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There are approximately 30 million small businesses in the United States, which employ more than 60 million people. With the recent economic impact of COVID-19, small businesses have suffered tremendously. In a survey conducted by Small Business for America’s Future, 53 percent of the survey respondents said they took on new debt, as a result of COVID-19. The report also showed that one in four respondents have new debt of more than $20,000 and 18 percent have more than $100,000. Given the current economic situation, small business owners are worried about losing their business and what that will mean to their loan liability.

The Paycheck Protection Program (PPP) was created by the CARES Act, which was enacted in March 2020. The program offered forgivable loans to small businesses suffering due to the global pandemic. The Economic Injury Disaster Loan (EIDL) program, however, existed before the pandemic. This program was updated through the CARES Act to provide emergency grants to small businesses consisting of up to $10,000. Since the crisis began, small businesses across the U.S. have received a total of $630 billion through both programs. Despite the relief offered by the programs, many small businesses do not expect to survive the economic crisis brought by COVID-19. Interestingly enough, per a survey conducted by Small Business for America’s Future, almost a quarter of small businesses are considering closing permanently due to the pandemic.

However, there may be reason for optimism. Experts say PPP loans and EIDL loans of less than $25,000 contain promising terms for borrowers and may also be discharged in the event of bankruptcy. But there are intricacies and limitations, due to the haste in which the relief plans were deployed. 

Defaulting on Loans

PPP and EIDL loans of up to $25,000 will not require collateral or guarantees from the business or business owner. Therefore, if a borrower cannot repay the loan and the defaults, lenders will not be able to seize the business or personal assets.Yet, the risk of a loan default is that the creditor is the federal government. This means that they could potentially report businesses to credit scoring organizations, thus negatively affecting the capability to borrow in the future. Furthermore, it could also lead to an increase in interest rates on future debt. Lastly, the federal government can collect assets such as the business’ income tax refunds and other amounts owed to the federal government. 
Unfortunately, those who received an EIDL loan that exceeded $25,000, are subject to have the remaining assets seized by the Small Business Administration to cover the outstanding debt. Furthermore, EIDL loans consisting of more than $200,000 are subject to a personal guarantee. This means that a business owner’s personal assets can be used to obtain outstanding debt. This includes, but is not limited to bank accounts, personal tax refunds, investments, and cars.

Bankruptcy Protection

For those who wish to avoid default, experts suggest that small businesses consider bankruptcy protection. Under the Small Business Reorganization Act, enacted in February 2020, Chapter 11 bankruptcy offers a favorable option by lowering costs, simplifying procedures, and providing greater flexibility in plan confirmation requirements to help small businesses regain control of their operations. 

AIS, a leading bankruptcy data provider, monitors the activity of small business bankruptcy cases known as Chapter 11 Sub-chapter V and shares the information with its banking clients. Based on the data, AIS expects June Sub-chapter V bankruptcies to reach their highest monthly total since the new law was enacted in February. Most likely, that number will continue to rise into the third and fourth quarters of this year.

Key Considerations

Generally speaking, PPP and EIDL loans can be discharged in bankruptcy. However, complications are not out of the question for small business owners.

In an effort to expedite the federal funding process, the SBA and Treasury Department created forms and guidance quickly, which led to a variation in application review policies amongst banks. Should a bank or the SBA investigate and find errors within the applications, the discharged PPP loan could possibly be at risk.

There are fewer concerns around EIDL funding since those loans were originated by the SBA. Still, EIDLs over $200,000 come with some risk, due to the personal guarantee, which could require both the business and the owner to file bankruptcy to ensure their debt is discharged.

According to the Labor Department, the number of people seeking unemployment benefits declined to 1.5 million (week ended June 6). This marks the tenth consecutive week of declining claims.The number of Americans currently receiving unemployment benefits appears to have stabilized, totaling 20.9 million (week ended May 30). However, "continuing claims” remain at a historic level, 14.3 million above the previous record in 2009.

The U.S. labor market snapped back to life in May, as the unemployment rate dropped to 13.3 percent from April’s 14.7 percent and the total nonfarm payroll employment increased by 2.5 million. This is the highest number of payrolls added in a single month since 1948.

The US Bureau of Labor Statistics says the economic activities in the U.S. that were curtailed in March and April, due to Coronavirus, have now resumed. However, the resumption is partial, as only certain sectors are showing sharp growth in sales and employment rates. So it’s too early to claim complete recovery, as the jobless rate remains four times higher than February 2020. Despite the recent gains, economists forecast a slow and irregular recovery. Government aid programs for businesses and households, which have driven trillions of dollars into the economy, are set to expire this summer. Many consumers and workers continue to be concerned about contracting the virus and prefer staying at home. The employment impact of pandemic-related safety regulations has yet to be realized and there is still potential for a second wave of the virus to resurface this fall.

Historically, unemployment numbers are a leading indicator of mortgage default rates, which in turn, drive many consumers into bankruptcy. AIS will keep monitoring job rates and other economic trends to help lenders and loan servicers better understand how to prepare for and manage a potential surge in bankruptcy filings later this year and into 2021.

According to AIS proprietary data, May 2020 witnessed a decrease of 41.94% in the total bankruptcy filings when compared to that of the same month last year.

In May 2019, the number of bankruptcy filings totaled to 68, 829, whereas, May 2020 accounted for just 39,961 filings (Figure 1). However, an increase of nearly 41% was also recorded in commercial chapter 11 filings, which raised from 535 filings in May 2019 to 757 in May 2020 (Figure 3).

Figure 1

As per month-over-month comparison, there was a nearly 4% increase; the number of filings in May 2020 reached 39,961 from 38,439 (Figures 1 and 2). Moreover, the total commercial chapter 11 bankruptcies also increased by 27%. Commercial chapter 11 bankruptcies totaled 592 in April 2020 whereas they increased to 757 in May 2020 (Figure 3).

Figure 2

Figure 3

The highest percentage of bankruptcies for May 2020 came from the South (East) (26%) followed by North Central (East) (20%), South (West) (13%), Pacific (14%), Northeast (12 %), Mountain (8%)  and North Central (West)(7%) regions of the country (Figure 4).

Figure 4

Bankruptcy Filings in May 2020 by regionThis is the third consecutive month of declining bankruptcy volumes, when compared to the same time period in 2019. The dip in bankruptcy filings during the second quarter is attributed to the COVID-19 shelter in place initiatives throughout the United States. As these precautions are gradually lifted a backlog of bankruptcies are expected to follow.

The AIS Insight Report is a proprietary report created by AIS using data derived sole from information obtained by the Federal Bankruptcy Court System and the latest in bankruptcy analytical tools.

To download the full May Insight Report, click here.