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Rethinking “Small” Business Bankruptcies

posted by Michelle Harner

Shutterstock_228943780It may surprise some, but approximately 90% of all chapter 11 debtors have less than $10 million in assets or liabilities, less than $10 million in annual revenues, and 50 or fewer employees (see data on small and medium-sized enterprises (SMEs) in the ABI Commission Report, here). These companies are the heart of chapter 11. Nevertheless, most of the media and caselaw coverage discusses only the megacases—e.g., Caesars, American Airlines, Tribune Company, etc.—representing approximately 2-3% of chapter 11 debtors. It is time to change the focus of the conversation.

When a small business closes its doors, an entire community feels the impact. Consider the following description of the ripple effects of the closing of a small mine in Lincoln County, Montana:

In addition to the workers and families directly impacted by the loss of jobs, the ripple effects of the loss of that income will impact local businesses at every level. Restaurants, stores and other shops depend upon local consumers to keep themselves afloat, the dollars that are paid to those employees find their way into the hands of a number of additional places, keeping a small local economy alive.  (Full story here.)

Similar stories occur most everyday in towns across America (see, e.g., here).

Chapter 11 needs to work for these companies. Evidence from almost three years of study and public field hearings before the ABI Commission, however, suggests that it currently does not. For example, one witness testified: “Chapter 11 is now viewed as too slow and too costly for the majority of middle-market companies to do anything other than sell its going concern assets in a 363 sale or to simply liquidate the company . . . [usually] almost exclusively for the sole benefit of the secured lender.” In addition, in an empirical survey conducted by Professor Dalié Jiménez, over half of the respondents disagreed with the statement that “[t]he Code provide sufficient tools for small and midsized debtors.”

The ABI Commission has proposed a separate framework for SMEs that could help change the dynamics of chapter 11 for most debtors. Notably, the proposal would apply only to non-individual business entities; a separate ABI taskforce is considering individual chapter 11 cases. The SME principles would cover non-public companies with less than $10 million in assets or liabilities; non-public companies with more in assets or liabilities (but less than $50 million) could request treatment as an SME debtor. As a general matter, the SME principles allow the company, court, and stakeholders to tailor the chapter 11 case to the particular company, rather than forcing smaller business debtors to tailor their reorganization to the static provisions of the Code. For example, SMEs would work with the court to establish a realistic timeline for the case and could use an “estate neutral” to help with various aspects of the case (including business planning, financial matters, or a plan of reorganization). Owners of these businesses (often families or founders) also would have an opportunity to retain their ownership interests.

As I recently stated in a short piece on Dealb%k, Congress should consider the Commission’s SME proposal carefully and thoughtfully.

*Note: The views expressed in this post are those of the author and are intended to spark a meaningful dialogue about chapter 11 reform. They are not attributable to the American Bankruptcy Institute or the ABI Commission to Study the Reform of Chapter 11.

SME image from Shutterstock.

Comments

Any proposal to add additional layers of procedure to the bankruptcy process -- especially one that begins from the premises that management is too worried about losing control and secured creditors' interests are inadequately protected -- demonstrates a severe disconnect with the realities of modern business.

Businesses file for bankruptcy to protect managers and shareholders from unsecured creditors' fraudulent transfer suits, and to facilitate transfers of interests in a business at the expense of employees, customers, and unsecureds.

Businesses that genuinely do not have any money do not file for bankruptcy.

If you're actually interested in protecting the interests of employees and customers, and in helping small companies restructure before its too late, try transferring standing to bring fraudulent transfer actions to unsecured creditors as soon as there is a filing; and subordinating high-interest secured debt to claims by employees and customers.

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