The Corporate Bankruptcy Wave Is Just Beginning

Business bankruptcies have soared to levels not seen since the Great Recession—and it is likely just the beginning. U.S. bankruptcies in the first half of 2023 reached the highest since 2010, according to S&P Global Market Intelligence. “In England and Wales, corporate insolvencies are near a 14-year high,” per?The Washington Post.?“Swedish bankruptcies are the highest in a decade, while in Germany bankruptcies jumped almost 50% year-on-year in June to the highest level since 2016. In Japan, bankruptcies are at their highest in five years.”

Commercial Chapter 11 filings increased 68% year-over-year in the first half of 2023 following a hiatus of corporate failures in 2020-21, according to an?Epiq Bankruptcy ?report. Small business bankruptcies, known as Subchapter V, also saw a 55% jump in filings. The rise in business failures is expected to get worse as companies grapple with a combination of weakening demand, sticky inflation and high borrowing costs—all of which did not exist just a few years ago during the pandemic.

Another worrying trend in the corporate bankruptcy arena is on the rise—businesses filing for Chapter 11 bankruptcy twice, also known as Chapter 22. A recent?eNews?poll revealed 23% of credit professionals have had a customer file for bankruptcy twice or more.

“My customer that filed for a double bankruptcy, or Chapter 22, was unable to turn the business around and succeed in these poor economic conditions,” said Alissa Lucas , CICP, director of cash management at Conair LLC (East Windsor, NJ). “For the first Chapter 11 bankruptcy, we sold our proof of claim for 95%, so it was not much of a loss. But we saw the second one coming and kept them on cash-in-advance terms for a long time before we decided to sell one purchase order on terms. They filed for bankruptcy shortly after.”

Businesses are struggling to stay afloat due to high inflation rates, price surges and tightening lending standards, making it more difficult for small- and mid-size businesses to secure funding. Chapter 22 filings increased significantly this year due to these macroeconomic factors. Not only that, capital is much more expensive. “Look at the cost of debt,” Mohsin Meghji, founding partner of M3 Partners, a restructuring and advisory firm, told?CNBC . “You could reasonably get debt financing for 4% to 6% at any point on average over the last 15 years. Now that cost of debt has gone up to 9% to 13%.”

Over the last several years, it also had become a more debtor-friendly time for businesses to file for bankruptcy. The bankruptcy court is more likely to give the debtor the benefit of the doubt, said Jeff Gregory, CCE , credit manager at Helena Agri-Enterprises, LLC (Collierville, TN). “So, the bankruptcy court may allow them some leeway in bankruptcy in order for them to repay their debts.”

The retail sector has been among the hardest hit, as several big-name stores filed for bankruptcy this past year. “Several large retailers are filing for bankruptcy a second time around after failing to effectively reorganize after their first collapse,” reads an article by?Sourcing Journal . Large retailers like David’s Bridal and Tuesday Morning are among those Chapter 22 filings this year.

Several companies, not just in retail, have filed or are headed toward a Chapter 22 filing, said Mike Papandrea , Esq., attorney at Lowenstein Sandler LLP (Roseland, NJ). “Companies might have filed in 2020 during the pandemic and recapitalized their business relying on cheap debt, but did not sufficiently address operational issues or otherwise restructure their business such that they’d be viable as interest rates went up and credit dried up,” he explained. “Companies that might have been able to reorganize in the era of cheap and easily available money are now faced with the possibility of filing a Chapter 22.”

Chapter 22s can result from a problematic prepackaged or prearranged first Chapter 11 filing. “Sometimes a debtor obtains approval for a Chapter 11 reorganization plan, which can also be done through a pre-packaged or prearranged Chapter 11,” said Bruce S. Nathan , Esq., partner at Lowenstein Sandler LLP (New York, NY). “Even where the company might have deleveraged or reduced their debts significantly in the original Chapter 11, which decreased interest payments, the business might have been left with ongoing economic and operational issues that led them to a repeat Chapter 11.”

A double bankruptcy can apply for other types of bankruptcy filings, not just Chapter 11. Gregory had a customer file for a second Chapter 12 bankruptcy this year. “They filed a plan for Chapter 12, which the court approved and made one payment but could not make the second payment,” he said. “So, they filed a second bankruptcy plan, which took six months for the court to approve. Now, we’re on the second Chapter 12 bankruptcy all within two years.”

Even if a company survives a bankruptcy, no matter their financial state, creditors must continue their due diligence and ask themselves if it is safe to continue to sell to that customer. “When a company exits a Chapter 11 bankruptcy, they’re required to file a disclosure statement that provides financial projections and a valuation of the business,” Nathan said. “Creditors can use this information as a benchmark going forward and evaluate whether their company is meeting those projections.”