The economy today remains strong, but we all know that’s not going to last forever. When the next downturn comes – and it will come – it’s inevitable that some small-business owners, for whatever reason, are going to face bankruptcy.
Deciding to declare bankruptcy is never an easy choice. But for a small-business owner, the decision is even harder. It’s true that today’s bankruptcy laws can give us the chance to take a breath, work out deals with our creditors, attempt a reorganization, and try to get back on our feet. Or – in extreme cases – liquidate. But unfortunately, these same laws have historically been expensive, complicated and favored larger organizations.
The good news is that’s about to change.
About a month ago, President Donald Trump signed a new law called the Small Business Reorganization Act of 2019, which will go into effect this February. Its impact on small businesses is expected to be significant.
The act is a “a fantastic accomplishment by the federal government and the National Bankruptcy Conference, American Bankruptcy Institute and National Conference of Bankruptcy Judges, all of whom had a hand in drafting and guiding the act to be signed into law,” writes lawyer Kyle F. Arendsen in the National Law Review. “Struggling small businesses should consider it as a potential remedy to their financial distress.”
Why so significant?
It’s because the new law will give businesses with less than $2,725,625 in debts more time (90 days) to file a reorganization plan with easier rules for extending. Debts will no longer be required to be paid in full for the business owner to retain ownership of a company. Instead, the owner will have to abide by a new formula for payback that projects disposable income over a period of three to five years. There will be less red tape because business owners will now be able to appoint a “standing trustee” instead of a credit committee to oversee their reorganization process. There’s also a new way for determining the owners’ and creditors’ equity interests, based on what is “fair and equitable.”
Most significant – in my opinion – is that it will also be much harder for creditors to take away certain personal assets of the business owner, such as a home or place of residence. Also helping will be an extension of the time period for the payment of administrative expenses.
Of course, even with the new law, declaring bankruptcy is still a last-resort option. Whether a business decides to close and liquidate under Chapter 7 of the bankruptcy code or reorganize under Chapter 11, there will still be long-term effects on the owner’s ability to receive future credit and build new relationships with suppliers and partners. It will also make things much harder to acquire capital for starting a new business, buying inventory and hiring people. And then, of course there are the costs.
That’s because declaring bankruptcy – at least right now - isn’t cheap, especially if you take the reorganization route.
Accounting and legal fees alone can run anywhere from $15,000 to $50,000 for a Chapter 11 reorganization and the process can last as long as five years, according to Brad Sadek, a Philadelphia lawyer specializing in bankruptcy law.
“Declaring bankruptcy can be very prohibitive for a lot of small business,” he says. “Some businesses simply can’t afford their regular operating costs plus funding, even under a Chapter 11 plan.” Sadek says that liquidating a business under Chapter 7 takes much less time and is significantly cheaper, with costs reaching about $8,000 on the high end.
But the new law should go a long way toward addressing those costs. It should simplify the steps and help the business owner make decisions faster. It should also give more flexibility to both small-business owners and their creditors. All of this is expected to cut down the time needed to be spent by lawyers and accountants.
“The biggest benefits would be the legal fees should be about half of a normal Chapter 11,” noted Michael Cibik of Cibik & Cataldo, a law firm in Philadelphia. “It’s just simpler than the original law. It will streamline the reorganization process.”
Of course, none of this addresses what some consider to be the biggest expense of bankruptcy: not learning from your own mistakes. “Many of our clients go back after the bankruptcy or during a bankruptcy pending reorganization to their bad financial habits,” Cibik says. “Unfortunately, realizing a bankruptcy will not solve all your financial problems.”