by Valorie H. Rice
Senior Specialist, Business Information
Extraordinary financial hardships experienced over the last few months by many individuals and businesses facing overburdening debt due to, or aggravated by, the coronavirus pandemic, might lead some to make the difficult decision to file for bankruptcy protection. A recent change in bankruptcy laws to facilitate the process for small businesses was updated through the CARES Act broadening eligibility for small businesses finding themselves in extenuating circumstances. This article reviews the most common types of bankruptcy filings, some of these recent changes to bankruptcy law and several key trends in filings in Arizona over the past 15 years.
Types of bankruptcy
Bankruptcies are under the jurisdiction of the federal courts. Rules for bankruptcy are in title 11 of the United States Code, otherwise referred to as the U.S. Bankruptcy Code. There are several different ways to discharge debt under bankruptcy and the chapter number of the Bankruptcy Code they refer to is the typical name for each. The six types of bankruptcy are chapter 7, chapter 9, chapter 11, chapter 12, chapter 13, and chapter 15.
Chapter 7 is referred to as liquidation bankruptcy. This type of bankruptcy is the most common type of bankruptcy filing in the U.S. and in Arizona. It is available to both individuals and businesses; including corporations, partnerships and sole proprietorships. A chapter 7 bankruptcy allows a trustee to liquidate all of the debtor’s nonexempt assets to pay creditors.
Chapter 9 is for municipalities. This includes cities, towns, counties, and school districts. Chapter 9 cases allow for reorganization of debts for the municipality so they can continue operation. Chapter 9 is a rare occurrence.
Chapter 11 is referred to as reorganization bankruptcy and is available to both individuals and businesses. In both Arizona and the U.S., chapter 11 filings are predominately business related. In chapter 11, a business comes up with a plan approved by the court to pay off creditors over a course of time allowing the business stay in operation. A new subchapter 5 of chapter 11 took effect in February of this year making it easier for small businesses to file chapter 11. More information on this is provided in a latter section of the article.
Chapter 12 provides family farmers or “family fishermen” who are under financial difficulty with a means to pay back debt over three to five years. There are typically less than 10 of these per year in Arizona and account for only one-tenth of a percent of total bankruptcies in the nation.
Chapter 13 is for individual debt adjustment, also called the “wage earner plan.” This type of bankruptcy allows a person with regular income to put together a plan to repay their debt while keeping their property.
Chapter 15 is available for instances of bankruptcy involving more than one country. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 instituted it.
For more information on each chapter of the Bankruptcy Code, visit the U.S. Courts Bankruptcy Basics page at https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics.
Arizona bankruptcy statistics
Arizona has three bankruptcy courts – Phoenix, Tucson, and Yuma. The Phoenix office services Apache, Coconino, Gila, Maricopa, Navajo, and Yavapai counties. The Tucson office services Cochise, Graham, Greenlee, Pima, Pinal, and Santa Cruz counties. The Yuma office services La Paz, Mohave, and Yuma counties. Phoenix has the highest number of bankruptcy filings in the state (Exhibit 1). Of the 1,047 claims filed in April 2020, 774 were in Phoenix, 217 in Tucson and 56 in Yuma.
Exhibit 1
Chapter 7 bankruptcy filings are the most prevalent type in Arizona followed by chapter 13, and then chapter 11. With the exception of 2011, there are fewer than 10 chapter 12 bankruptcies filled in Arizona per year. Chapter 15 has been available since 2005 but is rarely used. Exhibit 2 provides a look at the number of bankruptcies by chapter in Arizona.
Based on filing statistics, individuals are most likely to file chapters 7 or 13. Businesses typically use chapter 11, though chapter 7 is also used to a far lesser degree. For a business, chapter 11 signals regrouping and that the business aims to continue, while chapter 7 signals termination.
Exhibit 2
Business and nonbusiness filings
Reports in the news of businesses filing for bankruptcy have increased over the last few months. However, the majority of bankruptcy claims filed are by individuals rather than businesses. This is true for both the U.S. and Arizona.
Bankruptcies are labeled business when the debtor is a corporation or partnership or when the operation of a business comprises the major portion of the debt. Nonbusiness bankruptcies address debt incurred by an individual primarily for personal, family, or household purpose. Exhibit 3 shows that business bankruptcies typically range between three to four percent of total bankruptcies in Arizona. Changes in business conditions are evident in the data as the high mark of 6.3 percent was during the fourth quarter 2008 in the midst of the Great Recession. The lowest point occurred in the third quarter 2005 when there was a change in the bankruptcy code that resulted in an unusual amount of personal bankruptcy filings that quarter, placing business filings at 1.0 percent of total. The latest data are for first quarter 2020 (Jan.-Mar.) so effects of COVID-19 are not yet showing up in these data, but this is where we would expect to see business impacts.
Exhibit 3
New Laws affecting bankruptcy: SBRA and CARES
The Small Business Reorganization Act (SBRA), which went into law August 2019 and took effect in February 2020, added a subchapter 5 (Small Business Debtor Reorganization) to the chapter 11 bankruptcy code. This made it easier for small businesses to file. Under the new code, a small business debtor is someone engaged in commercial or business activities (other than primarily owning single asset real estate) with debts of no more than $2.7 million. The CARES Act increased that threshold to $7.5 million for the period of one year allowing more businesses to be eligible under the new code.
There is an anomaly in the long-term monthly data due to the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. This law went into effect in October 2005, making it more difficult for individuals to file Chapter 7 by requiring a “means test” if average monthly income over the six months prior to filing is above the median income of the state. Because of this, there was a rush to file Chapter 7 before the new rules came into effect causing an abnormally high number of bankruptcy filings in the months leading up to and including October 2005 and a corresponding drop in the months following it.
Conclusion
The data for second quarter 2020 should be available in July, at which point we will have U.S. statistics. April and May bankruptcy data for Arizona have been considerably lower than previous years. We are curious what these data will show us later in the year about the scale and scope of businesses and individuals facing financial hardships opting to seek bankruptcy protection during these historically difficult times. It remains to be seen how many businesses will choose to take advantage of these relaxed requirements to reorganize and attempt to stay in business through the storm. We will keep you posted.
Sources/Resources
U.S. Courts Bankruptcy Basics – https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics
SBRA law – https://www.congress.gov/bill/116th-congress/house-bill/3311/text
CARES Act – https://www.congress.gov/bill/116th-congress/house-bill/748
Ekvall, L.L.W and Evanston, T (2020, Feb 14). The Small Business Reorganization Act: big changes for small businesses. American Bar Association. https://www.americanbar.org/groups/business_law/publications/blt/2020/02/small-business-reorg/
Haimerl, A. (2020, May 6). When does a small business file for bankruptcy? An 8 more questions. New York Times. https://www.nytimes.com/article/small-business-bankruptcy-coronavirus.html
Sraders, A. (2020, May 11). A new bankruptcy law could prove a big help for small businesses. Here’s everything you need to know. Fortune. https://fortune.com/2020/05/11/recent-changes-to-bankruptcy-laws-could-prove-a-big-help-for-small-businesses-heres-everything-you-need-to-know/
United States Code – https://uscode.house.gov/
