The economic downturn is taking its toll on businesses of every size. The very thought of bankruptcy is viewed by business owners and management as somewhat of a defeat. There is bound to be a national restructuring, where previously viable industries and business models will vanish and be replaced by new ideas and new structures. That is where bankruptcy enters the picture. It offers the opportunity for resurgence. Businesses can use bankruptcy as a means to an end; a business tool to capitalize on a new beginning.
Filing a bankruptcy proceeding often invokes a fear of the unknown. Having a working knowledge of bankruptcy concepts is key to preserving remnants of an old business or providing a fresh start for a new one. Bankruptcy can be a way a business which is not necessarily in financial distress can purchase assets, effectuate a merger or obtain financing if it is available. In the case of small businesses, owners may be tied to the obligations of the business through personal guarantees or the use of personal credit. Having a comprehensive bankruptcy plan is the essence of emerging with personal finances in tact.
There are essentially two types of bankruptcies available for a business: Chapter 7 and Chapter 11. Chapter 7 is a straight liquidation. A trustee is immediately appointed randomly from a panel of individuals who have met the Bankruptcy Code qualifications to serve in that capacity. The trustee takes control of the debtor's assets, sells them and distributes the proceeds to creditors. The trustee can operate the debtor's business during the liquidation process. Trustees have full access to the debtor's books and records. The benefit to a Chapter 7 is that there is an immediate finality.
Chapter 11 is typically a reorganization case. As in a Chapter 7, all assets become property of the "Estate," but in a Chapter 11, there is no trustee and the debtor remains in possession of the assets. In fact, the debtor is referred to as the "debtor-in-possession" or "DIP." Businesses typically continue to operate in a Chapter 11 with the goal of restructure debt or otherwise re-order their financial or corporate structure. Although generally referred to as a reorganization, a DIP can liquidate its assets in a Chapter 11 proceeding and may want to do so believing that the DIP can achieve a higher value than could a Chapter 7 trustee. This process may ultimately benefit an owner who also has personal obligations for the business debt.
Bankruptcy as an Ally-Why Be a Debtor
The most common use of the Chapter 11 bankruptcy process is one designed to restructure the company's balance sheet. A company that wants to extend or refinance onerous debt, eliminate burdensome contracts or leases, and/or bring in new capital can generally accomplish these goals by a Chapter 11 filing which provides these opportunities and a temporary safe haven.
But, Chapter 11 is not just for severely financially distressed entities. There are a myriad of other business reasons for filing a bankruptcy. Bankruptcy may be a good alternative for a business that owns some troubled properties and other healthy ones. Structuring a "roll up" and then using the bankruptcy process to propose a long-term solution can provide the necessary and ultimate protection for the distressed properties. Other common business transactions such as sales, mergers and acquisitions may be accomplished in a more beneficial fashion for all parties under the protective umbrella of Chapter 11.
For example, with Bankruptcy Court approval, the Chapter 11 debtor can sell its assets during the course of the bankruptcy or through a plan of reorganization. The debtor only has to show that the sale is an exercise of its best business judgment and will benefit creditors. More importantly, the sale can occur "free and clear of liens and other interests." The liens attach to the proceeds, which the debtor disburses appropriately. That may permit a purchaser to acquire the assets without having to delve into disputes with creditors and with little or no risk of successor liability. Plus, a final sale order from the Bankruptcy Court is virtually impossible to overturn. All bankruptcy sales are subject to higher and better bids. However, the initial bidder which is outbid may be able to obtain reimbursement for amounts spent in due diligence, a so-called a "break-up fee."
Similarly, investments of capital, post-bankruptcy extensions of credit, and mergers can be accomplished free of many of the risks attendant with these transactions outside of bankruptcy. Because the bankruptcy process involves extensive noticing procedures and disclosure, some federal and state restrictions applicable outside of bankruptcy may not be imposed in bankruptcy.
Many lenders dealing with financially troubled companies insist on a bankruptcy filing before they will refinance. The bankruptcy gives the lender the opportunity to solidify its lien position or possibly even improve it. A lender is not obligated to continue funding a loan post-petition and thus, a debtor may want to obtain financing. This financing may be on an unsecured or secured basis but it requires Bankruptcy Court approval.
Cases change. Parties change. But, there seems to be a certain set of realities which exists in every bankruptcy case. Bankruptcy is fluid. Unlike usual commercial dealings or litigation in which the facts are established, a bankruptcy proceeding is constantly changing. One day the debtor may be seeking to reorganize and the next trying to liquidate a number of its assets.
The Bankruptcy Court is a court with broad jurisdiction. The Court can and will exercise jurisdiction over just about any entity and any matter that relates to the debtor in any fashion.
The Bankruptcy Court is a court of equity. That matters to a business person because it means the results are unpredictable. The Bankruptcy Code is designed to strike a balance between debtor and creditor interests. Nevertheless, as a court of equity, the Bankruptcy Court can wield enormous power in fashioning relief as it sees fit. And, every judge has his or her own unique theory for dealing with the numerous debtor/creditor issues that arise. The caveat is to keep expectations within reason and be prepared to change position or strategy on a moment's notice.
Bankruptcy events (e.g., sales and motions) are always an emergency. Not every issue that arises in a bankruptcy proceeding is presented as an emergency, but almost. In a typical Chapter 11, while the debtor may have had weeks to prepare an issue, it will file a motion to be heard on an expedited basis and creditors may be given literally hours to respond.
Debtors will almost always be given one bite of the apple. Most judges will follow the unwritten rule that debtors should have at least one opportunity to restructure. But, a debtor that abuses the system will be in trouble. It behooves a debtor to get it right the first time; it behooves a creditor to be patient. Cash is king. From either side of the aisle, cash wins at the end of the day. From a debtor's perspective, available cash is critical to get through the administrative expenses associated with the Chapter 11, and to weather the period of time when cash may not be available from a pre- or post-petition lending source. From a creditor' s perspective, a quick resolution of its claim is usually advisable inasmuch as cash is available early on in the case and everyone is optimistic that the debtor will survive. That may not be the situation down the road.
What Bankruptcy Cannot Do
- Save money initially. Chapter 11 is an expensive process in terms of professional fees, disbursements to the United States Trustee's Office, and uncompensated time for management to spend on bankruptcy matters.
- Allow the debtor to hide out. Chapter 11 is often referred to as a fish bowl. The financial reporting requirements are extensive and creditors are given carte blanche ability to explore the debtor's books and records.
- Restructure a company that has no business. Bankruptcy cannot substitute for the lack of viability. There needs to be a core business to reorganize.
- Force creditors or customers to continue doing business with the company. Trade vendors, which supply on an open account, can require COD payments and are not required to extend credit terms. Customers without a contractual obligation to purchase from the debtor can simply quit the relationship.
What Bankruptcy Can Do
- Provide at least a short respite from paying creditors. The automatic stay brings all collection efforts and lawsuits to an immediate halt.
- Provide an opportunity to alter debt repayment terms.
- End troublesome contracts or leases. The debtor has a relatively unfettered ability to reject contracts or leases which it no longer believes are in its best interest.
- Allow a business owner to work with creditors for an overall solution and to preserve personal finances.
No one can predict when the economy will improve or how different businesses will be impacted during the recovery. Phoenix has been through multiple cycles and it always seems to weather the storm. Clearly, bankruptcy can be a useful tool from the perspective of an owner, investor or purchaser. Bankruptcy no longer represents financial disaster--the once-feared "B" word really stands for a positive part of business.