Chapter 11 bankruptcy means going to court, being subject to federal bankruptcy law and following specific procedures. Often called a “workout,” out-of-court restructuring is not a bankruptcy proceeding. Instead, it is an informal agreement reached directly between your company and your creditors. Both court-supervised and out-of-court restructurings allow your company and your creditors to agree on a mutually acceptable plan to reduce or restructure your company’s debt obligations. When a consensual workout is possible, it is usually the better result. Whether it is possible comes down to a few questions.
How Much Cash
The first is cash. Before assuming you can do an out-of-court restructuring, you must consider how much cash is left in the business. If there is only minimal cash left, a consensual restructuring is unlikely and the company will most likely have to file. The main risk with an out-of-court restructuring is that the company could run out of cash before the restructuring agreement is finalized. If your company does have some cash on hand, the way forward depends on the level of debt you have and how complicated the restructuring is likely to be.
Think about who you owe. A company with one bank loan and a handful of suppliers will probably have an easier time negotiating an out-of-court restructuring. If a business has multiple banks, an array of suppliers and other creditors, it probably needs to consider the comparative advantages of Chapter 11. The reason is simple: a workout is voluntary and means you will have to reach a consensus with each of your creditors, and the more of them there are, the more likely one says no. A workout also depends on goodwill. Your lenders and major suppliers have to agree with you on what went wrong and how to fix it, and that is far easier when everyone trusts each other and has a good personal relationship.
A Successful Workout
When it works, out-of-court restructuring is cheaper, quicker and far less invasive. The upside of out-of-court restructuring is its informality and its flexibility. Like any other private agreement, the parties decide what they will do and how they will do it. Because the debtor-creditor negotiations in a workout occur outside of the bankruptcy court, the workout typically takes less time than a Chapter 11 case: six to nine months, often less, against an average of nine to 12 months in court. Unlike Chapter 11, a workout is confidential and doesn’t involve public disclosure. A successful workout is also less likely to disrupt company operations and maintenance of company relationships than is a Chapter 11 filing. And when creditors agree to a workout instead of demanding the protections of a formal bankruptcy, they are saying the business is viable. And that they believe it can get through the difficulties.
The weaknesses are just as real. An out-of-court restructuring can’t force your creditors to agree to a deal. If you can’t reach agreement with all of your creditors, you may be unable to reorganize. In a negotiation between your company and your creditors, however, it is easier for creditors to walk away. There is no automatic stay, so creditors can keep demanding payment on old debts, and if one vendor holds out, you are still stuck with legal action that threatens the life of your company.
Chapter 11 Bankruptcy
That is where Chapter 11 earns its cost. As soon as a bankruptcy petition is filed with the court, an automatic stay will go into effect. In Chapter 11 bankruptcy, the automatic stay deprives creditors of the ability to file lawsuits against your company, or enforce their rights if they already have sued you. It’s a big deal. A debtor in Chapter 11 can also reject executory contracts such as leases, license agreements, franchise agreements and equipment rentals. The power to reject contracts is useful if those contracts are more of a burden than a benefit. In retail the savings can be large. By contrast, in an out-of-court restructuring you may be stuck with the contracts you signed. When a bankruptcy judge has reviewed the case and approved the plan, it is more likely that creditors and other interested parties will find that the terms of the plan are fair. The court’s acceptance gives the plan increased legitimacy and can also be a significant boost to your company’s public image.
Sometimes the numbers show the business cannot survive in its current form. A workout provides you less protection than a bankruptcy, which is why some creditors won’t accept it. Then the best answer may be a sale, and buyers prefer Chapter 11 because they will receive a clean title and not the burden of the company’s old creditors.
Because of all the work and bureaucracy of a formal bankruptcy proceeding, Chapter 11 costs more than a workout. Court fees, lawyers’ fees and the fees of other professionals can add up quickly. The process is time-consuming and requires a significant amount of reporting and paperwork. It can also expose the company’s information to the public, as such proceedings are generally open to public scrutiny. That reporting includes monthly financial statements and budgets. Chapter 11 takes time, because your company must follow all of the court’s procedures and comply with all legal requirements. It is a formal legal setting, not a business negotiation.
Both paths are valid, and the choice depends on individual circumstances and goals. If you want flexibility and the freedom to avoid court, then an out-of-court restructuring might be the best option. If you need protection from creditors or a way out of bad contracts, Chapter 11 may be the better tool. Both methods are aimed at restructuring your debt so that you can maintain your operation and, eventually, regain profitability. The owners who get there are the ones who act early and strategically.
