But for this to be most effective, Congress must expand the definition of a “small business” to include companies with debts up to $10 million, up from the current $2.7 million. Lawmakers can also eliminate filing fees and reduce paperwork requirements so that a lawyer’s help is not necessary for an initial bankruptcy filing. The Small Business Administration can help by providing information about recent improvements to reorganization of debts in bankruptcy as part of its outreach regarding the stimulus’s expansion of the small-business lending program, which may expand further in the coming weeks.
Stopping debt collection is crucial: Without the tool of bankruptcy, in times of crisis, even solid businesses fare poorly. During the early years of the Great Depression, businesses that depended on mortgages and lines of credit could not get respite from creditors who needed cash. Creditors went to court, often forcing businesses in relatively good shape to liquidate. A similar scenario played out during the Great Recession: Sound firms went under.
The risk of a repeat underscores that this isn’t a typical recession, when weak businesses die, and strong businesses survive. This is different — more akin to wartime. We may see the destruction of the economy’s capacity to produce due entirely to the pandemic rather than economic factors. Bankruptcy can help mitigate the impact.
Under the bankruptcy law passed by Congress in 1898, failed businesses were typically liquidated. An investigation into the operation of this new provision began in New York before the onset of the Great Depression. It was unrelated to economic conditions.
While it was ongoing, several banking crises in 1930 and 1931 caused sound firms to go under and helped turn the recession that began in 1929 into the Great Depression. As the recession deepened, the Hoover administration brought high-level staff from the New York review to conduct a national review of bankruptcy procedure. After a lengthy investigation, the reviewers recommended that alternatives to liquidation be added to bankruptcy law.
In the final weeks of his presidency, Hoover begged Congress to act. But not until the day before President Franklin D. Roosevelt’s inauguration — after a 30 percent rise in business bankruptcy and with unemployment at 25 percent — did Congress amend the bankruptcy law to slow the liquidation of small businesses and farms.
The amendment allowed businesses and farmers to use bankruptcy to propose spreading out payments and reorganizing debt with the agreement of their creditors. But it didn’t go far enough because mortgage holders seldom agreed.
A 1934 law, the Frazier-Lemke Farm Bankruptcy Act, gave farmers a bypass. Even if the mortgage holder rejected an offer, foreclosure was stayed for five years, during which time the farmer could continue to occupy the land. Essentially, it allowed farmers to keep operating their farms and forced creditors — even mortgage holders — to wait.
The Supreme Court deemed this law unconstitutional because it went too far in depriving the mortgage holder of its property rights. Congress responded by reducing the stay to three years, among other tweaks. The court upheld the changed law.
Under the revised Frazier-Lemke Act, more farmers were able to get the relief they sought. But the most lasting effect of the court’s decision was that it set a precedent, allowing for additional relief to debtors through bankruptcy, even if the relief came at the expense of secured creditors like mortgage holders.
One of the first firms to take advantage of the Depression-era amendments to bankruptcy law was the Koplar Company of St. Louis. Koplar owned and operated apartment complexes and hotels, which were financed by mortgage bonds. During the Great Depression, its residential and retail tenants couldn’t make rent. Its hotel was empty.
Koplar tried to renegotiate with the mortgage bondholders, but these bondholders needed cash, too. Using the new bankruptcy law, Koplar was able to get new, more favorable terms on its mortgage bonds, keeping ownership of its buildings until economic conditions improved and tenants and guests could begin paying rent again.
The result illuminates the benefit of Congress making bankruptcy easier today: Koplar is still active in real estate in St. Louis, where it contributed to the revitalization projects in the once-blighted Central West End of the city, which now features a lively restaurant and bar scene. These are the businesses, with many jobs on the line during the pandemic, that Congress can help today by making reorganization in bankruptcy easier once again.
There is an additional reason for Congress to act: In matters of bankruptcy, states and localities are powerless to help businesses. The Constitution reserves the power to set bankruptcy law to Congress.
Adjusting the requirements to file a petition to reorganize business debts in bankruptcy should be a no brainer. It costs little now. It will have big trickle-down benefits if workers can return to their jobs because their employers are still in business. If workers have jobs to return to, it will help forestall a surge in personal bankruptcy later. Stimulus checks may keep households afloat for a month or two, but they won’t help for long, and they won’t help to preserve jobs or reduce pressure to collect debts that can swamp both individuals and businesses.
If Congress doesn’t act now to keep firms intact, eventually it will face making bankruptcy easier for households, too; this move, however, would be politically divisive and less effective than providing relief to businesses.
But by acting now, it can help ensure that more strong American businesses survive, helping owners, employees and consumers alike.