Small Business

The Surprising Truth About Liquidations During COVID-19

Legislation and common sense are reducing the damage to small and midsize businesses.

Big name bankruptcies have proliferated in North Texas over the last few months, but the pandemic-induced economic downturn doesn’t just impact the big names. Small to midsize businesses are also suffering, but the landscape for many of these businesses isn’t as dire as headlines make it seem.

For smaller to midsize businesses, there hasn’t been a significant uptick in bankruptcies just yet, says Dan Winikka, a partner at Dallas-based Loewinsohn Flegle Deary Simon LLP. With loans available from the federal government and changes to the rules surrounding debt for small businesses, many have continued to creep by without throwing in the towel or restructuring their debt. The Tuesday Morning, Pier 1, and JC Penney bankruptcies were businesses already on the brink prior to the crisis, Winikka says, and most businesses that were doing well have avoided bankruptcy since the downturn. 

Lenders are being lenient with businesses, because they would prefer to get paid back rather than have the business declare bankruptcy. “With the prospect of a rebound in the fairly short term, banks more willing to give relief and forbearance,” Winikka says. 

CARES Act Relief

The Coronavirus Aid, Relief and Economic Security Act (CARES Act) has thrown small businesses another lifeline should they decide to declare bankruptcy. New regulations allow a greater number of businesses to spread out their payments to creditors under Chapter 11 bankruptcy, allowing owners to restructure debt rather than fully liquidate in a Chapter 7 bankruptcy. The law increased the amount of debt small businesses owe from $2.7 million to $7.5 million while still filing for Chapter 11, meaning more owners are eligible to spread out their payments and maintain control of the business.

But this new legislation extends the debt limit for only a year, meaning if businesses are still in trouble in 2021, they may not be able to take advantage of the new rules. This puts businesses in a precarious situation. They have to decide if they want to declare bankruptcy under the new provision, giving them more control and leniency, or do they see if the business can power through the downturn and risking liquidation after the protection of the CARES Act ends?

It is still early in the process, and there is always the chance that the provision in the CARES Act could be extended, giving businesses more time to see if they can avoid filing for bankruptcy, but not forcing them to liquidate if they owe too much debt after the law expires.

The Great Recession 

When compared to the economic downturn in 2008 and 2009, the current bankruptcy environment is similar in that there hasn’t been a rush of liquidations, though eventually there may be a number of filings. Similar to today, creditors were flexible, deals were cut, and bankruptcies were avoided or at least spread out.

Eventually, there were many bankruptcies filed as a result of the great recession, though the filings on the front end of the downturn was very similar to what has happened in North Texas over the past few months. Companies that were already struggling were tipped over the edge by the Great Recession, and the rest were able to cut deals and extend their credit without filing, at least right at the start. The same pattern is happening today.

“The lenders extend and pretend,” says Winikka. “The lending partner extends the loan out, and pretend that everything will be ok.” If markets return what they were like prior to the pandemic, the filing might be an unnecessary move. “Most want to avoid bankruptcy at all costs, and it is certainly the right way to go if you can get it out of court.”

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