If your business is drowning in debt, many entrepreneurs choose to simply negotiate with the creditors. Others file Chapter 11. Both approaches have benefits and drawbacks. The main difference is that Chapter 11 is a legal process that involves filing in federal court and requires approval by a bankruptcy judge. Business Debt Settlement involves an agreement between the business and the creditors and is usually less expensive. Chances are that an out-of-court restructuring is best for you, if you can pull it off. Whether you can depends on how liquid your business is, how complicated your debt is, and how good your relationship is with your creditors.
Best Candidate for a Negotiated Settlement
Your cash position is always the starting point. What cash do you have available right now to pay your bills? If you have some cash, be realistic about how much and how long it will last. Time takes money, whether a business is paying creditors or avoiding paying creditors. Either way, the bill keeps accruing. As long as a company has time (and money), a negotiated settlement is cheaper than Chapter 11. When there is no time (and no money), Chapter 11 may be the only option. If you have minimal cash and many bills due, you may want to consider bankruptcy sooner rather than later.
In simple terms, the more creditors you have, the more difficult it is to negotiate a deal. If there are only a couple of big ones, it’s easier to put together an agreement. Having a lot of small creditors complicates things. In a bankruptcy, the judge will decide whether to approve or reject the company’s plan. But in a negotiation, everyone has to agree. You have to get unanimous approval of all of them, including banks, vendors and trade suppliers. One person who doesn’t agree can sink it.
Relationships count. The best candidate for a negotiated settlement is a company that has good relationships with its creditors. Everyone must agree on why the business is failing and what can be done about it. A favorable credit relationship makes it easier to strike a deal, while a bad relationship makes it harder.
Settling Has Real Advantages
If those pieces are in place, settling has real advantages. Compared with a Chapter 11 filing, a negotiated settlement is cheaper. Moreover, it is more flexible since it is not bound by the constraints of the Bankruptcy Code. Most out-of-court restructurings will take six to nine months, sometimes less, while Chapter 11 cases average between nine and twelve months. Then there is privacy. Chapter 11 is a public process, and putting a company into bankruptcy is a very visible decision. In a negotiated settlement, the negotiations are private. It is even better at protecting the business’s reputation with customers and employees. If a company manages to restructure without going into Chapter 11, that means its creditors have faith in the business and its management. They consider the problems to be temporary and fixable. Otherwise, they’d insist on the added security of filing a Chapter 11 case.
That points to the downside. Settlement gives you no automatic stay. Outside of bankruptcy, a company remains exposed to creditor enforcement actions. Creditors can move to collect what they are owed, and you will still be exposed to lawsuits.
A Chapter 11 Filing
The automatic stay that kicks in with a Chapter 11 filing immediately freezes all your creditors from taking any action against you, including lawsuits, so you can regroup. It does not take a judge to enter a stay. It is automatic upon filing the petition. Because the bankruptcy judge is also charged with approving the plan, this gives you a boost in credibility. Chapter 11 allows a business to break contracts it otherwise couldn’t get out of, such as some leases or agreements with franchise companies or with people who own equipment the firm rents, along with some license agreements. For retailers, this can be worth a lot of money. In addition, if the business is no longer viable and must be sold, the buyer wants to buy in Chapter 11, as it ensures the business will be sold free of its other obligations. Creditors, too, often prefer to deal with a company in Chapter 11 in that situation, because they get the court’s protections.
But the protection comes at a price. There’s the lawyer’s fees to pay, and of course the court filing fees, along with other professional fees. Restructuring in court takes longer because of all the bureaucracy of the federal court system. Chapter 11 requires lots of paperwork, like monthly financial reports and budgets, and technology today makes this information easy to get for the public and others interested. Plus, Chapter 11 is a formal legal proceeding before a U.S. bankruptcy court. The rules and procedures are tight.
So which is right for your business? Every Chapter 11 case is different, and no two are alike. It depends upon the facts. Both out-of-court and in-court restructurings are designed to give a troubled business a chance to get back on its feet. Solutions for managing an impaired business effectively and efficiently are available, yet they require commitment and forward-thinking on the part of the business owner.
