Analysis: COVID-19 behind the strange drop in bankruptcies

In general, bankruptcies increase as a result of economic downturns. It may come as a surprise, then, that bankruptcies have done the exact opposite since the arrival of the COVID-19 pandemic.

According to the American Bankruptcy Institute, the numbers from March and April show that bankruptcy court filings have fallen dramatically compared to this time last year or even to any time during the last decade.

Based on the number of filings in PACER, the U.S. Bankruptcy Court online database, bankruptcies have steadily fallen since the end of the last recession in 2008 to 2010. This is true for both Idaho and the country as a whole. In contrast to the national data, Idaho filings do not show the same dramatic drop in April and May. To date, Idaho filings resemble the year-to-year rates from 2017 through 2019.

Filing rates for all types of bankruptcies continue to be down nationally in the latest data available from PACER. The contrasting surge in Chapter 11 filings is the consequence of bankruptcy law. This disproportionate increase happens when businesses with multiple business units file for Chapter 11 debt reorganization. Because of how the law is structured, every separate business unit of a larger corporation may end up filing separately.

In the financial credit blog he administers, Robert Lawless, a law professor at the University of Illinois, recently explained: “The thing about chapter 11 filings is that they are tricky to count. Each subsidiary of a corporate group gets counted as a separate filing such that one corporate group can artificially inflate the filings.

“For example, the bankruptcy filing of Frontier Communications appears to have counted for over 90 of the 405 chapter 11 filings in the first two weeks of April this year. Gold’s Gym was responsible for 13 of the 334 filings in early May. The chapter 11 filings are inflated in this way every month, and the differences wash out over longer periods of time. But, when looking at shorter periods — even monthly periods — one entity with lots of affiliates can distort the numbers.”

According to Ed Flynn, an analyst at ABI, there were 1,110 Chapter 11 cases filed nationally between April 1 and May 24. Of these, 280 were solo filings, 67 were parent case filings, and 763 were child case filings. Historically, an average 20-30% of all Chapter 11 filings are child cases. In contrast, the April and May filings currently account for almost 70% of the Chapter 11 caseload.

While the seeming aberration of Chapter 11 cases can be explained, the drop in all other types of bankruptcy filings still needs examination. High unemployment is tied historically to rising bankruptcy rates. This is especially true when consumer debt is high, since Chapter 13 provides consumer debt relief.

An increase in individual filings may be on the horizon. Total household debt increased by 14.3% between December 2007, just prior to the Great Recession, and December 2019, just before the COVID-19 economic downturn. The biggest culprits in this increase are student loan debt, which has nearly tripled, and automobile debt, which has gone up over 60% according to data from the Federal Reserve.

The current lack of an increase in bankruptcy filing may be an artifact of timing. According to Lawless, consumers typically do not file immediately for bankruptcy and some can struggle up to three years after the onset of financial difficulty. The current lack of a surge in individual bankruptcy may simply be due to this delay effect.

The lack of both individual and business filings may also be due to the various federal or state moratoria on debt collections, evictions and foreclosures, which act to alleviate and delay financial pressures. Filings may begin to surge as these expire in the upcoming months.

In addition, large job losses typically lead to less access to credit, with the consequence that there will be less debt on household balance sheets. Less household debt may lead to less demand for individual bankruptcy filings.

As to why filings have actually dropped compared to previous years, the COVID-19 shutdown itself may be the cause. Shutting down all but essential services may have delayed bankruptcy filings by restricting non-essential travel, closing government facilities and courts, curtailing bank teller and accountant access and closing law offices.

Filings may have been delayed because the business world was at a standstill for two-and-a-half months. It’s hard to find a bankruptcy lawyer when no one is at the law office to answer the phone. Switching from working in an office to working from home did not happen overnight for most professional services such as accountants and lawyers.

The lack of a corresponding dramatic drop in filings for Idaho may be due to the state’s more liberal definition of essential services compared to the much more restrictive shut-downs of places like Michigan, Massachusetts and New York. It could also be just a simple statistical fluke.