Bankruptcy filings could reach a historical high next year as the coronavirus pandemic continues to wreak havoc on business operations in nearly all industries.Valley attorneys told the Business Journal small business owners have taken every measure to avoid closure or reorganization up to this point, meaning the most severe wave of shutdowns is likely yet to come.According to Jeremy Faith, founding partner of Encino law firm Margulies Faith, “people are going to max out their credit cards. There’s been a moratorium on evictions. There’s been government money coming out at different levels. People had credit available.”After fully exhausting those options, he said, an increasing number of businesses will soon have no other choice but to restructure or liquidate.
“(Bankruptcy) tends to be a trailing indicator,” Faith said.
In an October press release, American Bankruptcy Institute Executive Director Amy Quackenboss offered a similar prediction.“Families and businesses are faced with increasing financial challenges due to the COVID-19 pandemic and growing debt loads,” she said. “The expiration of government relief programs, high unemployment and a difficult financial outlook for many sectors will likely lead to filings increasing in early 2021.”Rabin Pournazarian, an attorney with Price Law Group in Encino, explained bankruptcy numbers this year are misleadingly low because “a lot of people are just waiting to see what happens. People have gotten SBA or PPP loans or are not paying their rent because there has been leniency on tenants. … That frees up money to do other things.”Federal aid, bank loans, credit lines and liquidation of nonessential assets have helped buy businesses time, but debt accrued during mandated shutdowns will inevitably swing back around. Many businesses won’t have enough time to earn back the revenue they lost this year.According to Faith, “within the bankruptcy community, the anticipation is that we’ll start to see the numbers shoot up sometime next year. It’s hard to know when that is.” Pournazarian agreed.
“Everybody is expecting (bankruptcies) to increase. The question is when.”By the numbersWhen analyzed separate from the context of the pandemic economy, this year’s bankruptcy statistics give a surprisingly rosy outlook.The American Bankruptcy Institute, sourcing data collected by New York research firm Epiq Systems Inc., said there were 40,209 total bankruptcy filings in the U.S. in October, way down from 67,858 filings registered in October 2019. Commercial or business filings last month totaled 2,521 filings under all chapters, down 30 percent from 3,579 filings in October 2019.
Federal law permits several types of bankruptcy. The most common is Chapter 7, open to businesses and individuals, where the court can liquidate the filer’s assets to pay back creditors. Filing this chapter will close a business. Chapter 11 allows businesses to keep operating by reorganizing their financial structure, usually to lower debt. And Chapter 13, for individual filers only, allows the court to create a monthly debt payment plan based on a filer’s income. Businesses cannot file under Chapter 13.For the year to date, total bankruptcies are down nationally, continuing a trend of declining bankruptcy numbers in the U.S. since the early 2010s. Commercial Chapter 11 filings, however, are up on the year, with 6,081 cases filed through the end of October. That’s more than all of 2019, which saw 5,519 commercial Chapter 11 filings.Numbers from the San Fernando Valley office of the Central District of California’s Bankruptcy Court corroborate the story.According to metrics provided by Maureen Tighe, chief judge of the Central District Bankruptcy Court, 2,158 cases have been filed in the court’s Valley office to date – 1,786 under Chapter 7, 73 under Chapter 11 and 299 under Chapter 13.All segments are down from 2019, with one exception: commercial Chapter 11 cases. So far in 2020, 50 business entities have filed for Chapter 11 in the Valley office, down from 38 in all of 2019.High-profile casesFaith said most of the business bankruptcy clients he has worked with this year were already battling balance sheet woes before the virus emerged.The same is true of many of the high-profile bankruptcy filings by large corporations in the Valley region this year.Guitar Center, for example, has been inundated with around $1.6 billion in debt since 2007, when its previous owner Bain Capital took it private for $63 a share.The Westlake Village musical instrument retailer announced this month it expects to file for Chapter 11 before the end of the year as the pandemic worsened an already fragile financial situation.Meanwhile, Santa Clarita oil and gas producer California Resources Corp., which filed for Chapter 11 in June and emerged last month, had been financially embattled for its entire lifetime, having assumed around $5 billion in debt when it spun off from Occidental Petroleum in 2014. It filed to restructure its balance sheet when the price of oil tanked this spring, which left the company unable to make payments to creditors.Faith said some industries are more likely to have already suffered business closures than others.“There are certain types of businesses, like restaurants, that just operate on such thin margins to begin with that they’ve got so little room to weather a prolonged downturn in their business model. A lot of what we’re seeing is food industry-related,” he explained.Locally, IHOP and Applebee’s parent company Dine Brands Global Inc. in Glendale in has seen two major franchisors file for Chapter 11: CFRA Holdings, which owned 49 IHOP restaurants throughout North Carolina, South Carolina, Virginia and Tennessee; and Wisconsin Apple, which has 25 Applebee’s locations.Over the hill, Los Angeles-based chain Souplantation, which goes by Sweet Tomatoes outside of Southern California, announced in June it would liquidate all assets under Chapter 7. The pandemic rendered its buffet-style business model unsafe and unviable.Faith added the events planning and live entertainment industries are also among the most immediately affected by the virus and could see more closures than other sectors.Pournazarian said what happens next depends partially on Congress.
“If another round of stimulus goes out, that might delay (filings) further,” he said.
Subchapter 5While Chapter 7 and 13 cases are way down this year, Tighe told the Business Journal the Central District has seen “a lot of activity” from small businesses filing for Chapter 11 reorganization.
She posited Subchapter 5 of Chapter 11, also known as the Small Business Reorganization Act, or SBRA, could be a causal factor.The SBRA was enacted in February as an amendment to the bankruptcy code that cut costs and streamlined the process of confirming a reorganization plan so small businesses have a better shot at keeping operational control.The CARES Act, upon its passage in March, increased the eligibility threshold for a business to receive SBRA benefits from $2.7 million in debt to $7.5 million in debt.That shift opened up Chapter 11 to a wider range of businesses that otherwise might not be able to afford it, granting them another option before liquidating under Chapter 7.
‘That new law will be very helpful,” Tighe said. “We’ve got a task force making sure it’s accessible to people.”The higher debt limit allowed by the CARES Act is currently set to expire on March 27, 2021, but Faith predicted it will be extended.“They’re never going to drop it if it’s my guess. There’s going to be a ton of pressure to keep it at the $7.5 million mark, especially if we see successful reorganizations,” he said.The American Bankruptcy Institute said about 1,000 small businesses have filed for Chapter 11 under Subchapter 5 since it became law.