Too many owners jump to bankruptcy before exploring other options. The question usually gets framed as bankruptcy versus reorganization. There are two types of bankruptcy: liquidation (selling the assets and closing the business) or reorganization (restructuring the debts of the business and staying in business). But there is a third path, and in most cases it is the one to try first. A workout is a privately negotiated rescheduling or restructuring of debt without going to court. Choosing well means taking these in order: a workout if one is attainable, Chapter 11 if it is not, and liquidation only when nothing else will work.
Understand that before you can begin your restructuring process, you must organize your books and records, review your monthly obligations, and look hard at where you stand with lenders, suppliers and employees. You will also need to determine just what you owe and what your assets are. Separate secured debt from unsecured, and add up liens, taxes, judgments and anything still contingent. Have business and personal accounts been commingled? Are the books current? In answering these questions, don’t make any extravagant assumptions. This organized snapshot gives you the factual foundation for any decision you make.
Depending on how much you owe and how complicated the problems are, a prepared owner can sometimes negotiate with creditors directly; other times it works better to go through a representative. With the right documentation and a clear understanding of the situation, creditors may be willing to extend the debt, lower the payment amount, restructure payments, or extend the due date. Yes, some or most of the creditors will end up in a reduced position, but this may be preferable to being owed nothing at all. But if you enter this talk without clear answers about your business and your liabilities, you will not get far, and time is short. As a practical matter, you will need advisors to go through the process.
You May Have to Consider Chapter 11
Sometimes, though, a workout is not enough. A supplier may be set on aggressive collections, or a lawsuit or judgment may threaten to close a location or drain your cash. Or creditors refuse to play ball. If the debts are larger, or if the reorganization or reduction is so large and comprehensive that it cannot be handled privately, you may have to consider Chapter 11. This is bankruptcy reorganization, a court proceeding. It makes the most sense when the stakes are high and there are real assets and opportunities to protect.
A Chapter 11 reorganization starts a little like a workout. You look at the balance sheet and start negotiating with creditors for a restructuring. The difference is the court. Under Chapter 11, existing management retains control of the company but is subject to substantial supervision by the bankruptcy court. In contrast, Chapter 7 means that control of the business is completely taken away and a trustee is appointed to oversee the liquidation process. As soon as the petition for Chapter 11 is filed, the automatic stay goes into effect. While the reorganization continues, the automatic stay prevents creditors from executing against the business’s assets, foreclosing on liens, or otherwise collecting on debt. The logic is that a company kept running is worth more than its parts, so in a reorganization its assets are valued based on what they can generate over time rather than their immediate liquidation value.
A Chapter 11 filing puts everything on hold while you propose a plan of reorganization. Any proposed repayment plan must have creditor approval, as well as court approval. In practice, an important part of the reorganization process is refining the proposed reorganization plan to accommodate all the different players. At the end, the debtor can emerge from bankruptcy with a contract that modifies debt and can be enforced, even over the objections of some creditors. Making a successful plan involves factors that can be hard to figure out on your own. Along the way, the company can reject executory contracts and unexpired leases. Office, store and equipment leases, supply deals, credit lines, and labor, pension and benefits contracts can all be on the table. In the largest cases, ownership often shifts from the old shareholders to bondholders and other creditors, who take equity in place of payment.
None of this is quick or cheap. It’s often necessary, but the process can be expensive and the time frame is uncertain. Some cases wrap up in a few months; others take several years, in part because every stakeholder has the right to be heard. Legal fees, professional fees, and management time are all part of the cost of reorganization. It is risky, too. Reorganizations often fail, a trustee may be appointed, and the assets can be sold with court approval. Going into Chapter 11 means preparations and paperwork, and when the case is over, you could still end up out of business. A workout can avoid these difficulties, and is usually the first choice. But what’s the alternative? If you can’t get a workout, if a lawsuit would bankrupt you, or if the creditors simply won’t come to the table, Chapter 11 has benefits. In the right situation it nearly always beats closing the doors: jobs and assets are preserved, and creditors often lose less than in a piecemeal sale.
An Orderly Wind-down
But if there is no reasonable chance of making the reorganization work, it’s time to close up shop. Sometimes liquidation is simply the least-bad option. The aim then is to wind down while doing as little harm as possible to creditors, employees and owners. The owners can agree to dissolve the company, or, if they cannot agree, the owners must petition the court to dissolve the entity. The other route is Chapter 7. If you proceed, the trustee for the bankruptcy case will take over the assets, sell them and distribute the proceeds to creditors. Either way, try to limit how much of the owners’ personal assets are exposed.
So how do you choose? Do what you can before you resort to filing bankruptcy. If the information is organized and clear enough, negotiate a workout with creditors. But if a workout has been impossible, and if the business has valuable assets, benefits and opportunities that make it worthwhile, Chapter 11 can be an option, especially if you can put together the right team to guide you. And if the business simply cannot be saved, or simply cannot be turned around, then it is time for an orderly wind-down. Whether you choose to negotiate your own restructuring or ask for help, the bottom line is the same: don’t delay.
