Small Business Bankruptcy

Basics
Ben Iverson
Marriott School, Brigham Young University
With Shai Bernstein, Emanuele Colonnelli, and Mitch Hoffman
Introduction
• Thanks for being here!
• Before we jump in: a quick poll
• Demonstrate a bit about our research and what we have learned
• This will work better if only half of you answer these questions right
now.
• If your birthday is on an even day (e.g. you were born on the 14th of
the month): please take the poll
• If your birthday is on an odd day (e.g. you were born on the 11th of
the month): please close the poll – you will answer the questions
later!
Bankruptcy Basics
• A small business facing financial difficulties has several options:
• Get more financing (but from where?)
• Renegotiate with:
• Landlord
• Employees
• Suppliers
• Change operations
• Shut down

• Should bankruptcy be on this list of options?

It is worth understanding more about
bankruptcy
• When is the right time to find
out where the nearest gas
station is?
• BEFORE you run out of gas

• Similarly, it is worth
understanding all of your
options even if your company
is far from needing bankruptcy.
What is bankruptcy?
• Part of the social safety net
• Constitutional right
• Designed to:
• Help businesses that are still viable to restructure
• While also repaying creditors as much as possible

• While bankruptcy might seem like a bad thing, it plays a fundamental role
in helping the economy to be healthy
• Analogy: going to the hospital isn’t a bad thing; it’s a sign the patient is
looking to get better.
• Doesn’t mean bankruptcy is for everyone, but an option to consider! That’s what
today is all about.
Two Bankruptcy Chapters
• Chapter 7: Liquidation
• When you are going to close the business
• Assets are turned over to trustee who auctions them off

• Chapter 11: Reorganization

• Create a plan of reorganization
• Creditors get to vote on the plan
• Ideally, firm survives with old debt discharged

• For Chapter 11 to work, you will likely need to plan out with a lawyer in
advance.
Can you identify which businesses have used
Chapter 11?
A. Delta Airlines
B. Chicago Cubs
C. Hertz Rental Cars
D. General Motors
E. Marvel Entertainment
F. Six Flags
G. Texaco

Correct answer: All of the above

Bankruptcy ≠ Failure
• In many instances – and especially in the aftermath of COVID-19 – Ch.
11 bankruptcy is a backstop to prevent shutting down firms that are
viable
• Those who use bankruptcy are not failures
• Rather, business conditions changed and the business and financing
need to adapt as well
• Or, the business owner tried something that didn’t work but now has
a better path forward.
Chapter 11 for small businesses
• Historically, Chapter 11 has not worked as well for small businesses
• High fees
• Complex voting rules that don’t matter for small businesses
• Hard for owner to keep the company

• February 2020: Small Business Reorganization Act

• Created “Subchapter V” in Chapter 11 especially for small businesses – those
with less than $7.5M in liabilities (right now)
• Makes it much easier for small business to survive the process and for owner
to retain control.
• Judge Small will go over the details!
And now: Judge Small
 Reorganizing Small
Businesses in Chapter 11
Subchapter V of Chapter 11
Who Can Be Chapter 11 Debtors?

• Corporations

• Partnerships

• Individuals
 Some Chapter 11 Tools

✓Automatic Stay
✓Debtor in possession controls and operates business
✓Reject burdensome leases
✓Sell all or part of the business
✓Obtain financing
✓Reduce unsecured debt
✓Re-write mortgages and other secured debt
✓Resolve all claims in one forum
Chapter 11 Does Not Work for Small Businesses
Because:

• Too Expensive
• Too Cumbersome
• Confirmation standards too difficult
• Creditors Are Too Apathetic
• Absolute Priority Rule
 ABSOLUTE PRIORITY RULE
IF CAN’T MEET HIGH VOTING REQUIREMENTS
[2/3 IN AMOUNT AND MAJORITY IN NUMBER]

MUST PAY CREDITORS IN FULL!

OR

GIVE UP OWNERSHIP OF THE BUSINESS

 Requirements For Small Businesses To Be Subchapter V Debtors

Must be “engaged in commercial or business activities”

Not less than 50% of the debtor’s debts must arise from commercial or business activities

Debts may not exceed $2,725,625 [$7,500,000 until March 27, 2021]

What Small Businesses May Not Be Subchapter V Debtors?

▪ a single asset real estate business

▪ a member of affiliated group with aggregate debt over $2,725,625 [$7.5M until 3/27/21]
▪ a publicly traded corporation
▪ an affiliate of a publicly traded corporation
Important Characteristics of Subchapter V

✓ No absolute priority rule

✓ Subchapter V trustee
✓ Only debtor may file plan
✓ Plan must be filed withing 90 days
Documents that must be filed with the bankruptcy petition

▪ Balance Sheet
▪ Statement of operations (p/l statement)
▪ Cash Flow Statement
▪ Federal Income tax return
The Goal is to get a consensual plan!

✓Debtor Gets a Discharge at Confirmation

✓Trustee Terminates at Confirmation
 In a Subchapter V Cram Down Plan

✓ Discharge is delayed until plan is completed

✓ Trustee remains to monitor compliance
 PROJECTED DISPOSABLE INCOME
income that is received by the debtor,
less the amount that is reasonably necessary to be expended for:

✓the maintenance or support of the debtor or a dependent of the debtor

or a domestic support obligation,

✓for the payment of expenditures necessary for the continuation,

preservation, or operation of the business
 How a subchapter V plan can be crammed down
over the objection of secured creditors

Three Options:
1. Creditor retains the lien and secured claim is paid in deferred
cash payments equal to the value of the collateral, or
2. Collateral is sold, or
3. Secured creditor realizes the “indubitable equivalent” of claim
An Example of a Cram Down of a Secured Claim

Debtor owns an office building with a mortgage of

$1,400,000, but the building is only worth $1,000,000,

• Write down mortgage to $1M

• Creditor retains lien but only for $1M
• Creditor has an unsecured claim for $400,000
• $1M mortgage can be paid off in installments
over time at a market rate of interest
Two ways to cram down a plan over the objection
of unsecured creditors

1. Pay projected disposable income

for 3-5 years (term to be
determined by the court) – after
which debtor gets a discharge
and the balance is forgiven, or
2. Pay with other property having a
value equal at confirmation to
the projected disposable income
for 3-5 years
Sources of funds to pay a lump sum to creditors

• Exit financing
• Owner’s 501k
• Wealthy aunt
• New investor
CRUCIAL SUBCHAPTER V CONSIDERATIONS

✓ SUBCHAPTER V IS VOLUNTARY

✓ THERE IS NO AUTOMATIC RIGHT TO DISMISS

✓ CASE WILL MOVE VERY, VERY FAST

START PLANNING EARLY BEFORE FILING!

✓LINE UP FINANCING
✓START DRAFTING PLAN
✓LINE UP CREDITOR SUPPORT
✓GATHER INFORMATION:
Balance sheet
Statement of operations
Cash flow statement
Federal income tax return
✓CALCULATE “PROJECTED DISPOSABLE INCOME”
 Chapter 11 Tools

✓Automatic Stay
✓Debtor in possession controls and operates business
✓Reject burdensome leases
✓Sell all or part of the business
✓Obtain financing
✓Reduce unsecured debt
✓Re-write mortgages and other secured debt
✓Resolve all claims in one forum
Quick Poll
• Want to briefly share the results of our research
• But first, would like to have the rest of you answer other poll
questions
• If your birthday is on an odd day, please answer poll
• If your birthday is on an even day, you already answered, just sit tight!
Our research: Knowledge and Stigma
• The vast majority of small businesses do not use bankruptcy when
they are in financial trouble. Why?
• Possibilities:
• Bankruptcy isn’t a good option – too expensive, or doesn’t work
• But SBRA could maybe change that?
• No knowledge of bankruptcy
• Stigma against bankruptcy

• With SCORE, we randomly showed videos to survey respondents to

provide information and reduce stigma about bankruptcy.
What do you think about the following statement:
"Soon after declaring bankruptcy, a small business
must cease operations."
• Correct answer: FALSE

• Control: 57.8% get correct (not much better than coin flip)
• Info Treatment: 79.3% get correct
• Info + Stigma Treatment: 84.8% get correct

• Conclusion: lots of small business owners don’t have basic info about
bankruptcy → view as death
Negative stigma is strong, but videos reduce
it!
Agreement with statement
• Rank agreement with 0.9
statements: 0.8

• Strongly disagree = -2 0.7

0.6
• Disagree = -1 0.5
• Neither agree or 0.4

disagree = 0 0.3

• Agree = 1 0.2

0.1
• Strongly agree = 2 0
Bankruptcy = Bankruptcy = failure Clients won't work Employees won't Friends and Family
embarrassing with you work for you will look down on
you

Control Info Info+Stigma

Now that you know more about bankruptcy, how
might that affect how you run your business?
• Will you invest more or less?

• Use more or less debt?

• Consider bankruptcy as an option if you hit financial troubles?

Getting info and reducing stigma increase
planned investment
• Control group:
• 31.8% plan to reduce investment
Difference: 2.4%
• 34.1% plan to increase investment
• Info Treatment:
• 28.1% plan to reduce investment Difference: 7.6%
• 35.8% plan to increase investment
• Info + Stigma Treatment:
• 28.0% plan to reduce investment Difference: 8.3%
• 36.3% plan to increase investment
Getting info and reducing stigma increase
planned debt usage
Plan to increase debt in next 6 months
20%
18%
16%
14%
12%
10%
8%
6%
4%
2%
0%
Control Info Info + Stigma
Getting info and reducing stigma increase
openness to using bankruptcy
• Control group:
• 27.7% would not consider Ch. 11
Difference: 11.0%
• 38.66% would consider Ch. 11
• Info Treatment:
• 23.5% would not consider Ch. 11 Difference: 30.4%
• 53.9% would consider Ch. 11
• Info + Stigma Treatment:
• 22.7% would not consider Ch. 11 Difference: 32.0%
• 54.7% would consider Ch. 11
Conclusions
• New bankruptcy law is important development for small businesses
• Thanks for tuning in today!
• Lack of information and stigma against bankruptcy are important
barriers to considering bankruptcy
• Doesn’t matter how good the law is if people don’t know about it or won’t
use it!
• And: can impact investment decisions as well!

• Thanks to SCORE for partnering with us…

• …and THANKS to many small businesses for taking the surveys!