Sometimes a business is just overleveraged, or the economy dries up. You find yourself in 2026 with an overleveraged business, behind on your payments to the bank and thinking about your options. Article 9 of the Uniform Commercial Code, which provides for a cooperative out-of-court reorganization, might be an option. It preserves the business operation, which continues in a new, debt-free entity. Bloomberg Businessweek covered this process in August 2020. So is it an option for you? The answer is often yes.
The typical Article 9 reorganization is an asset sale, done by agreement between the business owner and the bank. The company’s business assets, along with its operations, are transferred to a new legal entity with a clean balance sheet. All debt stays in the original, insolvent company. This separates the business from the debt that threatened it, and gives it a clean second chance to get back on its feet.
The Bank Does Not Want to Liquidate the Debtor
We know that you’re in distress and you’ve probably assumed that the bank wants to squeeze every last dollar out of you and that there are only two options: bankruptcy or shutting down. It sounds counterintuitive, but one of the reasons a bank might cooperate with an Article 9 reorganization is because the bank does not want to liquidate the debtor. Just like business owners, banks also want to get paid as much as they can. When it comes to a reorganization under Article 9, the worst-case scenario for the bank is a liquidation of the assets. But a liquidation will net the bank very little for the used business assets. The bank will have to put considerable time and money into auctioning off those assets, and the proceeds will be nominal at best and highly uncertain. For these reasons, a bank may prefer to make a cooperative deal.
It rarely ends there, either. Once a company has been liquidated, it’s very likely there’s still a “deficiency balance” owed to the creditors. And that deficiency will likely be personally guaranteed by the original owner who, after liquidation, must either pay the deficiency personally or file for personal bankruptcy under Chapter 7. Because the guarantor is likely insolvent, the bank gets very little out of the guarantee; often, the defaulted loan has already been charged off to a third-party debt collection agency, and the creditors will recover little more than a few pennies on the dollar. The forced liquidation of a used business is generally a very bad deal for a bank. So why not find a way to work out a deal?
Article 9 serves as a compromise between the lender and the borrower. The debt is removed from the business, so the guarantor continues to earn. Personal guaranties of business loans that are removed from business can be settled for an amount the owner can afford but that is more than the bank would get in a closure and liquidation. The creditors get more than they would recover in closure and liquidation; that is why the process is cooperative.
Alternative to Bankruptcy
Don’t be confused by the term “bankruptcy.” Article 9 debt relief is not a bankruptcy. It is an alternative to bankruptcy. It doesn’t happen in court, and it doesn’t require the services of a lawyer. It is a negotiation between borrower and lender. A reorganization under Article 9 is just that: a reorganization. The borrower’s business continues to operate.
The purpose of a Chapter 11 reorganization is to keep a small business alive and repay its secured creditors in full. The company files a plan with the court that lays out how it will repay its debts over a period of five years. This is a chance for an overleveraged company to get a second opportunity, and allows the creditors to recover. However, this process does not work well for small and medium-sized businesses because of its expense, the time it takes, and the fact that the company loses control over its business.
In fact, about 90 percent of all small and medium-sized businesses that try to reorganize under Chapter 11 eventually fail, get kicked out, and are often converted to Chapter 7 liquidation. So the worst possible outcome for a bank is that a borrower has tried Chapter 11 and now it has to go back to liquidation. It’s spent time and money, now it has to spend more. In Article 9, the bank and owner work together to solve the problem.
A Bargain for All Concerned
In a sense, we can think of the Article 9 reorganization as the bank selling the business assets to the new entity instead of at auction. The auction results in the end of the business. When assets are sold into a new operating entity instead, the business continues. A business that keeps running keeps producing value, and that is how even the creditors come out ahead. Article 9 is a bargain for all concerned.
Some liabilities are left behind, of course. The debts you personally guaranteed, and any other unsecured debts, stay behind in the old entity. So do vendor debts. Since you still have your business and your earning power, your creditors can get more of their money back by settling with you for a reasonable amount than they can get from liquidation. Vendors keep a customer relationship, employees keep their jobs.
So, 2026’s overleveraged owner should consider Article 9 debt relief. The cooperative solution preserves the business. It benefits both the owner and creditors. Article 9 developed as an alternative to bankruptcy, a process that has failed both creditors and owners, most of the time. The business survives and is renewed, and the creditors recover more than they would in liquidation.
