Reluctant to Restructure: Small Businesses, the SBRA, and COVID-19.

• Author: Gotberg, Brook E.
• Position: Small Business Reorganization Act of 2019

The global pandemic sparked by the proliferation of the COVID-19 virus created an economic crisis of an unprecedented nature in the United States, particularly among small businesses. Many of these small businesses were required by law or circumstances to temporarily close, limit hours or capacity, and/or invest in expensive measures intended to protect the safety of their patrons. The financial consequences of these protective measures were devastating. Fortunately, the law seemed primed for just such a crisis. Mere weeks prior to the national shutdowns caused by the virus, a new bankruptcy law intended to facilitate the reorganization of small businesses went into effect. The Small Business Reorganization Act of 2019 created subchapter V of Chapter 11, which permitted small businesses to reorganize with greater speed and less cost than ever before. In response to the COVID-19 crisis, Congress expanded the use of this provision to a larger number of businesses. However, despite the apparent advantages presented by the bankruptcy law and the economic devastation caused by the pandemic, small businesses declined to file for bankruptcy. Although it is too early to draw definitive conclusions as to why, evidence suggests that small business owners see bankruptcy as a tool of "last resort," which may neuter the ability of bankruptcy laws to preserve value as intended pursuant to broader bankruptcy policy.

TABLE OF CONTENTS INTRODUCTION I. THE COVID-19 PANDEMIC II. AN INTRODUCTION TO THE SBRA A. Traditional Chapter 11 Discouraged Small Business Filings B. The SBRA Made Improvements that Might Encourage Small Business Filings III. BANKRUPTCY STIGMA IV. COVID-19 COLLATERAL DAMAGE A. The Hit to Small Businesses B. Efforts to Respond C. The Role of Debt D. The PPP and Other Governmental Assistance E. Regional Differences F. Nationwide Decline in Bankruptcy Filings V. STUDY RESULTS A. Nature of the Study: Qualitative vs. Quantitative B. Introduction of Study Subjects: Small Business in Columbia, Missouri C. The Impact of COVID-19 Across Study Participants D. Financial Efforts to Manage the Pandemic Downturn 1. Negotiating with Landlords and Lenders 2. Applying for Governmental Assistance 3. Expected Financial Health by the End of 2020 E. "I Hope That Everyone Looks at Bankruptcy as a Bad Thing" CONCLUSION INTRODUCTION

The year 2020 is one that will not be soon forgotten, most obviously because of the devastation begun in that year by the novel coronavirus COVID-19, which infected millions of Americans, destroyed countless businesses, and fundamentally altered virtually every aspect of day-to-day life for most Americans. The economic devastation caused by COVID-19 is of particular note. As of this writing, the full ramifications are still not fully understood, although it is widely agreed that the economic crisis provoked by the pandemic was unprecedented, a term widely applicable and even worn out throughout 2020 and into 2021. (1) The impact of the pandemic on small businesses was particularly noteworthy, as these businesses were confronted with severely restricted revenues, leading many to experience significant financial distress.

In similar situations of business insolvency, use of the bankruptcy system can prove beneficial to debtors, creditors, and society as a whole. Indeed, the bankruptcy system is best understood as an essential element of a capitalist society that encourages entrepreneurship, risk-taking, and consumption on credit. The bankruptcy laws do not provoke insolvency, (2) but they do provide a problem-solving mechanism to manage its negative effects and, in appropriate instances, permit the reorganization of an insolvent business to facilitate future profitability. In normal times, bankruptcy may also serve as a filtering mechanism to separate those businesses with a future going concern value from those that would be best liquidated. In this way, bankruptcy is a tool to solve the collective action dilemma of insolvency; (3) whereas state law benefits creditors according to a race to the finish, bankruptcy law allows for an orderly repayment process that seeks to maximize and preserve the value of assets for the benefit of the creditors and the debtor's bankruptcy estate.

Bankruptcy can also be understood as a negotiation framework, through which debtors can obtain a unique advantage over creditors and compel concessions otherwise unavailable outside of bankruptcy. Indeed, it can be said that all informed business negotiations operate in the shadow of bankruptcy, (4) and actors may "use" bankruptcy as a tacit threat when negotiating, such that bankruptcy rules may force creditor concessions even when the debtor never files. Thus, bankruptcy is a strategic tool for businesses that are viable in the long-term but need some way to resolve short-term challenges that prevent the company from being profitable.

Despite the significant challenges introduced by COVID-19 in the year 2020 and the advantages of chapter 11 bankruptcy processes, which were heightened by the Small Business Reorganization Act (SBRA) (5) and then further expanded by the Coronavirus Aid Relief and Economic Security Act (CARES) in the same year, (6) small businesses generally did not take advantage of the bankruptcy system for the full first year of the pandemic. (7) There are a variety of theories that could explain why small businesses were slow to file for bankruptcy, even assuming that the subchapter V framework was successful in making filing easier and less expensive. While some of these theories are essentially benign, other theories may point to larger systemic issues associated with bankruptcy, which legislative tweaks to the Code may be insufficient to fully address.

Theories explaining reluctance to file for bankruptcy can be grouped into four categories: (1) reluctance to file based on an accurate understanding of how bankruptcy works, because bankruptcy is unhelpful or the timing is not right; (2) reluctance to file due to lack of information or misinformation; (3) reluctance to file in subchapter V because there are superior alternatives, in or out of bankruptcy; and (4) reluctance to file because of stigma, fear, or the underlying belief that all other avenues for a solution--including closing the business outright--should be exhausted first. An illustration of each category follows.

First, individual business owners struggling due to the impact of the global pandemic may choose not to file for bankruptcy, fully understanding the benefits that bankruptcy can provide, because they have made a rational determination that bankruptcy will not help them. Bankruptcy is not for everyone. A company that has no debt or that is able to fully service its debt despite a general financial squeeze has little need of bankruptcy. Companies without debt or large ongoing financial obligations (such as large leases for real or personal property) will not benefit from bankruptcy provisions such as the automatic stay, the ability to reject executory contracts, or the discharge. Alternatively, companies that have easy access to refinancing may also rationally avoid bankruptcy, assuming that they have the capacity to repay under the new financing terms. Furthermore, companies that are able to negotiate with creditors to arrange reduced or delayed repayment outside of bankruptcy may rationally choose to do so rather than invoke the power afforded by the Bankruptcy Code. On the flip side, a company that has no hope of survival is also unlikely to need or want a bankruptcy filing. If a company has nothing left to lose, there is no point in incurring the costs that bankruptcy will inevitably impose. (8) Finally, companies may benefit more or less from a bankruptcy filing depending on the timing. Many individuals and businesses might be reluctant to file until they have a sense of how things will play out in the future. (9) This may be especially true insofar as reorganization requires the proposal of a plan for repayment, which itself requires some level of certainty regarding expected costs and revenues. (10)

In contrast, other business owners may decide not to file for bankruptcy based on a lack of information or based on misinformation regarding the purpose and function of bankruptcy. Some may believe, wrongly, that bankruptcy is used exclusively for the liquidation of a company, because they are unfamiliar with the parameters of a chapter 11 reorganization. When suffering under this misimpression, business owners may rationally reject the notion of a bankruptcy filing because their company is still viable, even if it is currently under water. Others may choose not to file for bankruptcy, even if it would be helpful, because they are not aware of more specific bankruptcy tools such as preference avoidance, assumption or rejection of executory contracts and leases, and other provisions that go beyond simple discharge of debt. Still others might assume that, even though bankruptcy could be useful, it would be more costly or more difficult than it really is under the revised law. (11) This may be particularly true when it comes to an understanding regarding the benefits of the new subchapter V proceedings. Due to its recent enactment, even attorneys may be relatively uninformed regarding its usefulness to small businesses. (12)

A third category of business owners might decline to file under subchapter V of chapter 11 because there are alternative, pre-existing mechanisms that will work just as well or better to discharge old debt. Sole proprietorships with personal obligations associated with the business may prefer to file for personal bankruptcy under chapter 7 or 13 instead as a way of discharging personal debts along with business debts. Only individuals with regular income are permitted to file under chapter 13, (13) which disqualifies any businesses organized as corporations, LLCs, or partnerships from that chapter. However...