Lessons in Bankruptcy for Struggling Business Owners by Joel Glick, CPA/CFF, CFE, CGMA
Posted on August 20, 2020
The economic realities of the COVID-19 health crisis are setting in, forcing businesses of all sizes and in all industries to think about how and if they can continue to meet their existing financial obligations and remain afloat without taking on more debt. While some business owners consider bankruptcy to be a death knell for their operations, others recognize that filing for bankruptcy protection can help them restructure their debt and avoid personal liability while also helping them reorganize and emerge as a stronger company. Determining whether bankruptcy reorganization can rescue a struggling business, however, requires the specialized knowledge and insight that only experienced accounting, tax and legal professionals can provide.
According to the American Bankruptcy Institute (ABI), there were a total of 38,944 commercial bankruptcy filings during calendar year 2019, an increase of 2.4 percent from the prior year. While filings are expected to increase in 2020, it is important to recognize that those numbers, alone, do not tell the true story of whether businesses survive or cease operations after a bankruptcy filing. That information can only be found by looking at the different types of bankruptcy options filed by commercial businesses.
Chapter 11 Bankruptcy, Reorganization
The goal of a Chapter 11 bankruptcy filing is to help financially burdened enterprises restructure their debt so they can stay in business over the long term. It is ideally suited for businesses that have assets and can continue to generate some income; just not enough to cover their outstanding debt obligations. During this current coronavirus crisis, this may include companies that were forced by government mandate to temporary close their doors, those suffering the impact of reduced consumer spending, as well as businesses that have already used up the proceeds from SBA loans, such as the PPP.
Chapter 11 generally allows companies to apply for financial relief from creditors and continue to operate and earn income under a plan of reorganization approved by the bankruptcy court and often supervised by a trustee with the U.S. Department of Justice. As part of its reorganization plan, a business will need to file a series of financial statements with the court, pay required court costs and attorney fees to help negotiate with its creditors to pay off a mutually agreed-upon portion of its outstanding debt. This means that creditors may not agree to a business’s first reorganization plan, and additional time and money may be required to receive a final decision from the bankruptcy court.
Once a business completes its payment obligations, it may request the court discharge the remainder of its unsecured debts and allow the business to continue its normal operations. However, as a word of warning, business owners filing Chapter 11 bankruptcies that are unable to pay all their creditors’ claims in full may risk losing ownership and control of their companies under the absolute priority rule. This has been historically troublesome for small businesses that may not have ample funds to essentially “buy back” their business interests.
Subchapter V of Chapter 11 Bankruptcies for Small Businesses
Last year, before the COVID-19 pandemic reached the U.S., Congress enacted the Small Business Reorganization Act (SBRA) to make it easier, less expensive and less time-intensive for small businesses with less than $2,725,625 in secured and unsecured debt to file for Chapter 11 bankruptcy reorganization.
One critical provision of the law, which went into effect on Feb. 29, 2020, eliminates the Chapter 11 absolute priority rule that would otherwise allow creditors to take ownership interest in debtor’s assets. However, with the passages of the CARES Act in response to the COVID-19 pandemic, Congress temporarily increased the debt limit to $7.5 million through March 27, 2021. Consequently, more small businesses are eligible for reorganization under the new, Subchapter 5 provisions, and those qualifying businesses that previously filed for Chapter 11 reorganization may now convert those claims to fall under the Bankruptcy Code’s Chapter 11, Subchapter 5 and have any remaining unsecured debt discharged.
Chapter 7 Bankruptcy Liquidation
Businesses that default on their debt and do not have the ability to renegotiate their credit terms will likely be forced to file for Chapter 7 bankruptcy protection. These circumstances require businesses to cease operations while a court-appointed trustee liquidates of all their assets and distributes the proceeds to creditors. Although the proceeds from a Chapter 7 asset liquidation may not be enough to pay off all of a business’s outstanding bills, it does provide creditors with some form of restitution while allowing businesses owners to avoid personal liability for their business’s debts.
Bankruptcy filings may not necessarily spell doom for a business, but they are complicated processes that require the expertise of seasoned professionals to help guide businesses to achieve their intended goals.
Whether you need help evaluating cash flow forecasts, renegotiating with lenders, or evaluating the viability of other financial tools, such as determining if you qualify for a Subchapter V bankruptcy reorganization, the advisors and CPAs with Berkowitz Pollack Brant’s Forensic and Advisory Services Group are here to help. We have extensive bankruptcy experience working with debtors, creditors and creditor committees, trustees and receivers. Our full range of bankruptcy recovery and restructuring services include insolvency analysis; forensic accounting; claims analysis; debt structing and renegotiation; reorganization plan development; expert witness testimony; business valuations; and exit strategy planning and implementation.
About the Author: Joel Glick, CPA/CFF, CFE, CGMA, is a director in the Forensic and Advisory Services practice with Berkowitz Pollack Brant, where he serves as a litigation consultants and forensic accountant in matters relating to bankruptcy and receivership, economic damages and forensic investigations. He can be reached in the CPA firm’s Miami office at (305) 379-7000 or via email at firstname.lastname@example.org.