Bankruptcies might not be hitting Nevada as hard as they were during and immediately following the Great Recession, but they’re still impacting the state’s economy.
At the height of the recession’s bankruptcy fallout in 2009, 60,837 businesses filed in the U.S., according to the American Bankruptcy Institute (ABI). That number was down to 22,232 in 2018, the last full year of data available.
“During the Great Recession there was a significant amount of activity, certainly here, and it was a combination of consumer and businesses,” said Tom Fell, Fennemore Craig’s director of financial restructuring. “We saw an incredible amount of real estate-driven bankruptcies because values cratered and no one could get refinancing.”
Those bankruptcies have gone through the process and, for the most part, are no longer out in the world. Fell said today bankruptcies are down significantly from the peak, however the past year or two has seen an uptick in consumer cases. Quarterly business bankruptcy cases in 2019 were also up over 2018 in the first three quarters, according to the ABI.
Business cases are no longer mostly driven by real estate issues, though small business cases are seeing a slight uptick, Fell said, caused mostly by loan defaults and basic business operation inabilities.
Financial crises like the one experienced in 2008 exacerbate bankruptcy issues, but they don’t slide away when the economy is humming along. The U.S. is experiencing the longest economic expansion in the nation’s history, having positive growth since June 2009.
“Bankruptcy was routinely used by individuals during our most recent financial crisis to discharge debt from underwater real property and business investments. Bankruptcy continues to be relevant because individuals and businesses still suffer financial distress, sometimes self-inflicted and sometimes by circumstances beyond their control,” said Seth Adams, a shareholder at law firm Woodburn and Wedge.
“Bankruptcy is still frequently being used to help people shed debt and get a fresh start. Likewise, for businesses, bankruptcy provides a means to reorganize liabilities such that they can become profitable when they exit the bankruptcy process.’
Fork in the Road
Any bankruptcy starts with a petition filed with the bankruptcy court, which triggers protections for the filing business. From there it depends on a variety of other factors within the process.
Chapter 7 and Chapter 11 bankruptcies are both still relatively common place in the U.S., with 630 businesses filing for bankruptcy in January, according to the ABI. That’s an uptick from January 2019, Adams said.
Chapter 11 allows businesses to propose a plan to modify and restructure debts, while Chapter 7 is when a business seeks to liquidate all remaining assets. Chapter 11 can be an effective tool for businesses, but also proves to be an expensive option.
“Chapter 11 cases often take several years to conclude and, even then, may have plans which are effective for decades afterwards,” Adams said.
For those business that were looking to avoid Chapter 7 but deemed Chapter 11 too expensive, the Small Business Reorganization Act of 2019 could be a useful alternative.
According to Adams, the act streamlines reorganization for businesses with less than $2,725,625 in secured and unsecured debt while eliminating many of the time-consuming and costly hurdles of Chapter 11.
“In bankruptcy, everything from payroll to executive bonuses is under the scrutiny of the court,” Adams said. “Often, pay and employee benefits is one of the things reorganizing business seek to address the first day they file for bankruptcy. Chapter 11 debtors can, for instance, seek approval from the bankruptcy court to use what cash they may have on hand to address payroll to try and minimize the burden on employees.”
National Shock Waves
Major companies often hit the headlines when they run into financial issues and those effects can be felt across the nation, including in Nevada. During the first decade of the new millennium, many large companies were able to reorganize and emerge from Chapter 11 bankruptcy, which helped eliminate heavy debt loads, like General Motors and CIT Group.
Some companies were able to sell off assets, intellectual property and other components to shed debt and survive — at least in some capacity — like Radio Shack and Payless Shoes.
Others however, weren’t as lucky. Companies like WorldCom and Lehman Brothers were unable to reorganize and used bankruptcy to structure asset sales.
In large cases, including companies with locations across communities nationwide, the effects are heavy, Adams said.
“There are a litany of parties affected immediately,” he said. “Employees may experience delays in receiving pay and may have their retirement and other benefits modified. Likewise, vendors and suppliers of the bankrupt entity may need to work with bankruptcy counsel to ensure payment for goods and services already provided as well as to ensure payment for future goods and services.”
The current economy has seen retailers and restaurant groups experience turbulent times.
While Amazon gets much of the blame for the rise of brick and mortar retail corporations failing, Fell said he’s not sure that’s the core reason
“The reasons are varied,” he said. “You read about the Walmart or Amazon effect, there is some truth to that, particularly in certain corners of the retail [industry], but there’s some disagreement to their true effects.”
Perhaps a larger driver is the surge in private equity. Many national retail bankruptcies were at one time public and taken private with private equity and loaded up with debt, cited a Forbes article that recently reported entities taken private by PE ultimately fail 22 percent of the time.
When those large brick and mortar stores head through bankruptcy and close up stores, they leave a local landlord with a massive square-footage vacancy. Those landlords across the nation have to deal with courts across the country, often in Delaware or the Southern District of New York.
Companies can come out of bankruptcies fine. Brands can be strong enough to survive and have value. Some brands even simply sell their name, Fell said.
“From a public perception, I’ve never really had a case where the public was that aware or cared about a brand’s bankruptcy,” he said. “There are people who buy just the names out of cases, because the names always have value. Polaroid isn’t a business anymore, but it’s still used.”
Adams points to Sears current restructuring with a major investor who hopes to reopen stores in the future, likewise with Toys ‘R’ Us.
“Business’ brands can be a tricky item to address,” he said. “Unlike a company vehicle for instance, brands, copyrights, trademarks and patents are usually much harder to assign a concrete value to. Bankruptcy attorneys often work with appropriate experts and/or intellectual property lawyers to navigate this process depending on the client’s objectives.”
While Nevada is quite a bit more tame in bankruptcy numbers than a decade ago, there’s still some quirky cases to recently find their way to court said Ogonna Brown, a bankruptcy attorney and partner at Lewis Roca Rothgerber Christie.
The prime example Brown gave was that of the Las Vegas casino Lucky Dragon. The project took on EB-5 investors from Asia, which grants a visa for a six-figure investment. As the project went south, Brown said it was disconcerting to see non-native English speakers trying to determine if they’ll get their money back.
“In their minds a casino is very lucrative,” Brown said. “There was a blanket lien on the machines, so all the gaming was gone and the only thing for operations were the restaurants and hotel rooms. Everything else is peripheral, you use the food and cheap rooms to get people to gamble.”
She said the Lucky Dragon situation left a huge mess with lawyers and vendors involved and ended up costing the lenders.
“That’s been the most interesting, high profile case,” Brown said.
The state, and courts nationwide, are currently also running into new cases with cannabis. Because marijuana is still banned federally, many judges are unsure of how to rule.
“It’s been legalized in Nevada, however courts are extending quite a bit of scrutiny as to whether they can qualify as debtors in bankruptcy court,” she said. “You see a bit of shift in analysis. You don’t have automatic dismissals. The shift has happened overnight and there’s not a lot of case law on it.”
Fell said he believes bankruptcies won’t get back to the levels of the Great Recession, in part because it was likely a once-in-a-lifetime financial crisis, but also because lenders are getting more creative.
“It won’t be because the borrower never wants to, but the penalties can be harsh,” he said. “Those don’t kick in if you just hand in the keys.”
Brown said there’s currently quite a few cases were creditors are being taken advantage of by debtors trying to be “super creative,” including creating a fake creditor body so they could cram debt away. Others will hide possessions and assets to lower the value they’d have to pay back.
“It’s very difficult to navigate,” she said. “A lot of times debtors need bankruptcies for a fresh start, but in certain circumstances it’s people trying to out smart the system.”
Currently lenders are also in a good space, giving companies a healthy market to navigate. While there’s plenty of money to be had today, Fell doesn’t think lenders will get as loose with it as they did prior to the last financial crisis.
“Real estate values have clearly recovered, the commercial market is healthy and money was almost impossibly tight during the Great Recession,” Fell said. “That’s not the case today. Not only are interest rates low, there are lenders willing to lend with plenty of money. Folks with 10 year loans haven’t had trouble to refinance.”
But bankruptcies won’t disappear, he said. The economic cycle will see the economy slow down again, so those struggling companies using the extra cash available today, likely under poor management, will dry up when money gets tighter.
“Some companies won’t survive because of poor management,” Fell said. “But if they’re keeping an eye on things and focused and understand what works, they should be able to prepare adequately.
Likewise Brown said when she can see cranes in the sky and big cultural assets coming to town like the NFL’s Raiders and NHL’s Golden Knights, she knows her work will be a tad slower than normal.
“It’s all cyclical, when it’s doing well the bankruptcy system is generally slow,” she said.
But when times are tough, she compared bankruptcies to fighting over a melting bowl of ice cream in the desert.
“Act quickly or there’s nothing left,” she said.