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Year Ahead: Bankruptcy Guru on What Fashion SMBs Need to Know

With new coronavirus cases on the rise daily heading into 2021, one concern for struggling small- to mid-size fashion firms and retailers is what tools do smaller businesses have at their disposal to get past the next hurdle as vaccines begin to get rolled out to the general public.

The general consensus is that so long as the pandemic is still hanging around wreaking havoc on the global economic stage, fashion and retail firms will continue to see an impact on their bottom lines as local economies struggle with potential short-term lockdowns. Because the first half of the year is expected to be more of the same as all of 2020, it won’t be until the second half, and possibly more likely the year-end holiday season, that everyone can finally breathe a sigh of relief that the worst is over.

Sourcing Journal caught up with Paul Aloe, partner at the law firm Kudman Trachten Aloe, to see what advice he has for small businesses at the start of the New Year. He specializes in litigation and bankruptcy law, and counts fashion firms among some of his clients.

Sourcing Journal: What is perhaps the biggest challenge for small fashion companies?

Paul Aloe: Because the businesses are small [and have been started by entrepreneurs], most have given personal guarantees to landlords, banks and SBA loans, among others. So the concern is that if the business fails, the owner may fail with it…. It’s a problem that we see as very challenging for people to create a small business because, for the owner, so much is on the hook.

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SJ: As we start 2021, and looking at some of the issues your clients face, can we say that the worst is over for small businesses?

PA: There’s probably more pain to come. But, whoever survives will do better because there will be less competition…. I think you will see more bankruptcies ahead. In general, the pandemic has done a number on the industry. People are not going into stores and then we have the obvious Amazon effect.

SJ: We saw over 42 bankruptcies last year in the retail and apparel sectors here and abroad. While you expect to see more bankruptcies this year, is that the answer for most small- to medium-size fashion companies?

PA: Many of the distressed businesses that we deal with never file. Sometimes, you can get everyone who is owed money to work with you. I had a client who had three landlords, a licensor and a bank, and [this person] was able to do a workout with everyone that allowed the individual to continue with the business.

SJ: And what if they can’t? Are there any tools that can help them?

PA: I got a client who was able to file for Chapter 11 bankruptcy court protection using Subchapter V. It’s a good tool for businesses of a certain size that previously really couldn’t go through a Chapter 11 filing because it was too expensive. The mega cases like GM, Sears or J.C. Penney can go into a Chapter 11 because they have the resources to really do that. The Chapter 11 costs can be staggering. In Chapter 11 you have a creditors’ committee, and then you have to pay for your counsel and the committee’s counsel, plus quarterly fees to the U.S. Trustee. All that is just too much for a small business that’s already struggling to begin with.

SJ: But a Subchapter V isn’t new to the federal bankruptcy code. What’s new this time around?

PA: Under the Cares Act, Congress increased the number to $7.5 million of debt from $2.7 million. This hit the sweet spot for small- and mid-size d companies, the ones that are big enough to reorganize but, for economic reasons, couldn’t use a Chapter 11 option.

SJ: Any caveats to using the Subchapter V option?

PA: The CARES Act is set to expire in March, which would bring the threshold back down to $2.7 million. I’m hopeful that Congress will either extend the higher amount or make it permanent.

SJ: Anything that can help small firms filing under Subchapter V from the bill that President Trump signed into law Sunday night?

PA: One provision [allows the debtor] to defer rent for 120 days. When you file for bankruptcy court protection, you’re supposed to pay rent right away. There’s also a provision that could provide protection for vendors.

SJ: Tell me about the provision for vendors?

PA: Everybody who is an unsecured creditor that has been paid within 90 days of the bankruptcy filing has exposure to a claim of preference. If you’re a debtor, you don’t want to sue people who keep you alive. But in Chapter 11, you as a debtor are duty bound to get the payments back and you do that by suing the people you paid [in that 90-day period]. That creates tension. Before even thinking of doing a filing, a company can enter into a forbearance agreement with creditors to pay in accordance with its terms.

SJ: So, if changing payment terms would protect vendors from claims of preferential treatment, can you talk about timing, and must any agreement be in writing?

PA: A debtor who gets into trouble can go to their vendors to ask to stretch out the payments. Many times you can work with people who are owed money to work with you, and those agreements can help you stay in business. The agreement should be in writing…. Generally, creditors are better off restructuring with the debtor and have it continue to pay them something on the debt. As a customer, you also need your trade creditors to supply you with product to keep your business going.

SJ: How is this different in the larger mega bankruptcies?

PA: Some of the really big, big companies like a Sears or J.C. Penney tend to strong-arm their unsecured creditors [because] the banks want as much inventory in as their lien will get higher. And then the companies say instead of paying on 30 days, they will now pay on 60 days, and later it is 90 days and vendors have to take those terms…. What I generally see happening among the large retailers is that their balance sheets are awful, there is a bank lien on everything, and when the companies get into trouble, the unsecured creditors are out of the money. Inventory is never worth anywhere near what the company was supposed to pay [and they] are lucky to get anything.

SJ: Anything else to be aware of as we start 2021?

PA: I see smaller businesses going in for PPP (Paycheck Protection Program) relief from the bill that they just passed. It’s going to help these businesses. Before, there was a question on whether or not a company that files for Chapter 11 could take a PPP loan. The company had to apply and after it got approval, it still needed the bankruptcy court to approve before it could take the loan. The theory now is that a company can keep employees on payroll while it goes through the restructuring process. It turned out to be an important program for companies hit by the pandemic.