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Bankruptcy — A New Beginning for Smaller Businesses

The past decade has been rough on the brick-and-mortar retail industry, particularly for smaller companies that faced competition from big box retailers on one side and online retailers on the other. For many stores that have struggled to stay afloat, the pandemic was the final nail in the coffin.  
Retailers are that are struggling to keep their doors open  have options. The bankruptcy code can help a company stay in business while it reorganizes outstanding debt, and there are new features designed specifically for smaller businesses. 

Traditionally there were two options for businesses in the bankruptcy code, Chapter 7 and Chapter 11. Under Chapter 7, the debtor business liquidates all their assets, which are then distributed among its creditors, and goes out of business. 

Under Chapter 11, the debtor business retains control over their business while working out payment arrangements with creditors, allowing them to stay in business. 

Choosing between Chapter 11 and Chapter 7 depends a lot on the state of your business. If you were doing fine before the pandemic you probably have a strong foundation for your business and Chapter 11, which allows you to retain control over your business is probably right for you. If you were having trouble getting traffic through the door before the pandemic and the closures in March and April of 2020 were the final nail in your coffin, maybe chapter 7 is the way to go. 

Chapter 11 works well for larger companies and retailers — provided it has the resources to pay the trustee fees and create the plan and disclosure statement.  Chapter 11 has many features that work in favor of larger retail chains, which why we so often see these companies enter into Chapter 11. 

For example, Chapter 11 overrides local going out of business sale rules and restrictions, which may limit what merchandise can be sold and whether laws pertaining to returns and warranties apply. If your lease is above market, the debtor can “reject the lease” and cap the damages of the landlord, which are generally treated as unsecured claims. For example, if there is a chain of five stores and two are underperforming, the chain can use the bankruptcy process to renegotiate or get out of the two leases. 

Smaller chains, or chains with only a handful of under-performing stores, should consider bankruptcy under the new Subchapter V. Enacted last February under the Small Business Reorganization Act (SBRA), Subchapter V offers small businesses the chance to reorganize without the having a costly creditors committee, having to bear US Trustee fees. It also allows for easier confirmation of a plan of reorganization.  

As originally enacted when it went into effect in February of 2020, a company could file for bankruptcy protection under Subchapter V if they had debts totaling less than $2,725,625. The Coronavirus Aid, Relief and Economic Security Act (CARES) raised the ceiling to $7,500,000 until March 27, 2021. A bill is currently under consideration to extend the higher ceiling until March 27, 2022. 

It’s important to keep in mind that bankruptcy is harsh medicine, and not always the right medicine. A business owner needs counsel to consider all possible ramifications of any bankruptcy. Bankruptcies are easy to file and sometimes go horribly awry. Careful planning is the key to any successful bankruptcy. It is also important that business owners consider bankruptcy options early. All too often, business owners only consider reorganization after they have exhausted all cash and resources. By then it was probably too late to save a business that could have been saved had the business owner engaged counsel and considered options earlier.  

A small business bankruptcy will not make a bad business viable, but it can help a viable business shed unneeded locations, trim legacy debt, create a framework for negotiation with creditors and other parties in interest. 

For companies that have a strong underlying business but may be adversely affected by the pandemic, bankruptcy can be a new beginning. Numerous businesses are struggling, and while many will fail, some can be saved through a small business bankruptcy. Whatever business struggles you are going through now, it’s important to know there are options and a means to reorganize your debt and obligations while maintaining control of your business. If you started with a strong business, it can emerge from the pandemic even stronger. 

Paul H. Aloe is a partner at Kudman Trachten Aloe Posner LLP where he concentrates in the following areas: litigation, bankruptcy, zoning and land use, commercial real estate, business reorganizations, business law and employment litigation. He can be reached at [email protected].

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