Facing severe liquidity pressures, many business owners conclude that their ‘only option’ is to file bankruptcy. Often they are wrong. A debt re-negotiation is frequently a better alternative. This tool can accomplish many of the same results that Chapter 11 achieves and it does so faster and for much less money. But not always. In this article, we will provide an objective evaluation of the advantages and disadvantages of each.
Start with the odds. The Executive Office for the U.S. Trustee reports that fewer than 30% of Chapter 11 cases filed from 1989 to 1995 had a confirmed plan by the end of 1997. More than 70% of those cases were converted to liquidation or dismissed. Put plainly, if you file, the company probably won’t survive. Even the survivors wait. In 1997, only half of all confirmed cases took 429 days or less from filing to confirmation. According to Lynn LoPucki, large public companies typically take 21 months from filing to disposition, and 13 months if pre-packaged plans are taken into account. That is a long time to live with uncertainty, and it does not come cheap. Meanwhile, bankruptcy costs include professional fees, forms, schedules, and hearings, and the distraction caused by pulling managers out of the business to deal with the case.
Business Debt Settlement
Business debt settlement involves a more proactive approach in which the business has control over its fate. It usually takes one of three forms. A composition occurs when creditors agree to take less than the amount they are owed. An extension is when only the terms of the payment are altered. The debtor gets more time, but nothing is forgiven. A standby arrangement (also known as a moratorium or standstill) is a pause in repayment. For a specified period of time, there is no interest or penalties. These deals fit best when a sound company has been knocked off course by a one-time event and the business owner is simply looking for some breathing room to stay afloat until business improves.
The advantages are real. An out-of-court agreement lets the business continue operating without the time and expense of a court proceeding. It also enables you to address specific problems rather than putting the entire business relationship and the survival of the business itself up in the air. Further, out-of-court agreements are governed by contract law, so they’re pretty uniform across the states. It’s just executing a negotiated agreement. In addition, a debtor keeps more control. In bankruptcy, the U.S. Trustee selects the committee of creditors and/or trustee. In a workout, there are no statutory provisions for the appointment of a creditors’ committee or a trustee. There is no law that says that someone must be placed “in charge” of the company.
The weakness of a settlement is that it binds only the creditors who sign it. A creditor who refuses to go along with the agreement can keep up his collection efforts and sue the debtor, even though the majority of creditors have agreed to it. That is why these deals work best when one key secured creditor holds the vast majority of the security interests and its claims drive what everyone else recovers.
The Bankruptcy Court’s Powers
Bankruptcy, for its part, has tools no private deal can match. The first is the automatic stay, which stops all collection actions against the debtor as soon as bankruptcy is filed. The second is something called a discharge. This frees a debtor from the legal obligation to pay the debts that are included in the bankruptcy case. State law does not relieve the debtor of debts; without bankruptcy, the creditor is only bound if it agrees to accept some amount as full payment of a debt. A bankruptcy can void preferential payments and fraudulent conveyances. Bad leases and executory contracts can be assumed or rejected. The court can also authorize debtor in possession financing over the objections of creditors. A bankruptcy is a single forum to resolve disputes among creditors, and it can reject or limit the amount of professional fees. In short, the bankruptcy court’s powers are incredible. Bankruptcy is preferable where there is an allegation of fraud or where there is an extensive investigation involved.
Which Is Right for You
So which is right for you? If the business is viable and your creditors are willing to talk, a negotiated settlement will usually be less painful and disruptive than bankruptcy. If your business has more problems than assets, or has no hope of continuing, or has criminal or fraudulent undertones, or if the creditors are not in a bargaining frame of mind, it may be best to file. Your first priority is to do a realistic evaluation of your business’s viability and its financial condition. Weigh the chances of a settlement at the very start, because time and money spent on a workout that only a bankruptcy could resolve are gone for good. Neither settlement nor bankruptcy are magical cures to business problems. Picking the right one is half the battle.
