The Anticipated Tsunami of Commercial Bankruptcies Has Not Happened – Here’s Why

by Anthony Austin

Since March 2020, there has been a great deal of hand wringing over how businesses would weather the economic storm created by COVID-19. As the lockdowns dragged on longer than anyone expected, many speculated that the resulting economic chaos would produce a swath of defaults and bankruptcy filings. Now, more than a year removed from the initial lockdowns, are those predictions of chaos accurate or is the room for optimism?

Despite the lingering effects of 2020, there seems to be a feeling of optimism from businesses and consumers in 2021. The United States Census has found in July 2021 that 30% of surveyed Arizona businesses reported that the pandemic had little to no effect on business. During the same period in 2020, only 16% of surveyed businesses reported little to no impact while more than 35% reported a large impact. In contrast, only 21% of surveyed businesses reported a large impact in July 2021.

Further, there is evidence that consumer demand is climbing over the remaining months of 2021. A recent study found that fewer than 15% of consumers remain pessimistic about the U.S. economy. More importantly, that same survey found that consumer discretionary spending was showing growth in 2021 and more than 50% of consumers expect to spend extra and splurge on themselves. This uptick in demand is logical given that consumers in large part drastically reduced their spending in 2020. With pandemic fatigue setting in and the nature of a consumer-based economy, there is evidence that consumers are once again ready to spend on at pre-pandemic levels. 

Where is the optimism coming from in Arizona and other states around the nation? Much has to be credited to the large injections of capital by the federal government through the various relief acts passed in the last 18 months. By some estimates, the various facets of the federal government have committed or disbursed approximately $5.335 trillion in total COVID-19 relief funds. Nearly $1 trillion was directed to support for small businesses, with another $876 billion in economic stimulus payments. This flow of liquidity to consumers and businesses has done much to band-aid the economic harm created by the shutdown.

This optimism is also playing out in the lack of bankruptcy filings seen in 2021. For the District of Arizona, total filings in 2021 have fallen by more than 25% in year-over-year numbers. The drop-off is even more significant for reorganization filings, which saw a 40% drop-off from the previous year. This would suggest that companies and consumers are optimistic about their ability to operate without the aid of bankruptcy or are actually working through the economic fallout with their creditors.

There is no guaranty this optimism will result in actual positive economic results. There are numerous factors that may cause this progress to be halted or eliminated entirely, including the expiration of the eviction moratoriums and the imposition of new restrictions as COVID-19 variants take hold. Accordingly, creditors must be prepared should the wave of bankruptcies land at their shores. 

Perhaps one of the biggest risks for a creditor of a struggling business is the Small Business Reorganization Act, which implemented “Subchapter V” bankruptcies. These bankruptcies are a subset of the traditional chapter 11 process and are limited to businesses with debts less than $7.5 million until March 2022 and approximately $2.7 million after that time. These bankruptcies are a powerful tool in a potential debtor’s arsenal and, with the increased debt cap, are available to thousands of businesses. Subchapter V bankruptcies greatly streamline and ease the burden on a debtor under chapter 11 by removing many of the protections creditors have relied on in traditional bankruptcy filings. Notably, the debtor does not need the affirmative vote of its creditors to confirm a reorganization plan and has to pay only its “disposable income” for three to five years. These provisions can quickly sideline creditors, who must effectively sit and watch as their claims are reduced to pennies of the total amount. 

More generally, facing potentially unfavorable bankruptcy outcomes, any effort to collect on unpaid sums must be done strategically to ensure repayment while providing an opportunity for the potential debtor to emerge from behind the COVID-induced harm. Regardless of the industry or specific situation, a cautious and thoughtful approach is now required to ensure repayment of past-due monies. Brute force collection tactics like those used pre-COVID are likely to be ineffective and face the substantial risk of triggering a bankruptcy filing that may substantially impair the creditor’s ability to be repaid. 

Long-term and creative workout strategies are likely a creditor’s best route to full repayment. This is especially true given that 41% of Arizona small businesses do not expect to return to pre-COVID operations for some time. Accordingly, some lenders are granting deferments for missed payments in exchange for additional collateral or guarantees to secure the missed payments. 

Anthony Austin, a director in Fennemore’s Phoenix office, is a prominent attorney in the firm’s financial restructuring, bankruptcy and creditors’ rights practice group, where he works on matters that include collection and judgement work, breach of contract, partnership disputes and receiverships. He represents financial institutions, debtors, creditors, and trustees in all phases of complex litigation and restructuring transactions, including trials and appeals. As an experienced bankruptcy attorney, Austin has a wide range of commercial litigation experience involving foreclosures, receiverships and guarantor litigation.

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