Of Counsel: Bankruptcy Processes Re-Assert Value After 2020

May 2021

By Jonathan Margolies

Dickens was half-right: ‘It was the best of times, it was the worst of times …’


Surely the latter describes calendar year 2020 and beyond as the pandemic devastated our personal lives and the marketplace. While the impact of COVID-19 on business was pervasive, certain sectors of the economy were particularly ravaged (e.g., the hospitality industry, restaurants, and brick-and-mortar retail). A rash of Chap-ter 11 bankruptcies ensued throughout the country as businesses desperately sought to survive in and outlive the pandemic.

The pandemic highlighted the utility of Chapter 11 as a vital, if not indispensable, tool to thwart financial Armageddon, but it is important to understand that recourse to Chapter 11 is a significant strategy in both good times and bad. Notwithstanding a commonly-held view that bankruptcy is some boon to debtors to take unfair advantage of their creditors, Chapter 11 is actually a balanced framework that provides protections to both debtors and creditors. In its best configuration, Chapter 11 enables a business to overcome potentially fatal weaknesses, preserve business relationships, protect jobs, and facilitate the rebirth of a stronger company. As a mechanism for rehabilitation of ailing businesses, Chapter 11 is the most potent (and frequently the only) tool in the shed for the survival of companies beset by temporarily adverse market conditions and/or one or more adversarial and uncompromising large creditors. Such creditors are usually (but certainly not always) the secured lenders whose loans are in default and therefore seek to enforce their legitimate rights and remedies. 

Fundamentally, the impact of Chap-ter 11 concerns the lower half of the balance sheet—liabilities, rather than assets and revenue. The essence of a successful reorganization entails the restructuring of debt to bring the existing and reasonably anticipated income stream into alignment with operating expenses and long-term liabilities. This may be achieved during the pendency of the bankruptcy proceeding by focused reduction of operating expenses, disposal of unproductive assets, and abandonment of unprofitable lines of business, culminating in the filing and confirmation of a plan of reorganization, the end game of a successful Chapter 11 case. The journey to confirmation, however, can be a bumpy ride, as there can be a multitude of hurdles to overcome in the form of creditor opposi-tion and fulfillment of the many statutory requirements for confirmation. 

Chapter 11 was not immune (pun intended) from the effects of the pandemic. The Paycheck Protection Program provided a mas-sive capital infusion to troubled businesses, which were thereby able to stay afloat; however, the Small Business Administration initially determined that companies filing for Chapter 11 protection were ineligible for the first round of PPP funding, even though these companies needed (and their work-force was equally deserving of) this financial assistance as much, if not more, than non-filing companies. The SBA position spawned a tsunami of litigation in the bankruptcy courts nationwide as Chapter 11 debtors challenged (with mixed results) their SBA-declared ineligibility for PPP relief. 

The federal legislation that engendered the disaster relief funding also provided an expansion of the Small Business Reorganization Act of 2019. The act, otherwise known as Subchapter V-Small Business Debtor Reorganization, eliminates several major (and time-consuming)
hurdles for confirmation of reorganization plan and successful exit from bankruptcy. As such, it is an attractive option for qualifying debtors by enhancing the pros-pects for reorganization while reducing the time and expense of the process. 

As originally enacted, SBRA established a ceiling of $2,725,625 in total non-contingent secured and unsecured debt to qualify for Subchapter V treatment. As such, this advantageous pathway in Chapter 11 was limited to very small enterprises. To expand availability of Subchapter V in the midst of the economic ravages of the pandemic, Congress raised the foregoing debt ceiling to $7,500,000. It remains to be seen whether this increased debt ceiling remains intact in some future post-pandemic world. 

Some comment on Chapter 11 is appropriate here from a creditor’s perspective. The Bankruptcy Code arms creditors (for the most part, secured creditors) with an array of rights and remedies that should not be overlooked. In Chapter 11, secured creditors are entitled to full protection of their collateral including insurance cover-age and reimbursement for erosion of the value of the collateral (known in bankruptcy parlance as “adequate protection”) caused by debtors’ ongoing usage of the collateral. All creditors are entitled to full disclosure on all financial matters and issues relating to the debtor’s business, and monthly operating reports (“MO Rs”) must be filed, detailing the debtor’s ongoing performance. 

In addition to the requisite disclosures imposed by the Bankruptcy Code on debtors (i.e., Schedules of Assets and Liabilities, Statement of Financial Affairs, and MORs), creditors retain an arsenal of discovery tools to investigate all aspects of a debtor’s business and finances, and the bankruptcy courts usually enforce discovery rights of creditors as needed. 

Such a volume of information and data is generally unavailable to creditors outside of the bankruptcy realm. As vital stakeholders in the bankruptcy process, creditors are fully empowered to challenge myriad business transactions proposed by debtors and, at the end of the day, contest their treatment in any plan of reorganization, cast votes on the plan, and oppose its confirmation.