Prior to March 2020, the number of bankruptcies filed in the U.S. had been flat for the past few years and on the decline compared to 5-years prior. In fact, uscourts.com reported 486,149 Chapter 7 & 11 bankruptcies (April 1, 2019 – March 31, 2020) compared to 530,774 (April 1, 2015 – March 31, 2016) which is a 9% improvement over the 5-years prior.
Unfortunately, the financial impacts of the COVID-19 pandemic have put stress on businesses of all sizes and types unlike anything we’ve seen in the past century. The US government’s intervention to help business owners through the SBA Economic Injury Disaster Loan program and PPP loans have served as a strong bridge to keep employees on payroll and help businesses weather the sharp decline in revenue and profits. However, a pandemic and financial downturn of this magnitude will continue to have long-term impacts on many business owners and their company’s future health, unfortunately leading to likely increases in the number of Chapter 7 and Chapter 11 bankruptcies filed.
Chapter 7 bankruptcies are by far the most common type filed and occur when a business can no longer be supported by the income the company generates; for every Chapter 11, there are 50 Chapter 7s filed. A Chapter 7 bankruptcy creates a liquidation event whereby assets are sold at auction or as part of a going concern in order to convert the tangible property into cash to then pay off the business owners’ debts owed to creditors and lenders. Ultimately, the creditors care most about the fair market value of the assets to make them whole. Leveraging an expert business appraiser is helpful to all parties concerned in a Chapter 7 bankruptcy, particularly as it relates to asset values, disputes over the value of the company as a whole and fairness of value opinions relative to the claims of creditors and lenders seeking settlement and the any subsequent balances remaining that could be returned to the owners of the company.
Chapter 11 bankruptcies are different than Chapter 7 liquidation or wind downs as the business is voluntarily reorganized by its owners to continue its operations. There are typically three difference outcomes as part of a Chapter 11 bankruptcy. These includereorganization, dismissal or conversion to a Chapter 7 bankruptcy. The most common scenario is for the business owner (aka “debtor”) to file a plan to reorganize the business with the bankruptcy court which allows the debtor to maintain control of the business (aka “debtor in possession”) acting as the fiduciary. In some cases, the court may appoint a trustee or administrator to help govern the process with the owner. During the process, the debtor in possession (or trustee) has many responsibilities including but not limited to accounting for property, evaluating and responding to claims, filing monthly operating reports and other court ordered requirements. The debtor also likely has the right to hire key advisors to ensure the accuracy and legitimacy of their requirements, such as lawyers, appraisers, auctioneers, accountants, etc. These fiduciary responsibilities are foundational for the debtor in possession to meet the court’s requirements, fulfill the claims made by its creditors and ensure a fair and equitable outcome to meeting its outstanding financial obligations with secured and unsecured lenders. Ultimately, if the judge approved the reorganization and if the debtor’s creditors all agree without objection or filed petitions, the plan can be approved.
Below are more comprehensive resources on Chapter 7 and Chapter 11 bankruptcies and the importance of leveraging a qualified business appraiser as part of your group of trusted advisors while navigating the bankruptcy process.
COVID-19: Rethinking Chapter 11 Bankruptcy Valuation Issues in the Crisis