Picture an owner who can’t pay the bills and thinks his only option is bankruptcy. It’s not. Bankruptcy is stressful, time-consuming and pulls an owner away from running the business. It’s very expensive, with big retainers due up front, and professionals paid before unsecured creditors. Almost everything becomes a matter of public record. There are state-law and out-of-court options, though, that are quicker, cheaper, more private and more flexible. Here are six. But first, homework.
If you’re not filing bankruptcy but are asking your creditors to accept less than full payment, you must make a full and fair disclosure. There’s no formal disclosure statement, but you do need accurate balance sheets, income statements, cash flow projections, and a liquidation analysis showing what creditors would receive if you shut down the business. You’ll need an accountant or financial advisor or turnaround specialist to help you with these numbers. And before you do all that work, you need to figure out what’s really wrong with the business and whether it can be fixed. Some business problems are fixable. For others, orderly liquidation is the only reasonable response.
The first alternative is an out-of-court workout. That’s where a borrower deals with a creditor directly. No judge is involved. No law decides who gets what. The result depends on who has more bargaining power, the personalities of the creditors, and creativity. A workout can save a lot of money and hassle, but it takes time. Start early, before you’re desperate. Once the judgments are filed, the bank account levied, the landlord starts eviction, it may be too late.
Second, there’s your bank. Your secured lender is the one you need to talk to. It has the first lien on your assets and an owner’s personal guaranty, so it’s in the strongest position. But it also stands to lose the most. And it usually doesn’t want to repossess. The equipment it financed is worth much less than the loan balance, and it’s not easy to sell used equipment. The guaranty won’t help either, because you’re often judgment proof, or might file personal bankruptcy. So ask. Ask for a lower interest rate, for waived fees and penalties, for an interest-only period, for a longer loan term, for an expansion in your line of credit.
Get the lender’s deal put into a forbearance agreement. Most lenders have their own form for that, but you need to make sure it’s written down. You may have to admit that your loan is in default; you may have to give the lender a general release of claims; and you may have to reaffirm personal guaranties. The lender may charge a fee to do that; be sure you’re planning for it. Sometimes the lender will ask you for a guaranty if it doesn’t already have one, or it may require you to meet certain financial benchmarks. Don’t forget about your suppliers, either. If you want to pay back only part of what you owe or want payments stretched out, you need to have the supplier’s agreement in writing, too. A written agreement keeps everyone honest.
Option number three: bring in a turnaround specialist. In some cases lenders insist on this. This is a person who will help turn around your company by stabilizing the business, helping you manage it and provide realistic projections, negotiate with suppliers, landlords and other creditors, etc. Sometimes the big lenders will want you to work with their favorite national firm (they prefer to work with people they have dealt with before). However, a local turnaround specialist may be less expensive and already knows the landlords and suppliers in your town personally. The Turnaround Management Association is a national organization for these professionals, as well as attorneys, accountants and consultants.
The fourth option is a formal arrangement or composition of creditors. What’s an arrangement, I hear you ask? It’s an agreement between a debtor and two or more creditors that the creditors will settle for less than 100% of their claim against the debtor. The creditors forgive the remainder, and agree not to sue while the debtor stays current with payments. As you might guess, the percentage of creditors required to sign on in this case is very high. As a practical matter, there’s no way that a creditor wants to take a substantial loss unless all the other creditors have to take a big hit too. A composition can look like a short Chapter 11 plan, with classes of creditors, terms for each, and a claim form to be filed. Since there’s no automatic stay, however, the creditors all have to agree not to sue. They aren’t common everywhere, either.
Want to close your doors? An alternative to bankruptcy in some states is an assignment for the benefit of creditors (ABC). The company transfers all of its assets to an independent third party, called the assignee, a fiduciary (accountant, attorney, turnaround specialist) who liquidates the property and pays creditors pro rata. You choose the assignee, unlike in Chapter 7 where the trustee is drawn from a list. More than thirty states now have some kind of an ABC statute. The assignee notifies your creditors and sets a date by which they must file claims against the business. Sometimes the assignee will briefly operate the company to liquidate it as a going concern. ABC is less expensive, more expeditious, and less notorious than bankruptcy, and the assignee may get a higher price for your assets than a Chapter 7 trustee.
But there’s a lot that’s not to like about an ABC. First, there’s no automatic stay. If your creditors are already trying to get their money one way or another by suing you, evicting you, foreclosing on your property, your ABC is toast. Second, an ABC can be attacked as a fraudulent transfer, especially if your property goes for an unusually low price or to people who already know you. Third, disgruntled creditors can still file an involuntary bankruptcy, and if they do you’ll be stuck with that instead. And finally, ABC practice varies widely from state to state, with some states supervising an ABC through and through, while others leave almost nothing to the courts, so you’ve got to check local practice.
Alternative 6. A receiver. That’s a court-appointed officer (attorney, accountant or property manager) who takes over and runs or sells your business. Receivers are usually asked for by secured creditors — most commonly mortgage lenders — as part of the collection or foreclosure action. The receiver puts up a bond, inventories your assets, files periodic reports, and has to get court approval on any major decisions, like selling the business. But a court can approve a sale in a matter of a few weeks, while even a quick bankruptcy sale may take months. And depending on state law, the buyer may or may not get clean title.
None of this is risk-free. There’s no automatic stay, so creditors can still come after your bank account. There’s the risk that a cranky creditor will file an involuntary bankruptcy against you. Then some of those deals might be unwound. Any payments made before the filing could be attacked as preferences. Plus any money you’ve already spent on legal fees will have been thrown away. Involuntary petitions are usually filed by creditors frustrated by poor communication because they think the insiders are bleeding the company. The fix: explain everything. Bring all your creditors into the loop.
When it comes time to restructure the debt, you’ll sometimes find bankruptcy is still the only way out. If the owners have pledged assets whose value is far less than the debt burden, and the secured creditor won’t renegotiate outside of the bankruptcy court, you may have no choice. Otherwise most of these workouts, compositions, ABCs, and receiverships all run under state law, and each is fairly flexible. They can be tailored to your situation, and they’re faster, cheaper and less embarrassing than bankruptcy. But the rules and customs vary widely from state to state, so you need to know what’s in use around where you operate. And don’t wait until it’s too late, either.
