For Struggling Small Businesses, Bankruptcy Law Change Comes Just in Time

Legislation aimed at widening access to chapter 11 process took effect weeks before pandemic hit U.S. economy

Wall Street Journal By Katy Stech Ferek
https://www.wsj.com/articles/for-struggling-small-businesses-bankruptcy-law-change-comes-just-in-time-11589794201

Buried in debt, Eric Brown used to worry that one of his lenders would arrive at his worksite and repossess a piece of heavy machinery he uses to lay utility cables underground.

His company, Brown Bros. Telecom & Utility in Dalton, Ga., filed for bankruptcy March 13 after collecting less money than expected on a completed project. But to his surprise, getting a fresh financial start has been easier than he thought, thanks to a new law meant to make the process cheaper and faster while helping owners retain their ownership.

“It’s been an absolute game-changer,” said Mr. Brown, 42 years old. “And so far, it’s kept me working.”

The problems facing Mr. Brown’s company predated the economic fallout from the coronavirus pandemic, but attorneys and others who work with small businesses say the timing will be a big help to companies that have seen their revenue decline amid government-imposed restrictions to slow the spread of the virus.

The new rules became law in August last year following bipartisan legislation from congressional lawmakers who relied on recommendations from two legal advisory groups, the National Bankruptcy Conference and the American Bankruptcy Institute.

The measure’s changes took effect Feb. 19, and so far about 350 small businesses are using the new process, according to the U.S. Department of Justice. As part of the rules change, companies must file debt repayment plans more quickly, which is aimed at preventing bankruptcy attorneys from dragging out the process to boost their fees.

Small businesses no longer need to pay Justice Department fees or file a formal disclosure statement, a legal document that lawyers charge thousands of dollars to write up. It also gives small-business owners access to a court-appointed financial expert to help fix their problems.

The law “couldn’t have been signed into law at a better time, ensuring small businesses have the flexibility they need to weather this storm by opening the door to reorganizing while preserving jobs,” said Rep. Doug Collins (R., Ga.), who helped write the law, in a statement.

The law originally applied to companies with about $2.7 million in debt. In March, Congress raised that limit to $7.5 million for 12 months as part of a sweeping stimulus bill aimed at helping businesses cope with the coronavirus.

For decades, major corporations have navigated the chapter 11 bankruptcy process, which allows a business to halt lawsuits and propose a repayment plan for its debt. But legal experts say small-business owners have avoided filing because of the cost and the fear of losing ownership.

Smaller companies that did file often failed to survive, even after Congress’s earlier reform in 2005. Of the more than 18,000 small businesses that filed for chapter 11 from 2008 to 2015, only about 27% received a judge’s approval for their reorganization plan, Maine bankruptcy lawyer Bob Keach told Congress last year.

Legal scholars said small-business owners often couldn’t comply with the previous law’s requirement that they either repay all debt to retain ownership or convince creditors to accept less. That rule gave unhappy holdout creditors that power to object, leading the business to shut down or look for buyers.

“The playbook in mega-cases is powerful groups forcing ownership changes,” said Donald L. Swanson, a Nebraska bankruptcy lawyer who has studied the law. “For small businesses, the owner is the business. That’s why this didn’t work in the past.”

Under the new law, businesses are still required to fully repay taxes, loans and other forms of secured debt. But for unsecured debt—money owed to vendors, customers and other business partners—bankrupt small-business owners can retain ownership if they promise to use future profits to pay a portion of that debt through monthly payments.

Critics point out that obligating a business to dedicate all of its future profits to debt repayment doesn’t allow owners to save up or invest. And unsecured creditors can still argue that a bankrupt company can afford to repay more, but judges can overrule them if they declare the plan fair.

The cost savings will also help a bankrupt company afford the hourly rate of the new financial experts, who can draft successful business plans with projected cash flows and interest rates.

“That’s not necessarily the role of a lawyer,” said Florida bankruptcy lawyer Mike Dal Lago, who said small-business owners rarely could afford to hire similar help.

Justice Department officials selected 250 financial experts from more than 3,000 candidates to serve in the role.

One Georgia manufacturer said the new rules cut its estimated bankruptcy costs from $50,000 down to $15,000. Several lawyers said they have started taking cases for small businesses that previously couldn’t afford their services, including Richard Banks, who represents Mr. Brown’s company.

“We need to encourage people to use the laws that are out here and keep these small companies going,” Mr. Banks said.