Business owners in financial trouble are quick to assume bankruptcy is the only option. They can be correct, but they may not be. Bankruptcy is not the only path to restructuring, preserving some degree of stability, or facilitating an orderly wind-down. Yes, Chapter 11 reorganization and Chapter 7 liquidation are possibilities, but they’re not necessarily the only way to achieve your goal of getting the company back on its feet. And while there are many merits to bankruptcy (I won’t repeat them here), it’s also expensive, time-consuming, and can hurt both parties to the transaction (i.e., creditors and debtors). For creditors, that means they may not receive as much as they were owed and in the case of Chapter 7, the business may be shut down completely.
There are a number of non-bankruptcy alternatives, each with their own merits and flaws. Four that may be helpful to examine are receivership, assignment for the benefit of creditors, UCC Article 9 sales, and compromises with creditors (the so-called “out-of-court workout”). The last of these is business debt negotiation, and it’s the one that most directly answers the question in the title. The difference between business debt negotiation and bankruptcy is simple: you avoid filing for bankruptcy, and work instead to negotiate the debt down and come to a resolution with creditors. But the other three are worth understanding first.
Dealing with a Struggling Business
Receivership is a way of dealing with a struggling business that doesn’t involve bankruptcy. A judge oversees running or selling off the company and its assets. A receiver is an officer of the court who holds the property as a custodian and a fiduciary while the receivership continues. The receiver’s mission is to preserve and maintain the property, protect it from waste and conserve its value until the case is finally resolved. In a state court receivership, a receiver is typically appointed at the request of a secured creditor worried that the debtor will waste or impair its collateral. The request for a receiver is a protective measure on the part of the lender.
Assignment for the benefit of creditors (ABC) is a way to liquidate the business without filing for bankruptcy. The company turns all its assets over to a neutral third party, called an assignee, who takes title to them in trust and sells them, paying off the company’s creditors from the proceeds in order of priority. It offers some of the same advantages as a Chapter 7 liquidation, but it can be a lot faster. Both management and creditors get a say in how things will go. Unlike bankruptcy, lawsuits against the company don’t stop. An assignee works a lot like a receiver, using a neutral third party to take charge of assets. But unlike a receiver, the assignee is not necessarily appointed or supervised by the court. The law of ABCs varies widely from state to state: some states have statutes on the subject, others operate under the common law, and a few don’t use ABCs at all. The assignee decides whether to sell assets piecemeal or in a bulk sale. However, the assignee is a fiduciary and must act to maximize the value of the assets for the benefit of creditors.
The third option starts with your secured lender. Under Article 9 of the Uniform Commercial Code, a secured lender can repossess and dispose of the collateral, or retain it to satisfy the obligation. At times a friendly disposition can involve the consent of the debtor, but consent is never required. After a secured party obtains possession of the collateral, Article 9, Section 9-610 allows the lender to dispose of the collateral in a private or a public sale. It can simply take the collateral, sell it, and apply the proceeds to the debt. That sounds like something an owner would fight. For the business, the option of agreeing to give up the collateral and letting the lender sell it can be attractive, particularly where the owner and/or other guarantors want to be released from their personal obligations. Cooperation gives you leverage.
Out-of-court Workout
That brings us to negotiation. We’re talking out-of-court workout, the business reorganizing its balance sheet in a way that involves direct negotiations with its creditors. It’s not the right answer for every problem. But it’s often efficient and less costly and less damaging than a bankruptcy proceeding. The goal is to negotiate a consensual deal that brings payments — or their timing — into line with the firm’s cash flow. The exact form depends on the situation and on the company’s capital structure. It may involve reducing the principal or extending the maturity, or both, and sometimes issuance of new equity as well. A composition is a case in which a number of creditors agree that each will take a specified amount (maybe spread out in time) in full satisfaction of their claims. The similar exchange offer involves a single class of creditors – maybe bondholders or a group of lenders.
The first challenge is always getting your creditors to come to the negotiating table. Why should they accept an offer that’s less than a full payment? One incentive may be to provide the company with breathing room to improve the business, a chance to get back on its feet so your creditors get paid. Remember that bankruptcy can leave creditors with less than they were owed, too. Debtors get to deal directly with their creditors, not the bankruptcy court. A debt workout frees you up to run your business instead of staying alive in bankruptcy court.
Bankruptcy Has Its Place
Bankruptcy has its place, but it’s not the only option or always the best one. Bankruptcy costs time and money. A receivership, an ABC or an Article 9 sale can be the right tool in the right case, but each one is mostly about what happens to the assets. Negotiating directly with creditors is different. It’s about keeping the business running and matching the debt to available cash. It’s not always a viable option, but it’s worth trying and you should explore it. Some owners have filed believing they had no choice, when in reality they had other options that they had not explored. Before filing for bankruptcy, business owners should at least consider the alternatives and consult with a professional who works with creditors. If you have more questions about how debt negotiation can help your business, give us a call.
