Authored By: Sarah Hammitte
As we have all observed and some have experienced personally, COVID-19 impacted companies in the energy, retail, restaurant, entertainment, health care, travel, and hospitality industries on a global and national scale. In the Spring of 2020, mandatory shutdowns devastated the bottom lines of thousands of companies due to dramatic drops in demand for their products and services.[i] The economic impact of COVID-19 has forced several large, distressed companies into bankruptcy, but not nearly as many as one would expect.
Historically, bankruptcy filings reflect the rise and fall of our nation’s economic status. Following the global financial crisis, business bankruptcy filings doubled to 60,837 in 2009 from 28,322 in 2007.[ii] Given that the COVID-19 global pandemic caused the American economy to virtually shut down, economists and scholars predicted a tidal wave of bankruptcies to follow.[iii] And they did, for a while, primarily affecting large corporate businesses. Expecting an increase in filings, Congress even enacted a new Bankruptcy Law that would ensure there would be adequate funding in the Bankruptcy Courts to cover the predicted high caseloads.[iv] July 2020 experienced its peak in pandemic-driven bankruptcies with a 52% increase in Commercial Chapter 11 Bankruptcies.[v] This spike in large corporate bankruptcies was only second behind 2009’s peak.[vi]
But then, just as quickly as business bankruptcy filings rose, they fell, beginning as early as October 2020.[vii]Indeed, corporate bankruptcies fell to a historic low in 2021.[viii] Despite COVID-19’s worsening conditions, businesses across the United States were surviving the economic crisis that greatly exceeded the Great Recession in years prior. What was different?
Why Did the Tidal Wave of Bankruptcies Never Materialize?
Not surprisingly, the mandatory switch to remote court hearings had an impact on the decline in bankruptcy filings beginning in March 2020.[ix] April 2020 hit its sharpest decline for monthly filings due partly to the shift to online court proceedings.[x] For example, complex bankruptcy cases can require over 100 attorneys to participate in a single hearing.[xi]
Moreover, the majority of the businesses that contributed to the July 2020 peak in bankruptcy filings were already in financial distress, and COVID-19 merely accelerated their restructuring proceedings.[xii] Further, the enactment of the Coronavirus Aid, Relief, and Economic Security Act,[xiii] (“CARES Act”) in March 2020, provided small and large businesses the relief they needed to avoid filing for bankruptcy in most cases. The CARES Act set aside nearly $454 billion in funding programs to assist eligible businesses that were affected by COVID-19.[xiv] Eligible businesses had the opportunity to apply for grants including the Shuttered Venues Grant, and the Restaurant Revitalization Fund, totaling to nearly $44.8 billion in relief funds.[xv] However, as the economy has recovered since 2020, these grants and loans are no longer offered to businesses that may still be experiencing hardships from the pandemic to this day. Further, as of May 2021, the Payment Protection Program, (“PPP”), offered loans to businesses to help keep their workforce employed during the COVID-19 crisis.[xvi] All of these federal assistance programs allowed businesses that would otherwise file for bankruptcy due to the pandemic’s economic impact, to avoid filing, by increasing their debt limit.[xvii]
As a result of the various federal funding programs that were provided to stabilize the economy by allowing businesses to survive the harsh economic effects of COVID-19, the decision to file for Chapter 11 bankruptcy became increasingly difficult. To confirm a Chapter 11 Reorganization plan, courts must consider, among other things, the “feasibility” of the proposed plan.[xviii] The Bankruptcy Code defines feasibility to mean that the confirmation of the plan “is not likely to be followed by the liquidation, or the need for further financial reorganization, of the debtor” unless specifically proposed in the plan.[xix] This feasibility requirement requires adequate assurance of a business’s future performance. In an uncertain economy and COVID-19’s seemingly unpredictable future, the feasibility that a company who chooses to file Chapter 11 Bankruptcy in 2021 or 2022 will not need further financial reorganization is nearly impossible to estimate. In other words, the government assistance provided by the CARES Act has made it difficult for businesses to predict future performance, to determine which businesses will strive, or accurately place a value on their assets.[xx]
Furthermore, the CARES Act mandated debt forbearance, which allowed lenders to offer businesses that were suffering from the effects of the pandemic to suspend their payments rather than force them into default or bankruptcy proceedings.[xxi] Additionally, the strong stock market provided an alternative to filing for bankruptcy amid the pandemic. Many large, distressed businesses were able to avoid bankruptcy by selling stock, thus allowing them to raise capital without having to restructure their business or borrow money.[xxii]
Will the Bankruptcy Tidal Wave Ever Materialize?
Although the tidal wave of bankruptcies has yet to materialize, some experts believe that the U.S. Bankruptcy Courts will see a rise in filings in the second quarter for 2022.[xxiii] The stimulus payments are coming to a halt as the economy rebounds, more Americans are choosing to be vaccinated, and businesses are opening back up to the public. The decline in bankruptcy filings over the last two years were tied to temporary federally funded programs, generous lenders, a strong stock market, and historic-low interest rates. As businesses run out of stimulus money, with little to no federal assistance in sight, and as borrowing costs are expected to rise, those once generous lenders may turn into eager creditors. It is important to note that certain creditors made such allowances while businesses were in covid-related distress. The question becomes, once the economy fully rebounds and COVID-19 slowly stops to spread, will these creditors still be so generous. Further, the interest rates are expected to rise by the end of 2022, which could push businesses into bankruptcy court. Bankruptcy professionals fear that looking forward, as inflation continues to rise and monetary policies issued by the Federal Reserve begin to tighten back up, large businesses may begin to become financially distressed.[xxiv]
Why Does it Matter?
The same concerns that scholars had when predicting a massive wave of bankruptcies as a result of the pandemic remain true today. Bankruptcy Courts may run the risk of being overwhelmed. Historically, the bankruptcy system functions differently when they are congested causing them to be less effective.[xxv] Congested courts present special challenges to smaller business by increasing their likelihood of liquidation.[xxvi] Although larger businesses are much more likely to successfully reorganize, congested courts makes the process unduly longer and inevitably more costly.[xxvii] Precautions should be made when deciding to file for bankruptcy, especially Chapter 11, which primarily depends on obtaining financing to repay the debts.[xxviii]
[i]See, e.g., Allie Schwartz et al., Trends in Large Corporate Bankruptcy and Financial Distress, Cornerstone Research, 4 (Aug. 24, 2021), https://www.cornerstone.com/wp-content/uploads/2021/12/Trends-in-Large-Corporate-Bankruptcy-and-Financial-Distress-Midyear-2021-Update.pdf (“The Retail Trade industry had 31 bankruptcies in 2020, as the COVID-19 pandemic created a difficult environment for traditional retailers that faced lockdowns and reduced demands for in-store shopping.”).
[ii]See Annual Business and Non-business Filings by Year (1980-2020), American bankruptcy institute, https://abi-org.s3.amazonaws.com/Newsroom/Bankruptcy_Statistics/Total-Business-Consumer1980-Present.pdf (last visited Feb. 5, 2022).
[iii]See, e.g., Mary Williams Walsh, A Tidal Wave of Bankruptcies is Coming, N.Y. Times (Aug. 3, 2020), https://www.nytimes.com/2020/06/18/business/corporate-bankruptcy-coronavirus.html (expecting the number of large bankruptcies to challenge the record set in 2009).
[iv]See H.R. 8895, 116th Cong. (2021).
[v]See Alex Wolf, Commercial Bankruptcies Jump by Significant 52% Over Last Year, Bloomberg Law (Aug. 5, 2020), https://news.bloomberglaw.com/bankruptcy-law/commercial-bankruptcies-jump-by-significant-52-over-last-year (stating that 642 businesses filed Chapter 11 in July 2020, compared to only 423 in July 2019).
[vi]Schwartz, supra note 1, at 1.
[vii]See id. at 4 (“Starting in October 2020, monthly bankruptcy filings returned to levels more consistent with historical averages.”).
[viii]See Michael O’Connor & Chris Hudgens, US Corporate Bankruptcies Reach New Low in 2021, S&P Global (Nov. 8, 2021), https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/us-corporate-bankruptcies-reach-new-low-in-2021-67459322.
[ix]See Bankruptcy Filings Fall 11.8 Percent For Year Ending June 30, U.S. Courts (Jul. 29, 2020), https://www.uscourts.gov/news/2020/07/29/bankruptcy-filings-fall-118-percent-year-ending-june-30.
[x]Juli Collins-Thompson et al., Review of U.S. Business Bankruptcies During the COVID-19 Pandemic, Fed. Rsrv. Bank of Boston, 4 (Nov. 19, 2021), file:///Users/sarahhammitte/Downloads/sra-note-2105%20(1).pdf.
[xi]See 2020 Year-End Report on the Federal Judiciary, Supreme Ct. of U.S., 2, https://www.supremecourt.gov/publicinfo/year-end/2020year-endreport.pdf.
[xii]Alex Wolf, Corporate Bankruptcy Wave Turns to Dust, Defying Expectations, Bloomberg Law (Jan. 5, 2022), https://news.bloomberglaw.com/bankruptcy-law/corporate-bankruptcy-wave-turns-to-dust-defying-expectations.
[xiii]H.R. 748, 116th Cong. (2020).
[xiv]Steven M. Szymanski, CARES Act Programs for Business Too Large for the Paycheck Protection Program, Nat’l. L. Rev. (Apr. 2, 2020), https://www.natlawreview.com/article/cares-act-programs-businesses-too-large-paycheck-protection-program (“The CARES Act provides that 4003(b)(4) Programs will apply to any business organized in the United States that has significant operations in the United States and the majority of its employees based in the United States and that has not received adequate economic relief in the form of loans or loan guarantees under another provision of the CARES Act.”).
[xv]See generally COVID-19 Relief Options, U.S. Small Bus. Admin., (Date Last Reviewed: February 2022), https://www.sba.gov/funding-programs/loans/covid-19-relief-options.
[xvi]See generally Paycheck Protection Program, U.S. Small Bus. Admin., (Date Last Reviewed: February 2022), https://www.sba.gov/funding-programs/loans/covid-19-relief-options/paycheck-protection-program
[xvii]COVID-19 Bankruptcy Relief Extension Act Extends Higher Debt Limit for Small Business Bankruptcies, Hirschler(Apr. 8, 2021), https://www.hirschlerlaw.com/newsroom-publications-1684#:~:text=The%20CARES%20Act%20increased%20the,extended%20through%20March%2027%2C%202022 (“The CARES Act increased the debt limit under the SBRA to $7,500,000, initially through March 27, 2021. The higher debt limit has now been extended through March 27, 2022.”).
[xviii]See 11 U.S.C. § 1129(a)(11).
[xx]Alex Wolf, Corporate Bankruptcies Delated Until Virus Carnage Sorted Out, Bloomberg Law (May 11, 2020), https://news.bloomberglaw.com/bankruptcy-law/corporate-bankruptcies-delayed-until-virus-carnage-sorted-out?context=article-related (“In the present state of stay-at-home orders, sickened workforces, and a dropoff in global economic activity, there’s not much for even the riskiest investors to feel good about and not much certainty to build out a major restructuring. Things have to get better for people to see what companies need to file for bankruptcy,” attorney Monique Almy of Crowell & Moring LLP said.”).
[xxii]David Skeel, Pandemic Hope for Chapter 11 Financing, Yale L.J. Forum, 321 (Nov. 10, 2021), https://www.yalelawjournal.org/pdf/F7.SkeelFinalDraftWEB_3s3482o2.pdf.
[xxiii]See Charlsy Panzino & Chris Hudgins, U.S. Corporate Bankruptcy Pace Likely to Speed Up in 2022, S&P Global(Oct. 11, 2021), https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/us-corporate-bankruptcy-pace-likely-to-speed-up-in-2022-67011237.
[xxv]David Skeel, Bankruptcy and the Coronavirus, Economic Studies at Brookings, 6 (April 2020), https://www.brookings.edu/wp-content/uploads/2020/04/ES-4.21.2020-DSkeel-2.pdf.
[xxvi]David Skeel, Bankruptcy and the Coronavirus: Part II, Economic Studies at Brookings, 3 (July 2020), https://www.brookings.edu/wp-content/uploads/2020/07/ES-6.6.20-Skeel-1.pdf.
[xxviii]Skeel, supra note 25, at 4.