When two major national retailers, J. Crew and Neiman Marcus, filed for Chapter 11 bankruptcy in the first week of May, the news reports read like obituaries, with the novel coronavirus being listed as the companies’ cause of death.
But for many businesses, Chapter 11 bankruptcy, in which companies seek to restructure their debts so that they can stay in operation, represents not death but rather a second chance at life. And although relatively few companies have turned to bankruptcy so far in response to the COVID-19 pandemic, bankruptcy attorneys are bracing themselves for a cascade of filings later this year as businesses scramble for a lifeline to sustain them until life is at least somewhat back to normal.
By and large, the companies filing for bankruptcy this early in the game were already quite ropy even before the pandemic began—J. Crew and Neiman Marcus were both laboring to service billions of dollars in debt stemming from leveraged buyouts. Bankruptcies had already been piling up in the ailing retail chain sector, which has the double misfortune of being one of the industries most severely savaged by the pandemic. Smaller companies that were struggling even before the pandemic, meanwhile, may just simply liquidate their businesses and walk away entirely.
Companies that were in fine health before the pandemic, however, have been mostly hoping for a quick recovery, planning for the worst, and biding time to see how things shake out. Bankruptcy attorneys and creditors’ attorneys both report that lenders, lacking any decent alternatives given the scale of the crisis, are taking a similar approach and exhibiting unprecedented patience with borrowers, especially those who were current on their loans before the pandemic hit.
“Across the board, creditors are being abnormally cooperative in their willingness to agree to forbearance and wait and see what happens,” said JP Cournoyer, a bankruptcy attorney with Northern Blue in Chapel Hill. “We’ve got cases where creditors who would ordinarily be aggressively pursuing collections of debt have given some forbearances. So that’s something that’s kind of unique about this circumstance. Everybody seems to understand that this coronavirus is a very unique circumstance.”
JCPennies on the dollar
Inevitably, though, at some point that patience will run out. Attorneys said that they expect the wave of Chapter 11 bankruptcy filings to really hit toward the end of this year, and even into 2021. Bankruptcies usually follow a period of negotiations between creditors and borrowers over how to restructure debts, and by year’s end it may be easier to make some guesses about a business’s post-pandemic prospects and figure out what sort of a repayment plan might make sense for both sides.
Here, too, the nature of the crisis might strengthen companies’ positions. Brian Darer, a creditors’ attorney with Parker Poe, noted that during the Great Recession, much of the action in bankruptcy court stemmed from the floundering real estate industry, where companies often owned valuable real estate assets. But companies in the industries hardest hit by the pandemic—restaurants, retail, and hospitality—often possess far less valuable collateral, which could make it easier to “cram down” loans (persuade a judge to restructure debts over creditors’ objections).
“The lower the value, in some sense the easier it is to restructure the loan. In some sense, a retail or restaurant location where the collateral might be just the equipment and the inventory, it might be easier to restructure than it is when the collateral is real estate,” Darer said. “If you have a million dollar loan on a restaurant or retail shop, and the collateral is only worth $100,000, that cramdown now becomes a lot more affordable. It gives a lot more options for the debtor in a cramdown situation.”
One of the main benefits of filing bankruptcy, either by companies or by individuals, is that creditors are generally prohibited from trying to collect debts while the borrower is under the protection of the bankruptcy court. Companies have at least six months to get a plan confirmed, and judges can extend that to up to 20 months with cause. Cournoyer said that particularly for individual filings, but probably for Chapter 11 filings as well, bankruptcy judges are likely to be more lenient and more accommodating in terms of giving a debtor more time to work things out.
“What that means in terms of the strategic advantage of a debtor is it means breathing room,” Cournoyer said. “It would give a company the ability to file Chapter 11 to buy themselves breathing room and time to survive while they wait it out. It would give them the ability to stay alive until the coronavirus’s effects on the economy start to abate.”
Seeking shelter from the storm
As fate would have it, last year Congress created a new subchapter of Chapter 11 for businesses that have unsecured debts of less than $2.7 million. The Small Business Reorganization Act, which took effect only in February, streamlines the bankruptcy process and reduces costs, making bankruptcy viable for a wider range of businesses. It also makes cramdowns easier and makes it easier for owners to retain their stakes in a business without paying off creditors in full.
Congress has also tweaked bankruptcy laws in response to the pandemic. The Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) temporarily raised the cap for the SBRA so it applies to businesses with total eligible debt of less than $7.5 million. The CARES Act also temporarily allows individuals filing Chapter 13 bankruptcy, which lets them restructure their debts without liquidating their assets, to spread their repayment plan out over seven years as opposed to the usual five. Loans from the Paycheck Protection Program should also help tide companies over, although companies that were already in Chapter 11 were explicitly excluded from the law’s benefits.
“With Congress increasing the debt limits [for the SBRA] pretty substantially, I think that’s going to have a huge impact on the number of businesses that are able to take advantage of that new law,” said Rebecca Redwine, a bankruptcy attorney with Hendren Redwine & Malone in Raleigh. “It is certainly a dialogue that is going on among the insolvency professionals nationwide. It was just enacted, so we were all still trying to get our arms around it when the law came into effect, and then this happened, so we’re all kind of rushing to study up on it and see how it can benefit our clients.”
Despite the advantages that bankruptcy offers, most people and businesses turn to it only as a very last resort because of the stigma that some may associate with it. But bankruptcy attorneys said that process exists to help people and companies that have hit a patch of bad luck get a fresh start, and expressed hope that it might be viewed very differently in light of the pandemic.
“One of the most common questions I get asked is, who’s going to find out that I filed for bankruptcy,” said Damon Duncan of Duncan Law in Greensboro. “But because we’ve all had to deal with this virus, we’ve all been impacted by this virus, I think people will be more understanding of why individuals and businesses are looking for bankruptcy relief to move forward.”
And don’t come back
Rates of coronavirus infections appear to be falling, and many states are starting to relax social distancing restrictions, bringing the potential for businesses to start opening back up. But the nightmare scenario would be a second wave of infections spiking the fall as the weather turns colder, and stay-at-home orders having to be re-imposed. Dr. Anthony Fauci, the director of the National Institute of Allergy and Infectious Diseases, warned a U.S. Senate committee of just such a danger during a May 12 hearing.
For many businesses, a second shutdown could be a backbreaker, and another reason why it makes sense for previously healthy companies to wait before committing to any plan for debt restructuring. A Chapter 11 filing generally only makes sense if there’s good reason to expect that a company can return to profitability once its debt is back under control.
Redwine noted that a second wave in the fall would likely bring a second wave of government stimulus to help ease the pain for businesses. But even with government help, a start-stop reopening would make it much more challenging to companies to emerge intact on the other side.
“I think it’s very easy right now for creditors and debtors to kick this can down the road 90 days and maybe another 90 days. But problems are going to come up with whether a creditor is willing to go another 90 or 180 days if there’s another shutdown. For a lot of them, I think the answer is going to be no,” Darer said. “With this shutdown you’re going to see a lot of deferrals and forbearances. If there’s a second shutdown, I think you’re less likely to see as many, and I think you’re more likely to see lawsuits, foreclosures, and bankruptcies.”
Follow David Donovan on Twitter @NCLWDonovan