In-Depth: COVID-19 – Bankruptcy Considerations
Supplement to Could Filing For Bankruptcy Help A Business Slammed By COVID-19? (Barack Ferrazzano Client Alert, March 2020)
Short Term – Bankruptcy Will Provide Breathing Room
In the short term, a bankruptcy filing will allow some breathing room for the business confronted with an imminent eviction or foreclosure action. A bankruptcy filing triggers an “automatic stay,” which will stop dead in its tracks any action, whether taken in a court proceeding or outside of one, to evict the company that filed for bankruptcy (referred to as a “debtor”) or to foreclose on or seize any of its property. Any particular landlord or lender can ask the bankruptcy court to terminate the automatic stay as to that landlord/lender and the enforcement of its own rights, but such a request starts a legal proceeding that can take 60 to 90 days to resolve (or longer if the court is swamped with similar requests or otherwise inclined to drag its feet to allow debtors some time to recover).
Long Term – This Situation Is Not Well-Suited To Bankruptcy
In the long term, a bankruptcy filing may not provide much relief to the distressed business. This is especially true with a business that is trying to preserve its rights under a lease. To preserve the lease, the business must bring the lease current – likely an impossible task because the business would have to pay rent for the months in which it had no revenue. Of course the landlord, faced with an empty space, might be more lenient than what the bankruptcy law requires. If nothing else, a bankruptcy filing might give the tenant the time and leverage needed to demonstrate to the landlord that working with the tenant, who expects to see its business recover in the post-virus world, is a better option than taking back vacant space.
A bankruptcy filing might work better for the company that does not face landlord pressure, but is in default on loans and/or faces suits by unpaid suppliers. Chapter 11 of the bankruptcy law, available for the company that wants to continue on in business, can be used to reduce debt and to spread out over several years the repayment of debt. This type of bankruptcy is often used by owners of real estate (shopping centers, apartment buildings, office buildings, hotels) where the real estate is the principal asset of the business.
However, two things make Chapter 11 a poor option for most businesses:
- First, a successful reorganization under Chapter 11 usually requires that the owners of the business make a new and substantial contribution of capital to the business. It may well be the case, especially with smaller businesses, that the owners have no ability to make the sufficiently large contribution to capital that would be needed to successfully reorganize under Chapter 11.
- Second, a Chapter 11 bankruptcy proceeding can be very expensive, and there are nearly infinite ways in which a recalcitrant lender or landlord can derail the proceeding.
In late 2019 Congress added a new section to the Bankruptcy Code designed to reduce the time and expense it takes for a small business to reorganize under Chapter 11. There is no experience yet with the new section, but it seems unlikely that it will make bankruptcy an affordable option for many small businesses.
Bankruptcy, Or The Threat Of It, Does Provide Leverage For Borrowers & Tenants
If a successful bankruptcy case is defined as a case that ends with a court-approved plan of reorganization, then very few businesses slammed by COVID-19 will be able to make successful use of the bankruptcy laws. The vast majority of Chapter 11 cases result in a sale of the business or a Chapter 7 liquidation case. However, a bankruptcy filing, or threat of filing, does give the business in crisis some breathing room and some tools to slow down its antagonists (creditors of all sorts), to impose costs on them, and to confront them with the possibility, albeit slight, that their rights may be materially compromised if the case were to continue. This is often enough to get creditors to the table to negotiate a workable plan for addressing defaults and allowing the business to continue.