[co-author: Lance Kodish, Law Clerk]

COVID-19 is taking an alarming and unfortunate toll on our country’s population. Each day, we collectively face daunting health risks, and the economic cost to individuals and businesses alike has already been, and will continue to be, staggering. Accordingly, more than at any point in the past decade, both debtors and creditors should consider the potential benefits of the bankruptcy process. This post discusses four basic bankruptcy concepts that always merit consideration, especially in these trying times.

Preparatory Actions Prior to Filing – Borrowers should consult with legal counsel to review contracts, leases, and loan documents.  Borrowers should check default provisions, notice, grace and cure rights, and potential defenses to performing under contracts that can help to postpone or avoid bankruptcy altogether. Many borrowers should contact lenders and/or landlords to discuss viable short- and medium-term workout solutions that could be less costly for all parties than potentially protracted bankruptcy litigation.

Automatic Stay – A bankruptcy filing triggers the Bankruptcy Code’s automatic stay.  This injunction bars further action against the bankruptcy estate absent court permission to the contrary. Such actions as foreclosures, collection proceedings, garnishments, and other asset seizure efforts that could adversely impact the debtor’s existing assets are suspended. Since bankruptcy filings will increase in the coming months, creditors should amplify their efforts to discover which counterparties might be required to file and take proactive measures before the automatic stay could impair their rights.

Preferences – Creditors that transact business with troubled companies must understand the risk of preferential transfer claw backs. Debtors and bankruptcy trustees can seek to claw back transfers made to creditors in the 90 days before a bankruptcy filing. Even if a creditor has fully performed under a contract (e.g., supplied goods), payments received in the 90-day pre-bankruptcy period might be subject to a claw back. The Bankruptcy Code includes defenses creditors can assert to defeat preference claims. For instance, transfers made in the “ordinary course of business” and for “new value” are protected. Nevertheless, creditors should seek legal advice to help protect against lawsuits that seek recovery from them.

“Small Business” Chapter 11 Proceedings – In August 2019, the Small Business Reorganization Act of 2019 (“SBRA”) took effect (https://www.pbwt.com/bankruptcy-update-blog/sbra-springs-to-life). The primary benefit of the SBRA is that companies with debts under $2,725,625 can file for chapter 11, obtain the benefits of the automatic stay (and other protections), but streamline and reduce the otherwise prohibitive time and expense of the bankruptcy process.  In addition, section 1113 of the recently-passed CARES Act (i.e., the $2.2 trillion stimulus bill passed by Congress as “Phase 3” of its response to the COVID-19 pandemic) amends the SBRA to expand access for small businesses with debts up to $7,500,000 to be eligible to file under the SBRA standards. This new debt limit is to remain in effect for one year, when the threshold will then revert to $2,725,625. Small businesses with liquidity issues should consult with bankruptcy professionals about this option.