CHAPTER 11 FILINGS IN 2020 AND BEYOND
Unless your January 2020 payroll included Nostradamus, the forthcoming global pandemic and resulting mass quarantines were largely unforeseeable. Last year’s unpredictability did, however, lead to the rather predictable material increase in Chapter 11 bankruptcy filings. Epiq Companies recently reported to the American Bankruptcy Institute that commercial Chapter 11 filings increased 29% in 2020. Indeed, over 7100 companies filed for Chapter 11 in 2020, the most since 2012. While debtors submitted the lion’s share of these petitions during the second and third quarters of 2020, Q4 2020 filings slowed significantly. Further, despite the noticeable increase in filings, these numbers are nowhere near those of the Great Recession. Why did COVID-19 not have the impact one might assume and what are the projections for the future of Chapter 11 filings?
IMPACT OF COVID-19 ON CHAPTER 11 FILINGS
The impact, or lack thereof, of COVID-19 on Chapter 11 filings is best analyzed in a sector by sector approach. Two key sectors which contributed to the increase in filings during 2020 – energy and retail – were already distressed pre-pandemic. As such, COVID-19 merely accelerated energy and retail companies’ need to file. Of the ten largest bankruptcies in 2020, the energy or retail sectors included six of them and, overall, these sectors comprised nearly half of all 2020 bankruptcy filings. To be sure, coronavirus was merely the straw that broke the already strained camel’s back in these sectors.
Other sectors, however, bore the brunt of the pandemic with the aid of wide-ranging stimulus measures. The Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”), signed into law at the end of March 2020, provided more than $2 trillion in financial support for businesses and consumers. Of that $2 trillion, $454 billion was made available to the Federal Reserve in order to provide loans and loan guarantees to businesses. Additional stimulus was provided in December 2020 in the form of the Consolidated Appropriations Act (“CAA”), which provided another $284 billion for small businesses.
The positive effects of the stimulus measures were especially prevalent in the lower middle market (“LMM”), which has comprised 77% of bankruptcy filings over the last 10 years. Compared to 2019, LMM filings actually decreased in 2020 by 0.7%, based on numbers from Reorg Research. Increased flexibility of banks and other capital providers who were willing to modify loans, relax covenants, and provide additional liquidity also played a factor in ensuring the success of LMM businesses, along with the CARES Act and CAA.
Robin Elliott, President and Chief Executive Officer of Busey Bank praised the quick action of various government and quasi-government entities: “Arising from lessons learned during the Great Recession, federal and state governments, along with governmental and quasi-governmental agencies, acted quickly to introduce liquidity and payment relief measures into small and mid-sized business to allow them and their creditors increased flexibility to weather the pandemic – a truly coordinated effort for the benefit of our economy.” The other markets – upper middle market (“UMM”), large, and mega, on the other hand, all experienced an increase in filings during 2020.
POST-2020 BUT NOT POST PANDEMIC
Unfortunately, while LMM businesses were able to withstand the short-term effects of the pandemic, their stability is not likely to last long as few companies will be able to withstand the lasting impact of the pandemic. A new round of stimulus from the government in the form of the American Rescue Act of 2021 should keep more companies afloat; however, eventually, the additional financial and operational leverage some of these companies assumed to survive 2020 could come unsustainable as the global free market economy adjusts to the massive fiscal stimulus provided by governments around the world.
Unlike LMM businesses, UMM did see an increase in Chapter 11 filings during 2020 and that trend is likely to continue. After two months of 2021, 80 corporate bankruptcies have been filed, a decrease from the 98 filed in the same period in 2020, according to S&P Global Market Intelligence. Although this trend seems promising, the slowdown in filings now could hint at a boom later in 2021. In fact, one sector where bankruptcy filings and foreclosures are expected to increase is commercial real estate. On February 16, 2021, during his testimony before the Senate Banking Committee, Federal Reserve Chairman Jerome Powell said that commercial real estate prices “appear susceptible to sharp decline.” This analysis makes sense given two of the more significant changes in the population’s behavior during the pandemic: (a) more people working from home leading to less demand for office space; and (b) an increase in online shopping leading to the shutdown of brick-and-mortar retailers.
The public’s new habit of working and shopping from home will likely also lead to continued pressure on the retail industry. In the first two months of 2021, the consumer discretionary sector – the retail sector – has seen 14 bankruptcies, the most of any sector so far in 2021. Belk Inc., a private department store chain, filed in late February, joining other retail giants such as J.C. Penney Co. Inc, n/k/a Old COPPER Company Inc. and Neiman Marcus Group, both of which filed in 2020.
The energy sector did not start prosperously in 2021 either. The mid-February winter storm event in Texas claimed its first bankruptcy, Brazos Electric. The unexpected drop in temperatures resulted in over $2 billion of invoices that Brazos could not pass on to its customers. Oil and gas company, Seadrill, also filed in February. This case marks the second time Seadrill has filed chapter 11 in three years. Although the future of the energy sector is still uncertain, the S&P Global Ratings distress ratio for the oil and gas industry has changed drastically from the beginning of the pandemic. In April 2020, the proportion of speculative-grade issues with option-adjusted composite spreads of more than 1,000 bps relative to U.S. Treasuries was 64.2%. By the end of February 2021, the ratio was only 6.3%. Despite this drastic difference two oil and gas businesses were downgraded by Moody’s early in March, indicating a possibility of more filings to come.
Beyond 2021, the economic outlook is a bit more optimistic. Elliott believes that the economy will remain strong throughout 2022, with the possibility of a modest 18-month downturn in 2023: “The increased liquidity in the system will allow for ongoing cover of economic weakness that was present prior to the pandemic. As the liquidity gets absorbed with business getting back on its feet, the weakness will again begin to show through and will need to be dealt with, most likely through employment, wage reductions and real estate divestment.”
LMM and UMM businesses, especially those in the commercial real estate, retail, and energy sectors should consider how they may be able to restructure their businesses without filing for Chapter 11. Having conversations early in the process will likely lead to fewer “freefall” cases – where a business enters Chapter 11 without an agreement with creditors on the terms of its restructuring – and more “pre-packaged” cases – where the terms of the restructuring have been agreed upon before filing. Pre-packaged cases are easier to manage and typically cost much less than freefall cases. The preferable and most cost-effective route in most instances, however, is an out-of-court restructuring that will give businesses the time for supply and demand to return to pre-pandemic levels and allow for both the near-term survival and long-term growth.
 See e.g. Lauren Thomas, The bankruptcies that rocked the retail industry in 2019, CNBC.com (Dec. 28, 2019) (discussing the multiple retail bankruptcies in 2019 and predicting more in 2020); see also Mark Passwaters, Oil, gas sector had few bankruptcies in Q4’20, but reprieve could be short lived, S&P Global (Jan. 22, 2021).
 Michael O’Connor & Chris Hudgins, Slowdown in US corporate bankruptcies continues as COVID-19 recovery looms S&P Global Market Intelligence (March 3, 2021).
 Distressed Company and Industry Updates, Cowen.