The CARES Act Will Lead to More Small Business Bankruptcies—Here’s How to Protect Your Business from Getting Burned

JCPenney, Neiman Marcus, and other household names have recently filed headline-grabbing Chapter 11 bankruptcy cases. From energy to hospitality to retail, the COVID-19 crisis has had a devastating economic impact on a wide range of companies across industries. And, of course, small businesses are no exception. According to a survey conducted by the National Federation of Independent Businesses, “92% of small employers are negatively impacted by the outbreak of the novel coronavirus.”

While Chapter 11 bankruptcy has historically not been an option for most struggling small businesses due to the expense and complexity of the process, that may be changing as a result of recent legislation. What does that mean for all of the solvent businesses out there? They may be forced to deal with more of their business debtors inside of bankruptcy court, rather than through traditional debt collection means. In this article, we address recent changes ushered in by the Coronavirus Aid Relief and Economic Security Act (CARES Act), and provide businesses with advice on what to be prepared for and how they can protect themselves in this time of economic uncertainty, including:

  • Signs of customer distress
  • Protect yourself and help ensure payment going forward
  • What to do upon receipt of a notice of bankruptcy filing

Implications of the Small Business Reorganization Act

A case filed under Chapter 11 of the U.S. Bankruptcy Code is often referred to as a “reorganization bankruptcy.” On August 23, 2019, the Small Business Reorganization Act (SBRA), which added Subchapter V to Chapter 11 of the Bankruptcy Code, was signed into law and became effective on February 19, 2020.

SBRA streamlined the Chapter 11 bankruptcy procedure—allowing it to proceed more quickly and less expensively—for small business debtors with debts totaling up to $2,725,625. The CARES Act, which went into effect on March 27, 2020, temporarily (for one year) raised the debt threshold for SBRA filing eligibility to $7,500,000.

The SBRA makes the process for reorganizing under Chapter 11 more streamlined by shortening deadlines for various case filings, appointing a standing trustee in every case to facilitate the debtor’s dealings with creditors and keep the proceeding on track, not appointing a creditors’ committee in most cases, and not requiring debtors to pay quarterly U.S Trustee’s fees. In addition:

  • The debtor is the only party permitted to file a plan of reorganization.
  • The debtor is not required to file a disclosure statement unless ordered to.
  • A plan of reorganization can be approved even if all impaired classes of creditors object.
  • Individual debtors who have used home mortgages to finance their businesses have a right to modify those mortgage loans through a plan of reorganization.
  • Debtors may retain ownership of their business, even if the plan of reorganization does not fully repay unsecured creditors. In other words, the “absolute priority” rule does not apply under Subchapter V.

By raising the debt limit, and making other debtor-friendly changes through the SBRA, Congress made the streamlined Chapter 11 bankruptcy process available to significantly more small business debtors. Debtors have a new tool available to them to restructure their debts, which means their creditors, many of whom are facing their own financial challenges, need to be even more vigilant.

Spotting Signs of Customer Distress

As a supplier of goods or services, there are certain telltale signs you should be on the lookout for to determine whether your customers are experiencing financial distress. Missed payments, requests to modify contract terms, lack of communication, and an increase in collection activity (such as the filing of lawsuits) against a business are all indicators that a business may be struggling to pay its bills.

To help guard against risks, develop and implement internal procedures that will alert you when payments are being made outside of normal trade terms—or not being made at all. While many businesses are making accommodations to their customers right now, going deeper in the hole with a customer often doesn’t make sense if it’s putting your own cash flow at risk. Before taking any steps to accommodate a customer, consult with legal counsel to make sure that you are, first and foremost, protecting yourself.

Protect Yourself and Help Ensure Payment Going Forward

Once you’ve identified signs of potential distress, take steps to minimize the risks moving forward. It’s important to move quickly, and in consultation with legal counsel, because once a customer files for bankruptcy protection, there is little you can do to improve your likelihood of being paid relative to other creditors.

Require Cash in Advance

One of the simplest and most straightforward ways to ensure payment from a customer is to require cash in advance before supplying goods or services. In some cases, this may require the renegotiation of an existing contract. To the extent your customer is not currently paying in accordance with the terms of an existing contract, you may have the right to suspend your own performance, which can give way to discussions regarding new payment terms. An added benefit of requiring cash in advance of performance is that it can mitigate risks associated with preference lawsuits should your customer ultimately file for bankruptcy.

Requests for Adequate Assurance

If you suspect that a customer may be, or may become, unable to perform under a contract for the sale of goods, but is not yet in breach, you may want to consider demanding adequate assurance. Under Section 2-609 of the Uniform Commercial Code, a party to a contract has the right to demand adequate assurance of performance from a distressed contract counterparty. If the counterparty fails to provide adequate assurance, you may be able to repudiate the contract.

Request Other Forms of Financial Assurance

Explore with your legal counsel whether it’s advisable to seek various forms of financial assurance from a customer, such as obtaining a security deposit, letter of credit, or collateral to secure a debt. Depending on the product or service you supply to a customer, you may also be able to exercise a statutory lien, such as a construction lien, or a special tooling lien, in certain circumstances.

What to Do Upon Receipt of a Notice of Bankruptcy Filing

Regardless of how diligent you may be, today’s severe economic downturn makes it likely that you will be forced to deal with certain debtors in bankruptcy court. The new Small Business Reorganization Act only increases that likelihood.

Once you become aware of a customer’s bankruptcy, call your lawyer for advice. The “automatic stay” imposed once a debtor files for bankruptcy means that normal collection activity against a debtor must stop, and you can put yourself at risk of penalty by engaging in such activity. That doesn’t mean, however, that you must sit idly by during a customer’s bankruptcy. There are additional protections that may be available once the bankruptcy has commenced.

The creditors’ rights attorneys at Fraser Trebilcock are up to date on the latest developments in the bankruptcy laws, and we are seasoned Bankruptcy Court litigators. Experience has shown us that favorable results for creditors are possible within the constraints of the bankruptcy laws. For instance, a small business debtor’s reorganization in bankruptcy may allow repayment to creditors in situations where the debtor would otherwise have just shuttered its business and paid nothing. For assistance in dealing with a financially distressed customer, inside or outside of bankruptcy, please contact a Fraser Trebilcock attorney.

We have created a response team to the rapidly changing COVID-19 situation and the law and guidance that follows, so we will continue to post any new developments. You can view our COVID-19 Response Page and additional resources by following the link here. In the meantime, if you have any questions, please contact your Fraser Trebilcock attorney.

Jonathan T. Walton, Jr.’s legal practice focuses on cases arising from commercial transactions, the Uniform Commercial Code, the federal and state securities laws, banking laws and bankruptcy litigation. In the areas of banking, commercial, construction and real estate litigation, he represents lenders, contractors and owners on construction-related claims, and lenders and borrowers in commercial and residential foreclosure matters, large loan defaults and collections, lien priority disputes, and title insurance company liability. He can be reached at (313) 965-9038 or

Fraser Trebilcock attorney Amanda S. Wolanin specializes her practice in business and tax law, bankruptcy, family law, estate planning, litigation, and real estate law. You can reach her at (517) 377-0897, or at

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