Owners of businesses that are failing or in trouble often assume bankruptcy (Chapter 11 reorganization or Chapter 7 liquidation) is the only option. It is an option, but may not be the only or best way. Bankruptcy can be a costly, lengthy and drawn out process that’s often unsatisfactory to both shareholders and creditors. Bankruptcy is not a necessary first step, and many businesses can resolve their debts through negotiated or consensual plans.
When a business can’t make its debt payments, there are often non-bankruptcy options to consider, like a receivership, assignment for the benefit of creditors, sale under UCC Article 9, or a compromise with creditors - sometimes called an out-of-court workout. Each has its pros and cons, but all of them are potentially viable solutions that can provide a better outcome than a bankruptcy. No single method of restructuring debt is the best one for every company.
Swift and Flexible Alternative
The first alternative is a receivership. Here a court appoints a receiver, who takes over the management and operation of the company’s assets. The receiver’s role is primarily to preserve the value of those assets pending resolution of the matter. The receiver is an officer of the court who holds the business property as a custodian and fiduciary pending the final outcome of the case. That means preventing waste and working to maximize the value of the assets and protect all parties’ interests. In state court, a receiver is most often appointed at the request of a secured creditor who believes that the property or business is in jeopardy of loss, dissipation, or waste, unless it is taken into the custody of a court.
The second alternative is an assignment for the benefit of creditors, or ABC, where an assignee - a neutral third party - takes title to the company’s assets and holds them in trust. In other words, the business transfers all its assets to an assignee, who then sells those assets for the benefit of the creditors, making distributions based on their claims. An ABC is a liquidating transaction similar to a bankruptcy Chapter 7. The assets are sold in a more streamlined process that takes less time than bankruptcy and has input from management and creditors. One advantage of an ABC is that the assignee typically can avoid many of the procedural hurdles of a bankruptcy by relying on state law. Thus an ABC offers a swift and flexible alternative to a Chapter 7 liquidation. It is not a shield, though. Bankruptcy stays litigation; it freezes all civil proceedings against the debtor. An ABC does not, so lawsuits against the business can go on even after the assets have been handed over.
The rules and requirements vary widely from state to state, so you’ll need to check the relevant state laws. Some states have statutes setting out ABC procedures; others don’t. Of the rest, some rely on common law, some don’t use ABCs at all, and even in those that do, some have court oversight, others don’t. You need to ask questions about how it will work in your jurisdiction. In any state, the assignee has discretion over how to sell the assets, whether through a liquidation or a bulk sale, but the assignee, like a receiver, has a fiduciary duty to ensure that the assets are preserved and maximized, and any distribution proceeds are handled fairly.
The third alternative is a sale under Article 9 of the Uniform Commercial Code. If your business has a secured lender, it likely has a security interest in the assets, and if the lender wishes to liquidate the assets, it can do so by taking possession or control of the assets. Under Article 9, a lender can either retain collateral in satisfaction of the debt or simply sell it and apply the proceeds to the outstanding balance. In the friendly cases, a secured lender can invoke Article 9 remedies with the borrower’s consent — which, by the way, it does not actually need. After the collateral is in its hands, under UCC 9-610 it can liquidate it in a private or public sale. That might seem like a fairly ruthless course, but there’s more to it than it seems. When a debtor consents to surrender the collateral and to the sale, it leaves the debtor with bargaining power in negotiating with the lender, especially when one or more of the obligors want to be released from personal liability. That is an important exit strategy.
Out-of-court Workout
The fourth alternative is an out-of-court workout, in which the business restructures its balance sheet directly with its creditors. Although an out-of-court workout is not always feasible, it can be an efficient alternative to bankruptcy, avoiding its costs and minimizing its damaging effect to the business. It is faster and cheaper, because a workout avoids the paperwork and expense of bankruptcy, even a Chapter 11. It makes sense if it is a viable alternative and the company can get creditors to agree to it. The goal of a workout is to negotiate a consensual deal with the creditors to either change what your business owes or when it has to be paid back so it will match up with how much cash your business can actually bring in. With this approach, you, the business, and your lenders can reach a negotiated solution that is likely more satisfactory to everyone than a bankruptcy would be.
The form a workout takes depends on the nature of the distress and the capital structure of the business. You can negotiate a restructured or reduced debt, or a debt-to-equity swap. This can mean a deferred payment of the full debt, or payment of a percentage of it, or a reduction of the principal balance owed. In a debt-for-equity swap, the creditors agree to take equity ownership of the business in lieu of partial or full payment on the debts owed to them. This reduces the amount of debt outstanding, and the creditors become part owners of the business. When there are lots of creditors, you might ask for a composition agreement where each creditor agrees to accept a specific amount, perhaps on a deferred payment schedule, in full satisfaction of the debt. The agreement binds everyone who participates. An exchange offer works just like a composition agreement, except it is offered to one specified class of creditors, such as bondholders, or a certain group of lenders. There is the potential, however, for a messy and complicated negotiation that may or may not lead to an amicable agreement.
Restructure Its Debt Outside Bankruptcy
So, can a business restructure its debt outside bankruptcy? In many cases, yes. You don’t always have to go to bankruptcy court to resolve your financial troubles. As you’ve seen, there are several other ways to restructure your debt that may work for your company. There are benefits and disadvantages to each method, but all can work as alternatives to bankruptcy. The key question for any strategy is whether it will help the company in the long term. Each situation is different, so you’ll need to consult an experienced lawyer to make sure you understand your options.
