Analysis

Rise In Ch. 11 Cases Echoes 2008 Financial Crisis

By Vince Sullivan
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Law360 (July 17, 2020, 4:09 PM EDT) -- A 26% increase in Chapter 11 filings so far in 2020 as compared to last year can largely be blamed on the effects of COVID-19, and restructuring professionals say the spike is mirroring trends seen at the beginning of the 2008 financial crisis.

Legal services firm Epiq Global released a report this week with data on the number of bankruptcy filings so far this year, revealing commercial restructuring cases are up 26% over 2019 as of the end of June, while the number of bankruptcy cases of all kinds was actually down by a similar margin over last year.

The jump in business restructurings reverses a continuous, but slight, downward trend in those types of bankruptcies over the last few years.

Chris Kruse, vice president of Epiq's Automated Access to Court Electronic Records, or AACER, program, said the trend echoes what happened during the crisis of 2008, where corporate insolvency cases spiked in the weeks after the onset of the downturn, which was then followed by a surge in personal bankruptcies.

"The data doesn't lie. It's growing," Kruse told Law360. "We saw this in the last cycle starting in '08 and '09. The Chapter 11 commercial cases preceded the personal bankruptcies by some period."

Epiq's AACER service performs a daily "scraping" of electronic bankruptcy court records in all 94 district court jurisdictions, Kruse said, and prepares reports for clients that include large institutional lenders interested in assessing credit risk and other factors.

And since the onset of the coronavirus pandemic and related financial woes, a growing number of clients have been requesting reports on a weekly basis instead of the more routine monthly basis.

"They're looking for signals from the market," Kruse said.

Epiq's report shows there have been 3,604 new business Chapter 11 cases through June, an increase of 26% over the same six-month period in 2019, and that June alone saw 609 new cases for a jump of 43% over the same month last year.

The number of total bankruptcies has declined by a similar margin — dropping 23% over the same period last year.

The crisis 12 years ago showed similar trends, where financial institutions began failing at the end of the first quarter, kicking off a surge of commercial cases to be followed by a wave of personal bankruptcies.

David Prager, the managing director of the disputes consulting practice of Duff & Phelps, said the rise in commercial bankruptcies so far in 2020 will likely continue as the fallout from COVID-19 spreads throughout the economy, closely tracking the pattern seen in 2008.

"What we did see in the financial crisis is that there was a very long time from when Bear Stearns starts to fail in March 2008 until the peak of the financial crisis, probably a year or more," Prager told Law360. "We saw these points in time when the government would come in and support things, and markets would come back so people calmed down."

Yet as that government support wavered as the crisis continued into 2009, Prager said, the number of bankruptcies jumped.

"I think we may see a series of events like that going forward. For the rest of the calendar year, with the government aid and elections, there will still be some support and liquidity — and eventually that is going to dry up," Prager said. "When that dries up, then I think we'll see the real wave coming at us."

According to reports from the U.S. federal court system, 2008 saw 9,272 business Chapter 11 cases filed, a number that rose to 13,683 in 2009, or 47%. The reports also show that by the end of 2008, there had been 714,389 nonbusiness Chapter 7 cases filed, and that number jumped by 41% by the end of 2009 to more than 1 million new cases.

Laura Davis Jones, a name partner with Pachulski Stang Ziehl & Jones LLP, said both the 2008 crisis and the current COVID-19 crisis are similar in that they both arose unexpectedly, but the situation the economy is facing now is different because revenues have evaporated almost overnight for many industries.

The coronavirus' impact is also being felt on a much wider scale geographically than the financial crisis of 2008 and 2009, Jones said, reaching every continent and virtually every industry that depends on public operations.

"This is very international in scope," Jones told Law360. "There is not a country that is not affected by this."

Deirdre O'Connor, Epiq's managing director for corporate restructuring, affirmed that the current situation differs from 2008 in that the effects of COVID-19 are far broader than what was felt in the last cycle.

While the initial wave of commercial Chapter 11 cases has been largely concentrated in the retail, energy and transportation sectors, its impact will be felt widely, she said.

"This wave is very broad. It affects everyone," O'Connor said. "The last financial crisis started in the mortgage sector and became distinctly between lending institutions. … This one affects all of us from top to bottom."

Jones elaborated that 2008 saw lenders impacted first, which then spread into the housing sector and trickled down to the building trades and related industries as demand for homes dropped.

Predicting which companies or industries will be the next to feel the pain of the crisis is nearly impossible, O'Connor said, but certain indicators point to trouble for some in particular.

The Chapter 11 cases filed so far this year that cite the coronavirus involve companies that were already in a precarious financial state, including limited liquidity. As COVID-19 restrictions forced many businesses to close their doors for several weeks, that liquidity was eaten up in the face of evaporating revenue.

O'Connor said the pain in retail, energy and transportation will likely continue and, if the pattern of previous cycles holds, will be followed by a wave of personal bankruptcies.

Corporate Chapter 11 filings being up by 26% contrasts with the overall 23% decline in all types of cases, but individual cases will probably surge due to the historic jump in unemployment, Kruse said.

Liquidity injections via stimulus packages approved by federal and state governments and forbearance deals from lenders have staved off the surge for now, but if these programs begin tapering off in the coming months, people out of work will have no income as months of bills come due.

Prager said the hope is that people are able to go back to work before they fall too far behind on their personal financial obligations, but after about two months of mounting expenses — especially with mortgages or rent — it becomes harder to bounce back financially.

"I'm not encouraged by the way things are heading, and it seems we may have more bad days coming before we get to the good days," he said.

Jones said the government aid currently available has provided a parachute for individuals that was not available back in 2008, so the number of personal bankruptcies might not reach the same levels as they did back then.

But the aid available to corporations this time around was not provided quickly enough or in the right manner to stave off insolvency for the hundreds of companies that have filed for Chapter 11 in recent months, she said.

Personal filings may be mitigated by the number of employers that are able to bring workers back on board as business restrictions are eased, Jones said, and the stimulus payments and extra uninsurance compensation available to many laid-off workers could be enough to bridge the gap until that happens.

"In 2008-2009, there was no parachute, so people had no choice but to hold on as long as they could and then file," she said.

September will be a major turning point for many corporations and individuals, Jones explained, as the reopening status in many areas will dictate whether normal or close to normal business operations can resume.

The spike in Chapter 11 cases has also been augmented by increased access to the bankruptcy system for small businesses through the Subchapter V program, which reduces the cost of filing and administering Chapter 11 proceedings, O'Connor said.

The program went into effect in February, so there is no year-over-year comparison available, but the 506 cases that have taken advantage of Subchapter V so far this year indicate it is a popular option for companies that may have previously been forced to shut down without reorganizing.

The report said 133 of the 506 Subchapter V cases in 2020 were filed in June, trending upward over the short life of the program. That trend will probably be mirrored by large corporate cases over the next few quarters as the economic world adjusts to the "new normal" post-pandemic, O'Connor said.

"We are expecting increased bankruptcy filings on the large corporate scale to come down the pike in the next few quarters," she said.

--Editing by Philip Shea and Alanna Weissman.

For a reprint of this article, please contact reprints@law360.com.

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