According to Epiq, there were 7,128 Chapter 11 bankruptcy filings in 2020 and a total of 529,068 filings across all chapters. Surprisingly, given the economic impacts of the COVID-19 pandemic, that overall number marked a 35-year low, although Chapter 11 filings were up 29% compared with 2019.

Despite data like this on Chapter 11 filings, there is a lack of research examining some of the intricate details involved, especially for smaller businesses. To date, the majority of research on Chapter 11 has been focused on large corporations. While this might lead to more headline-grabbing topics, it ignores the large portion of small businesses that make up the total filings.

 

“If you’re a scholar, that’s what all your colleagues are writing about and if you also write about large corporate bankruptcy, you may feel that you’ll be more likely to be taken seriously than if you’re just writing about small businesses,” Pamela Foohey, a professor of law at the Indiana University Maurer School of Law, says.

Foohey says that there is a heightened focus on larger Chapter 11 cases because small business cases generally “don’t present intense financial issues,” including high leverage and multiple tiers of debt. However, by ignoring smaller businesses that file, researchers are failing to look into some of the socioeconomic differences in Chapter 11 bankruptcy, specifically potential racial discrepancies.

Although this area has been largely unexamined, there is still some research that has explored racial discrepancies in Chapter 11, as well as a host of research on the consumer side that may indicate what the reality looks like on the commercial side.

Discrepancies in the Nonprofit Sector

Foohey is at the forefront of research on racial disparities in bankruptcy filings and has been one of the few researchers to wade into the waters of Chapter 11 in relation to the topic. Foohey has focused on the nonprofit sector, building a database of nonprofit bankruptcy filings since 2005, with the bulk being religious organizations such as churches. Although she is just scratching the surface, Foohey says that what she has found is “astonishing.”

According to Foohey, roughly 75 churches per year have filed for Chapter 11 in the last 15 years and more than two-thirds of those filings were made by churches with a predominantly Black congregation. This larger proportion of filings by Black churches is made all the more striking because roughly 23.7% of the entire church population in the U.S. is made up of churches with primarily Black congregations, according to 2018-2019 data from the Association of Religion Data Archives.

When churches file for Chapter 11, they often do so because they face problems paying the mortgage on the church building itself, accord to Foohey. In her research, Foohey found that many Black churches had mortgages that were “the equivalent of subprime loans,” and that in her discussions with pastors at Black churches, there was an unwillingness by lenders to “budge” at all when it came to mortgage modifications. Conversely, Foohey has found that white churches are more regularly provided with leniency when asking for mortgage modifications, with the experiences she’s heard about from white pastors looking “radically different” than those of Black pastors.

Due to this inability to get any help from their lenders, Black churches resort to Chapter 11 to force mortgage modifications. The results of such filings expose the inequity in how Black churches seeking modifications are treated versus white churches. Foohey says other research has estimated that somewhere between 15% to 25% of small businesses that file for Chapter 11 reach a confirmed reorganization plan. Meanwhile, her research has shown that 65% of Black churches that file for Chapter 11 reach a consensual solution, either through a confirmed reorganization plan or a deal with the mortgage lender, meaning they ultimately get the mortgage modifications they were seeking in the first place.

“These churches shouldn’t have been in bankruptcy to begin with,” Foohey says. “They should have gotten a mortgage modification pre-bankruptcy, but they’re using bankruptcy to force their lender’s hand and put them in a deal that will work for the bank and them going forward. It’s likely implicit bias that they get these loans and that lenders are more likely to give a deal to the white church before bankruptcy than the Black church.”

Lessons from Consumer Bankruptcy

The consumer side provides a much larger swath of insights on how racial discrepancies permeate the bankruptcy apparatus. For example, in addition to her research on bankruptcy for nonprofits, Foohey is one of the investigators for the Consumer Bankruptcy Project (CBP), which has been collecting and analyzing data on consumer bankruptcy filings since 1981. Such research has consistently shown that Black people are more likely to file for bankruptcy than their white counterparts, largely due to the structural inequalities embedded in the economic system of the U.S.

“There’s a longstanding disparity in the percentage of Black Americans as a part of their population that file bankruptcy,” Foohey says. “They face discrimination and disparities in the market, and so when you’re paying more, you’re more likely to default. Black households have more disruptions in their employment and face disparities in wages, so they make less money also. The two combined, it makes sense that they’re more likely to file bankruptcy.”

The racial discrepancies in consumer filings go deeper than just who files. There is also quite a difference when it comes to choosing between Chapter 7 and Chapter 13, the two primary consumer types.

In Chapter 7, filers essentially liquidate their assets and discharge their debts. Chapter 7 usually takes six months and costs roughly $1,500 in attorney’s fees.

On the other side, Chapter 13 is “reorganization for people,” according to Foohey. Filers retain their property and pay disposable income over a three-to-five-year period to pay off debts. In addition to being a longer process, Chapter 13 is more expensive than Chapter 7, with the average cost sitting at $3,800. It also is often a less successful path, with a third of filers reaching the end when filing Chapter 13, according to Foohey.

So why file for Chapter 13? One of the driving forces is the “no money down” aspect of the process. Chapter 7 requires upfront payment of attorney’s fees, whereas Chapter 13 allows those fees to be structured into the plan itself. Based on the CBP’s analysis, this “no money down” element is a major factor in explaining the racial discrepancies between Chapter 13 and Chapter 7.

“In places in which there’s a high Chapter 7 percent, the no money down cases don’t explain much of the racial disparity in filing Chapter 13,” Foohey says. “The higher percentage Chapter 13 districts, there’s convergence between no money down and racial disparities such that the no money down Chapter 13 cases [explain] almost all the racial disparity in the use of Chapter 13.”

Going further, according to Foohey, research specifically examining the racial divide in consumer bankruptcy filings has consistently shown that Black households are more likely to file for Chapter 13 versus Chapter 7. Even worse, research focusing on outcomes in Chapter 13 has shown that “one of the statistically significant variables of not succeeding [in Chapter 13] is being a Black household,” Foohey says.

According to Robert Lawless, a professor of law at the University of Illinois and a co-researcher with Foohey for the CBP, there are additional factors that make finding ways to combat these issues difficult.

“I think some of it is structural racism in the country, the legacy of racism in the country,” Lawless says, further citing concerns about access to quality legal services and implicit bias as other factors to consider. “There’s a lot of different factors here. It’s not just one thing. There’s not just one easy solution.”

In addition to the racial component, Foohey says that regional discrepancies also exist, with people in the South more likely to file for Chapter 13.

“There’s no true financial reason why,” Foohey says. “In fact, it has long been accounted for by something called local legal culture, which is the influence of attorneys year over year in that area pushing one chapter versus the other chapter.”

More Data, More Solutions

Despite the mountain of evidence on the consumer side and the growing evidence on the commercial side, there has not been much done to combat the issue of racial discrepancies in bankruptcy. However, that doesn’t mean there aren’t ideas on how to resolve some of these disparities. One of the simplest would be to use Chapter 13 less or to simply eliminate chapter choice entirely.

“There’s evidence from northern districts that people with homes can do just as well in Chapter 7 as Chapter 13,” Foohey says, noting that attorneys, trustees and bankruptcy judges need to take a more active role in advising filers to opt for Chapter 7. In addition, Foohey argues that allowing for a “no money down” approach for Chapter 7 would make it more appealing. The American Bankruptcy Institute has supported these measures, as well as the call for more expansive collection of demographic data in bankruptcy at both the consumer and commercial level.

“We always call for that,” Foohey says. “We call for it in every paper since the beginning of time.”

For Foohey’s research on nonprofits, she has to personally gather race-related data for each entity that files, which requires her to reach out to pastors to confirm the racial makeup of congregations. Having that data more readily available would allow for a deeper examination of how race relates to bankruptcy and for a better look at how bankruptcy affects all races and ethnicities. This, in turn, would make it easier to expose the racial discrepancies within the bankruptcy system and provide a better indication of how those issues can be solved, especially on the commercial side.

“I absolutely think that the bankruptcy system should be collecting demographic data on people who filed bankruptcy,” Lawless says. “I think it’d be very easy for the courts to do that, to implement, to do some data collection on demographics.”

Some of the elements on the consumer side could be addressed as part of the Consumer Bankruptcy Reform Act of 2020, which Senators Elizabeth Warren (D-MA) and Jerrold Nadler (D-NY) brought to the U.S. Senate in December. However, concrete initiatives to address the commercial side are lacking, especially without the type of data available at the consumer level.

Despite this, Foohey and Lawless believe that based on what we know about consumer bankruptcy and what Foohey has unearthed in the nonprofit sector, there is no reason to believe that the racial divide in bankruptcy is a purely consumer-level issue. In addition, it also may be telling about the actual financing minority-owned businesses receive.

“It would suggest that it’s worth exploring whether there’s disparities in the terms of credit extended to minority-owned businesses,” Foohey says.

“I don’t know [if] there are data that specifically address racial disparities in small business lending or small business workouts, but I also have no reason to think that they are any different than any other part of our society,” Lawless says.

Phil Neuffer is managing editor of ABF Journal.