Originally appeared on Baltimore Business Journal
Filing for bankruptcy protection may seem taboo to small business owners, but a relatively new and little-known program could prove to be the difference between surviving the Covid-19 pandemic or closing for good.
The flood of bankruptcies that many economists, lawyers and accountants expected has not transpired. While several large companies in the retail industry have filed for Chapter 11 bankruptcy — J.C. Penney, Neiman Marcus and Brooks Brothers to name a few — most small businesses have held off as they try to tread water.
Small businesses have typically not filed Chapter 11 bankruptcy because the reorganization process associated with doing so tends to be costly and take a lot of time. If businesses don't have enough cash for reorganization, creditors will push them to liquidate.
However, for many small businesses the clock is getting closer to striking midnight as the federal stimulus money dries up and the coronavirus pandemic continues to persist. Despite what President Donald Trump says, medical experts don't expect a vaccine to be widely available until 2021.
A law passed by Congress last year that went into effect in February provides small businesses with a lifeline: a new section of Chapter 11 known as Subchapter V, which involves a more timely and less costly reorganization process.
Subchapter V was created to provide an option for businesses with $2.7 million or less in debt. It prevents creditors from proceeding with collections, guarantees a reorganization plan is filed within 90 days and waives quarterly bankruptcy trustee fees. Congress raised the debt limit to $7.5 million when it passed its coronavirus relief package, known as the CARES Act, in March.
"It was pure luck that we have such a useful tool that came out right when this [pandemic] happened," said Vadim Ronzhes, a tax consultant at Rosen, Sapperstein & Friedlander in Towson.
Accountants and attorneys have traditionally recommend against filing for Chapter 11 in the past because of how difficult it can be to get a reorganization plan approved, Ronzhes said. With Subchapter V it's a much easier and quicker process, he said.
During the proceedings, a business may continue to pay expenses such as employees wages and benefits while it develops a plan for paying off creditors, Ronzhes said.
"The whole goal is to make sure that the business is operational and that you're able to continue supporting the community that you're operating in and make sure your employees are getting paid," Ronzhes said. "That is definitely one of the biggest benefits."
Another benefit is that the company can bring on new investors or owners. In the current operating environment with all-time low interest rates, Ronzhes said outside investors are looking to provide debt or investment capital.
Perhaps most important, Ronzhes said, is that the Subchapter V process brings all creditors to the table to come up with a plan for paying off debt. Everyone does not have to approve of the plan, but at least all parties will have been a part of the conversation, he said.
During the pandemic many small business owners have complained about the challenges of working with landlords who are unwilling to rework leases. The Subchapter V process can force those landlords to come to the table while allowing the business to remain operational instead of being forced to close.
There are downsides to filing for bankruptcy though. For one, it will negatively impact credit ratings. Filing for bankruptcy also carries a negative stigma. But in the current economic situation brought on by the pandemic, Ronzhes said the good more than likely outweighs the bad.
"If you have multiple debtors and one person decides to file suit and take money out of your bank account through levies, that could end an organization," Ronzhes said. "As soon as you start paying employees, they're not showing up. This is a way to reorganize and I think it's going to be used a lot by businesses to give themselves breathing room."
One industry that won't be helped is real estate, Ronzhes said. Real estate firms are usually structured by having separate limited liability companies for individual properties. Those LLCs won't be able to file for Subchapter V protection because the overall organization may still be profitable.