Post-Pandemic Insolvency Trends in the Mid-Market

By: Adam Spiro

As we cautiously enter the “post-pandemic” world, mid-market business owners are starting to ask what the future will look like.

The pandemic brought two years of record low mid-market business insolvencies[1]: BIA filings by businesses in 2020 were down nearly 25% from the previous year both in Quebec and Canada-wide[2], and 2021 filings saw another annual decrease of 4% in Quebec and 11% Canada-wide[3]. This drop in formal insolvency proceedings was more pronounced for restructurings than for bankruptcies, with the 2021 figures consisting almost entirely of a decrease in the filing of proposal proceedings—with 21% less both in Quebec and Canada-wide[4].

This trend seems to have reversed in early 2022. The most recently available statistics from May show a significant uptick in Canadian business insolvencies, with total BIA filings increasing over May 2021 (+27%), and for the 12-month period ending May 31, 2022 versus the pervious year (+10%)[5]. While the year-over-year statistics show a relatively equivalent increase in bankruptcies and proposals, the 2022 versus 2021 monthly statistics show a significant Canadian trend towards restructuring proposals (+67%) over bankruptcy liquidations (+19%)[6]. Quebec is in line with the national average for the rate increase in insolvency filings both on a monthly basis for 2022 versus 2021 (+26%) and on a year-over-year basis (+11%)[7]. The Quebec short-term trends skew even more strongly towards restructuring proposals (+38%) over bankruptcy liquidation (+25%), with a slight opposite skew in the year-over-year trends (bankruptcies +12%; proposals +9%)[8].

What is driving this trend reversal? Many companies had been in holding patterns during two years of pandemic-related uncertainty. They took government subsidies and trimmed workforces just to keep the lights on, all the while delaying drastic irreversible decisions in the hope that they would be able to rebuild their businesses in a post-pandemic world. With the direct pandemic-related impacts on business coming to an end, the “new normal” is turning out to be a challenge—government subsidies are over,  interest rates and inflation are rising, labor shortages continue to affect businesses and supply chain issues persist, causing businesses to evaluate their options.

The good news for challenged companies with strong fundamentals is that the options are not limited to handing over the keys to a trustee in bankruptcy to liquidate the company. The first possibility for a company feeling the pinch of rising interest rates is to try to negotiate a forbearance arrangement with its lenders to buy time to secure new financing. If formal creditor protection proceedings become necessary, proposal proceedings under the BIA provide debtors with the benefit of a stay of proceedings of up to six months to restructure their debt and/or operations[9]. Amongst other:

• The stay of proceedings can buy the debtor time to refinance existing secured debt;
• Operational inefficiencies can be corrected by selling off or closing unprofitable business units (e.g. by disclaiming leases and other agreements) and decreasing headcount;
• Proposals to settle claims can be offered to unsecured creditors for a vote, which can be particularly attractive for companies that have, for example, overextended themselves by using trade suppliers and tax authorities as a source of financing;
• The assets of a business can be sold as a going concern, free and clear of all encumbrances, to pay secured creditors and/or to protect jobs, suppliers and other interested parties.

While collateral underlying secured loans remain sufficient for most lenders, lenders will nevertheless need to keep a close eye on the impact of rising interest rates on asset values, particularly in the real estate sector. If prices drop significantly, the value of collateral may suddenly become insufficient to secure loan balances. If cashflows remain strong, loans will continue to be paid—but rising interest rates can also cut into cashflow, causing a perfect storm of declining cashflows and asset values.

All in all, the outlook is not as grim as some are making it out to be. Surely, so-called “zombie companies” that were surviving on government subsidies without operational cashflow will need to be weeded out in the coming correction, but our strong insolvency regime, coupled with the creativity of insolvency professionals, can limit the scope and scale of damage caused by an economic downturn.

[1] For the purpose hereof, we have excluded CCAA filings.

[2] Insolvency Statistics in Canada—2020: https://www.ic.gc.ca/eic/site/bsf-osb.nsf/eng/br04459.html.

[3] Insolvency Statistics in Canada—December 2021: https://www.ic.gc.ca/eic/site/bsf-osb.nsf/eng/br04582.html#t3.

[4] Ibid.

[5] Insolvency Statistics in Canada—April 2022: https://www.ic.gc.ca/eic/site/bsf-osb.nsf/eng/br04655.html.

[6] Ibid.

[7] Ibid.

[8] Ibid.

[9] There is no limit to the duration of a stay of proceedings under the CCAA.