Mitigation, Restructuring and Bankruptcy: Small Business Tools in the Era of COVID-19
The impact of the COVID-19 pandemic has been sudden and severe. Worldwide, populations are dealing with a public health crisis, which has abruptly impacted the economy. As cases continue to increase across the United States, both the federal government and state governments, including California, are directing people to “shelter in place” and “socially distance” from each other in an attempt to curb the spread of the virus. These orders have generally shut down daily life except for “essential” businesses. As a direct result, the economy has come to an abrupt halt and many businesses have been forced to close or significantly reduce their operations.
Concern for this economic impact is, in part, due to the speed and severity with which it has affected so many industries. With the current economic conditions, there is much speculation that bankruptcy filings, among not only individuals, but small businesses, will see a sudden increase in the coming months. Experts agree that filings will increase, the only question is when.
Because of COVID-19’s economic impact, it is important that businesses make an assessment now, regarding their needs, assets, and liabilities, so they can best prepare to survive COVID-19, or to take proactive steps in preparing to enter bankruptcy or wind down. In making this assessment, one of the questions to ask is whether the business can survive with quick financing, to help bridge the gap between the current operating conditions and their return to normal.
If financing is an attractive option to the business, both federal, state, and local governments have attempted relief packages and short-term financing that may help the business stay afloat during the COVID-19 pandemic. This article will focus on the offerings of the federal government; however, examples of California’s programs include its Disaster Relief Loan Guarantee Program and interest free deferral of sales and use tax for qualifying businesses.
Relief Under the CARES Act
At the federal level, the intent of the CARES Act created several Small Business Administration (SBA) programs, to provide financial assistance to small businesses. One of these is the Paycheck Protection Program (PPP), available to small businesses (businesses with 500 or fewer employees), which provides the business with a partially or fully forgivable loan to meet payroll obligations, rent or mortgage obligations, and utilities. A second is the Economic Injury Disaster Loan and Emergency Economic Injury Grant, also available to small businesses, providing a low rate loan for business expenses that could have been met if not for COVID-19. This program is practically capped at $25,000, with $10,000 of that available as a forgivable advancement. Both programs have seen high demand and available funds are supposedly being quickly allocated. However, current reporting indicates that banks have started rejecting PPP applicants citing a lack of funding. Further funding of this program is mired in politics. If interested, it is still recommended that businesses apply as soon as practicable and that they call around to SBA approved lenders to see which can get your application processed fastest and establish a place in the application queue.
Because of this demand, a fair alternative may be to apply for a non-disaster SBA loan. The CARES Act provides that the SBA will cover all loan payments on these loans, including principal, interest, and fees, for six months on all existing non-disaster SBA loans and those made by the end of September 2020.
Contracts and Excuse of Performance
A business should also consider whether it has any active contracts impacted by, or related to, COVID-19. This may include contracts for goods or services or loan, mortgage or rent agreements. If this is the case, there may be a basis for excusing or delaying performance.
Some contracts include force majeure provisions which may excuse contractual obligations for “acts of god.” If the contract has an express force majeure provision, it is important to review the contract’s language to ensure that pandemics, epidemics, or disease are not excepted. Even if your contract does not contain such a provision, California has codified its equitable protections in California Civil Code § 1511. There are also the common law doctrines of impossibility, impracticability, and frustration of purpose which may excuse contractual obligations.
Business Interruption Insurance
Now is also a good time to review the business’ insurance policies to determine if the business has business interruption insurance; insurance intended to cover losses when a business is shut down or limited under certain conditions. These policies are often purchased as part of a commercial property insurance policy, or as a separate policy. It is important to review the policy terms to determine whether COVID-19 is a qualifying event. If you think your business may have a claim, it is advisable to go ahead and make the claim, so that any potential claim is received before any deadlines pass.
While it may be a difficult decision, another consideration a business may weigh concerns its employees. Depending on the current operations and demand on the business, a business may choose to minimize its expenses during this time by reducing employee hours, or furloughing or terminating its employees. If this is an option your business may exercise, it is advisable that you consult with an attorney to ensure the business stays in compliance with California’s labor laws.
Bankruptcy and Restructuring
For businesses devasted by COVID-19, who cannot continue operations even with a quick influx of funds, they may also consider bankruptcy and/or restructuring. While bankruptcy is often considered the worst-case scenario, it is not the taboo subject it is often perceived. This perception could be because when most think about bankruptcy, they think about Chapter 7 bankruptcy. When a business files for Chapter 7 bankruptcy, its debts are discharged through the liquidation of the assets and the business is essentially given up. In some situations, this will be the right option for the business.
Alternatively, a business may continue and emerge operational from a bankruptcy by choosing to restructure by filing for a Chapter 11 bankruptcy. Chapter 11 allows a business to restructure by continuing to operate itself while seeking confirmation of a plan by which its debts, incurred before filing, are repaid to creditors and then discharged. This process may be expensive for the business and will often require the business to have a financier which may be especially troublesome during the COVID-19 pandemic. However, as of 2019, the Small Business Reorganization Act (SBRA) came into effect for debtors with an aggregate debt of about $2.7 million, which streamlines the Chapter 11 restructuring process. The CARES Act has temporarily extended the SBRA’s application to businesses with an aggregate debt of up to $7.5 million. If your business is considering bankruptcy, consult with a bankruptcy attorney early in the process in order to prepare and select the best path forward.
Another option for individuals operating an unincorporated business, such as a sole proprietorship, is to file for Chapter 13 bankruptcy. By filing Chapter 13, the debtor is allowed to develop a plan to repay all or part of its debts over a three to five-year period, with debts discharged upon successful completion.
While bankruptcy is the most common avenue for businesses that can no longer continue their operations, there are expenses and procedures associated with the bankruptcy process that may deter some businesses from considering it as a serious option. If so, or as a means of considering all options, a business may also choose to close and wind itself down. In winding down, a business will need to file paperwork to officially recognize its ending, as well as providing for all of its debts. This may provide the business an opportunity to negotiate with creditors to resolve any outstanding debts using the funds the business has available. However, be sure to pay your employment related taxes first and in full because business owners may be held personally liable for these taxes, even if the business was an LLC or corporation.
Although the economic impact of COVID-19 has been sudden and severe, all hope is not lost. There are options available that may provide assistance for the survival, restructuring or winding down of your business. To explore some of the options detailed above, it is advisable that you consult an experienced attorney.
Other articles that may be of interest to you:
Trademarks and Service Marks: An Often Overlooked Method of Business Asset Protection
Protecting and Perfecting Your Mechanics’ Lien when the Owner/Developer Files Bankruptcy
Article by Hannah C. Kreuser, Esq., in 2020. Ms. Kreuser is part of Porter Law Group, Inc. in Sacramento, California. www.porterlaw.com.