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Coronavirus-era bankruptcy surge heavily favors reorganizing over liquidation

While 2020 was an exceptional year for U.S. corporate bankruptcies, a larger share of distressed companies upended by the COVID-19 pandemic is using court processes to restructure instead of close shop.

Nearly 62% of U.S. corporate bankruptcy filings in 2020 sought reorganizations, the highest rate for any year going back to at least 2010, according to S&P Global Market Intelligence data. Companies were less likely to liquidate in 2020, a departure from 2019 and 2018 when corporate liquidations outpaced reorganizations in bankruptcy filings. As of March 30, the share of filings seeking restructuring is larger in 2021 than in 2020.

In U.S. bankruptcy courts, companies can file restructuring plans through a process known as Chapter 11, which allows for liquidations in some cases though they are less common. Chapter 7 bankruptcy proceedings are strictly for liquidations.

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It is generally more common for larger U.S. companies to opt for Chapter 11 bankruptcy because it gives managers more control over the fate of their businesses, experts say. When companies enter Chapter 7 bankruptcy, they effectively cease to exist and a trustee is appointed to run the business.

Strong brands and operations in niche markets give bigger companies longevity that makes them less likely to pursue Chapter 7 bankruptcies, Diane Shand, a senior director at S&P Global Ratings, said in an interview.

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Reorganizations have been increasingly prevalent as otherwise healthy companies use the bankruptcy process to navigate the extreme environment created by the pandemic, experts say. Creditors and debtors have struck deals prior to bankruptcy filings, and there have been many asset sales to preexisting lenders and bondholders, Joshua Friedman, global head of restructuring data at Debtwire, said in an interview.

"We've seen significant Chapter 11 activity with the goal of protecting the business," Friedman said.

Retail sales plunged in April 2020 in the wake of lockdown measures aimed at stifling the spread of the coronavirus. Even when some states lifted restrictions, businesses faced depleted consumer confidence during the initial months of the pandemic.

Stimulus money and a higher number of asset sales could be steering more companies to reorganize rather than liquidate, Connor Murphy, a director at Burford Capital, a global finance firm focused on law, said in an interview. Many companies that entered Chapter 11 bankruptcy over the past year did so because they needed help navigating the "zero-revenue environment" created by the pandemic, Murphy said.

"There wasn't necessarily anything fundamentally broken about their business model," Murphy said.

Hertz Global Holdings Inc. is a prime example. There was nothing inherently wrong with its business, but the rental car company entered Chapter 11 pretty quickly when the economy began to shut down in March 2020, Murphy said. Chapter 11 was Hertz's only real option, and it allowed the company to restructure some debt and get through a challenging period, Murphy said.

Hertz has asked the court overseeing its bankruptcy to approve the adequacy of its proposed disclosure statement to allow the company to emerge from bankruptcy ahead of the company's busy summer season. The company did not respond to a request for comment from Market Intelligence.

When J.C. Penney Co. Inc. filed for its reorganization, it did so with a restructuring plan that aimed to reduce the company's debt and give it more financial flexibility. By December 2020, J.C. Penney had become Old COPPER Co. Inc. and completed the sale of most of its retail and operating assets.

More prepackaged or prearranged bankruptcies also help explain the greater number of Chapter 11 bankruptcies in 2020, experts say. In these prepackaged bankruptcies, financial stakeholders agreed there was a viable business plan and investment proposition for the businesses beyond the pandemic, Lex Suvanto, head of financial communications at Edelman, said in an interview.

"Everybody was willing to stay on board and reinvest in the company," Suvanto said.

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Not many large corporate bankruptcy cases start out in Chapter 7, though some eventually convert to it, Ed Flynn, an American Bankruptcy Institute consultant, said in an interview. Smaller businesses tend to be involved in Chapter 7 bankruptcies more often than Chapter 11, Flynn said.

Those smaller companies seeking to liquidate have typically run out of other options or the owners of the business do not have the energy to carry on with a sinking ship, David Berliner, a partner in BDO USA LLP's restructuring and turnaround services practice, said in an interview.

While 2020 had the largest number of retail bankruptcies filed in 11 years, the pace of Chapter 11 filings slowed at the end of 2020. There are likely to be fewer retail bankruptcies in 2021 than 2020, and more storefronts are expected to close as companies reposition themselves to take better advantage of the growth of e-commerce, Berliner said.

The broader pace of bankruptcies in 2021 is back to pre-pandemic levels despite longstanding expectations of a second wave, experts say. Whether bankruptcies pick back up depends at least in part on the pandemic and how consumers and businesses respond when the economy reopens, experts say.

"I would expect a jump if we see things deteriorate once again," Friedman of Debtwire said. "Otherwise, it seems to be in the bankruptcy world relatively business as usual, contrary to what I think most people have been expecting for a long time."