What Are Insolvency Laws and How Do They Help Small Businesses?
The word “insolvency” signifies financial distress for individuals or businesses when debts cannot be paid on time. It is generally used after a company has entered into informal arrangements with its creditors to pay off what is due. When those do not pan out, further steps are taken.
Why Do Businesses Become Insolvent?
Businesses and companies become insolvent for a number of reasons. Poor human resources management and inadequate accounting are two main causes. It can also happen when businesses raise their costs and share that with large clients, who soon after end the relationships. Other reasons that lead to less income and high debt include not meeting customer needs, and costly lawsuits.
Insolvencies can be temporary when assets are liquidated and/or debts are restructured into manageable payments. Many times, smaller companies are bought by larger ones that assume the debt. Creditors tend to prefer those options over not getting repaid at all. A repayment plan has to be realistic and have evidence showing where the cash will come from while the business remains profitable.
Is Insolvency the Same Thing as Bankruptcy?
Insolvency and bankruptcy are two different things. Insolvency is a temporary situation that hopefully gets resolved. When that does not happen, a company may have to declare bankruptcy. During bankruptcy proceedings, a court decides how the insolvent party will handle the unpaid obligations. That could involve selling off more assets, and could negatively impact a company’s credit rating.
New Bankruptcy Laws
For the past few years, lenient lenders, low interest rates, and government stimulus money have worked to decrease the number of Chapter 11 filings. The 2019 Small Business Reorganization Act (SBRA) also made Chapter 11 more accessible to debtors; the CARES Act (temporarily) raised the debt limit to $7.5 million for many eligible small businesses. How did this happen?
In 2020, a subchapter was added to Chapter 11 through the SBRA: Subchapter V. Designed to help small businesses with limited time and resources, it lessened the time and money needed for bankruptcy cases. Through Subchapter V, businesses with less than $2.7 million in debt could apply for this program. Things changed after the $2.2 trillion CARES Act; now the threshold is $7.5 million. In essence, small businesses with debt up to $7.5 million can be eligible to file for bankruptcy under Subchapter V.
Impacts of Subchapter V
As a result of Subchapter V, more small businesses have become eligible to apply for faster, less costly bankruptcy filings. Since 2020, more than 3,400 small businesses filed for Subchapter V relief, bypassing traditional Chapter 11 filings. Insolvent businesses can reap these other advantages by filing for Subchapter V:
- Creditors are responsible for uncovering debtor abuse and fraud because there are no appointed creditors’ committees. Debtors pay creditor committee expenses in typical Chapter 11 filings.
- With Subchapter V, creditors are responsible for determining if debtors are properly qualified small businesses.
Contact the Philadelphia Business Attorneys at Sidkoff, Pincus & Green P.C. if Your Business Has Become Insolvent
The rules for legal bankruptcy filings have certainly changed these past few years and it can be challenging to know what best suits your needs. For a confidential consultation, contact the experienced Philadelphia business attorneys at Sidkoff, Pincus & Green P.C. Call us at 215-574-0600 or complete our online form today. We are located in Philadelphia, and help clients in South Jersey, Pennsylvania, and New Jersey.