of new bankruptcies is likely coming.
But the new Chapter 11 rules will help ease some of these concerns, including making it easier for the business owner to put a stop to all debts and renegotiate what’s owed. It provides time to pause, get a better look at the future and make a plan. It’s far less bureaucratic than ever before — and bankruptcy leaders agree it’s a better and easier system for small businesses to utilize.
“The SBRA ensures that small businesses will be able to reorganize and rehabilitate their financial affairs effectively under the Bankruptcy Code,” Samuel J. Gerdano, the executive director of the American Bankruptcy Institute, said in a statement at the time of the bill’s passing. “ABI commends the Congress for developing this important and bipartisan bill.”
Absolutely and without question, going bankrupt will have an impact on a small business owner’s ability to borrow in the future. But in my experience it’s more of a hit to the ego than a hit to the pocketbook. Future creditors will likely look with sympathy at business owners who were forced into bankruptcy during these very unprecedented times, and most business owners I know who emerged from Chapter 11 were able to build back their credit slowly over subsequent years.
“With their companies’ financial troubles beyond their control because of the virus outbreak, many will file for Chapter 11 because the stigma that bankruptcy has long held will be gone,” says David Wander, a partner at Davidoff Hutcher & Citron in New York, told the Associated Press. “The tsunami is going to happen in the coming months and it’s going to be ongoing.”
So maybe Mr. McConnell’s right and some states should be allowed to go bankrupt. Without question, many small businesses will be taking that route. Given the chance to take a breath and reorganize, many of those small businesses willing to use bankruptcy as a strategy will potentially re-emerge and grow again.
• Gene Marks is a CPA and owner of The Marks Group, a technology and financial management consulting firm that specializes in small- and medium-sized companies.
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