Tariff Response Options for Small Businesses Facing Financial Distress

The Trump Administration’s new tariffs are having an oversized impact on small businesses, which already tend to operate on razor thin margins. Many businesses have been forced to raise prices, find new suppliers, lay off staff, and delay growth plans. For businesses facing even more dire financial circumstances, there are additional tariff response options, including workouts, reorganizations, and liquidations.

Background on Tariffs

In basic terms, a tariff is a tax imposed on imported goods. Tariffs can serve a number of strategic goals, which include bolstering U.S. manufacturing and encouraging fair trade. Since taking office in January, President Donald Trump has increased tariffs on the import of many foreign goods, including those from China, Mexico, and Canada. The burden of these new tariffs is being felt across industries. It is also impacting businesses of all sizes that rely on overseas suppliers or imported goods.

Options for Small Businesses

For small businesses facing higher costs, disrupted supply chains, and slimmer margins due to the new import taxes, it is imperative to explore all of your options. Below are a few ways to ease growing tariff burdens:

Lower Your Expenses

Small businesses should start by reviewing their financials to identify areas to cut costs. Costs savings may also be achieved by streamlining and optimizing your operations through automation, analytics, and other technology.

Diversify Your Supply Chain

Now is also the time to look for alternative suppliers, both domestically and abroad. Small businesses should also explore the possibility of negotiating more favorable terms with existing suppliers.

Strategically Raise Prices

Many small businesses must raise prices to maintain their margins. Gradual adjustments associated with added value, like improved customer service or loyalty perks, can help maintain customer loyalty. Being transparent about why the price increases are needed, i.e. higher tariffs, can also lessen the impact.

Amend Contracts

Going forward, small businesses may want to consider including contract provisions that address the impact of tariffs, such as price adjustment provisions or termination rights that are triggered when tariffs reach a certain level.

Securing More Favorable Financing Arrangements

Small businesses should explore opportunities to obtain more favorable financing terms, such as a lower interest rate, extension on payment periods, or even temporary forbearance, through refinancing and other means. Some businesses may also benefit from debt factoring or invoice discounting.

Next Steps for Businesses Facing Financial Challenges

For small businesses in significant financial distress due to higher tariffs, there are additional options. Signs that you need to consider more drastic measures include declining revenue, cash flow issues, missed loan payments, and mounting payables.

Loan Workouts

Because loan workouts can give a business the flexibility needed to continue operations, restructure, and return to profitability, they are often the first option when facing financial distress. A commercial loan workout involves a negotiated agreement between a borrower and lender that restructures or modifies the terms of an existing loan with the goal of avoiding a default. Workouts can be beneficial for both businesses and lenders, as they allow the borrower to remain operational and reestablish financial stability, while the lender preserves a viable means to recover debt.

When negotiating a workout plan, businesses must demonstrate commitment to fulfilling their obligations and include concrete steps for reducing costs, increasing revenue, and improving profitability. The terms of a workout plan will vary based on the terms of the original loan and the circumstances of the debtor. Below are a few common examples:

• Interest rate adjustments
• Change in payment terms
• Principal forbearance or forgiveness
• Loan maturity extensions
• Covenant modifications
• Collateral adjustments
• Conversion of debt
• Guarantees
• Debt restructuring

Subchapter V Reorganizations

The Small Business Reorganization Act (SBRA), also referred to as Subchapter V, established a valuable tool for small businesses in financial distress. Established in 2020, Subchapter V is designed to serve as a streamlined bankruptcy process for small businesses.

Under the SBRA, small businesses with significant debt can reorganize and remain operational, while avoiding the more costly requirements of a Chapter 11 bankruptcy. A committee of creditors will not be appointed unless ordered by the court for cause. The debtor will generally not be required to prepare a disclosure statement, and more important, only the debtor can file a plan of reorganization. These features of a Subchapter V reorganization allow the process to proceed more quickly and prevent contested hearings that increase costs.

The SBRA also relaxes the requirements to confirm a plan. It eliminates the “absolute priority” rule, which requires that a Chapter 11 Plan be approved by all classes of creditors in order for business owners to retain their ownership interest. In a Subchapter V reorganization, equity owners can retain their ownership so long as the plan does not “discriminate unfairly” and is “fair and equitable.” It is also easier for the debtor to confirm a plan over creditors’ objections. Essentially, a plan will be confirmed so long as it provides that all of the debtor’s projected disposable income for three to five years will be used to make plan payments. Disposable income is defined as income that is available after the payment of ongoing business expenses.

To take advantage of a Subchapter V reorganization, small businesses must meet certain eligibility criteria. Most notably, debtors cannot have debt in excess of $3,024,725. Additionally, the debt must be at least 50% comprised of commercial or business debt.

Liquidations

Liquidation involves converting assets into cash to satisfy creditors. Because it results in the closure of the business, it is generally considered a last resort. In a voluntary liquidation, the owners of the business (partners, LLC members, shareholders, etc.) decide that it should be placed into liquidation. Meanwhile, a creditors’ liquidation results from a creditor petitioning the court to wind up the business because it is balance sheet insolvent or unable to pay its debts when due.

Liquidation generally involves a formal legal process in which a liquidator is appointed to sell off assets, pay creditors, and distribute any remaining funds. Once the liquidation process is complete, the company ceases to exist as a legal entity. This is different from bankruptcy, where a business may be restructured or liquidated.

How Scarinci Hollenbeck, LLC Can Help Determine Your Best Tariff Response Options

Scarinci Hollenbeck, LLC is here to help small businesses navigate the financial challenges posed by the recent increase in tariffs. Whether your business needs assistance renegotiating a supplier contract, devising a workout plan, or reorganizing, Scarinci Hollenbeck, LLC has the right legal team, including members of the Bankruptcy & Creditors’ Rights, Corporate Transactions & Business, and Litigation practices.

Results may vary depending on your particular facts and legal circumstances.

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