Two Sides of the Same Coin: How a Rise in Bankruptcies will Affect Factors in 2023
Since the passage of Subchapter V of Chapter 11 of the U.S. Bankruptcy Code in 2020, the number of businesses seeking protection through the restructuring process has increased rapidly. Jason M. Medley and Elizabeth Lally of Spencer Fane discuss this increase and how factors can capitalize on it.
BY: ELIZABETH LALLY, PARTNER, SPENCER FANE AND JASON M. MEDLEY, PARTNER, SPENCER FANE
While crypto firms and larger companies like Virgin Orbit have dominated the bankruptcy headlines in 2023, much of the recent rise in bankruptcy filings has come from small businesses. Specifically, the number of businesses seeking protection pursuant to Subchapter V of Chapter 11 of the U.S. Bankruptcy Code has increased significantly over 2022 and into 2023.
The Small Business Reorganization Act of 2019 (Subchapter V) became effective as of February 2020 and altered the rules of a traditional Chapter 11 bankruptcy. Specifically, Subchapter V was designed to make bankruptcy restructuring more feasible and affordable for small businesses. Bankruptcy debtors can elect Subchapter V treatment provided that 50% or more of their scheduled debt comes from business or commercial activities (If you take real estate as boot collateral, note that a single asset real estate entity, in addition to public companies and their affiliates, do not qualify for Subchapter V treatment) and debts do not exceed the current limit of $7.5 million. Although the breadth of Subchapter V eligibility is being tested, with several lower courts taking differing positions on the same cases, it is undeniable that the number of debtors seeking Subchapter V protection has risen year-over-year since Subchapter V’s passage in 2020 — with this trend seeing a significant jump over the first two months of 2023.
In 2020, 1,116 Subchapter V cases were filed. This number rose to 1,717 in 2021 and dipped slightly to 1,595 cases filed in 2022, averaging approximately 133 Subchapter V cases per month last year. As of Feb. 28, 693 Subchapter V cases have been filed, marking an average of 346.5 cases per month.
Most industry professionals would chalk this increase up to small businesses that were never able to “recover” from COVID-19, many of which received one or two rounds of governmental financial assistance while also experiencing rising costs of goods across all industries in the wake of the pandemic before dealing with steadily rising interest rates. Additionally, this number is expected to continue to rise due to recent uncertainties in banking, which has resulted in more uncertainty in the United States and global economies, along with already tightening credit. The latest survey from the Board of Governors of the Federal Reserve System found roughly 44% of banks reported tightening standards for business loans in Q1/23.
While a struggling economy and an increase in bankruptcies is concerning overall, it provides an opportunity for factors to engage in post-petition financing or to stave off other inferior creditors that can be a nuisance to struggling small businesses. The automatic stay is just as potent and the Subchapter V process of filing a plan of reorganization moves fast and is inviting for small businesses. The tightening of bank underwriting combined with the worsening state of the U.S. economy and the resulting rise in bankruptcy filings is an invitation for factors to fill the void and provide alternative financing solutions. Thankfully, factors often come to the rescue during these times. Now, if only the state legislators, and their newfound affinity for disclosure laws, would stop making it more difficult for factors to do so!
Jason M. Medley is a preferred attorney with the International Factoring Association, and his partner, Elizabeth Lally, is a bankruptcy and banking guru at the national firm of Spencer Fane. Lally also serves as a Subchapter V Trustee. They can be reached at jmedley@spencerfane.com and elally@spencerfane.com or by phone at 281-352-6032.