Every business owner faces a harrowing moment when they discover that their debts exceed their assets or that they cannot cover payments on time. You are looking for a way to pay these debts or give them up without the drama and uncertainties of filing bankruptcy. Like most entrepreneurs, you probably assumed that bankruptcy is the only available option for a business in so much financial trouble. As you will see in a moment, this is not so.
As a rough summary, a Chapter 11 is a “reorganization” of debts whereas a Chapter 7 is the “liquidation” of a business. Bankruptcy, in and of itself, is not a bad option, however there are other options that you should consider before you pursue bankruptcy. In addition to the fact that bankruptcy is a costly process, there are some instances in which, in my opinion, it does more damage to the two parties on either side of the equation, the creditor and the debtor. There are several alternatives to bankruptcy, and each one comes with a tradeoff: receivership, assignment for the benefit of creditors, a UCC Article 9 sale, and a compromise with your creditors (often called an out-of-court workout). I would like to take you through each option to better understand what is involved.
The Simplest Approach Is to Negotiate Directly with Creditors
The simplest approach is to negotiate directly with creditors. A workout is an out of court restructuring of the balance sheet, typically between the business and the business’ creditors (some companies hire a consultant like us to intervene, but you don’t have to). If you have a business and you’re in trouble, don’t be afraid to go talk with your creditors and negotiate your terms. The beauty of a workout is that, if it can be done, it is more efficient and less expensive than bankruptcy and does less damage to the business. The idea is to reach a consensual compromise, adjusting obligations and/or timing of payments to match cash flow. You will most likely have a reduction of principal and/or a maturity extension, and maybe the issuance of new equity. The exact shape depends on what went wrong and how the business is financed.
In a composition agreement, all the creditors agree to take some amount, perhaps on a schedule, to fully satisfy the debt. Exchange offers are similar, but refer to a specific class of creditors, such as bondholders or a specific class of lenders. Be open about your situation and try to reach an agreement that works for both sides.
The Next Three Options Sound More Formal
If a workout is not realistic, the next three options sound more formal, but they do not require a bankruptcy filing. The first is receivership. I know this is a scary word for business owners. Receivership is simply the court-supervised operation or liquidation of a business and its assets. The court appoints a receiver, an officer of the court who holds the company’s property as a custodian and fiduciary while the case is pending, to manage the assets of the company to preserve their value and keep them from being wasted. In state court, the request usually comes from a secured creditor fearing its collateral will be dissipated or harmed by the business.
The second is an assignment for the benefit of creditors, or ABC. Here the business transfers all its assets to an independent party who takes over title to the assets, liquidates them, and pays creditors according to their priority. In many ways it is very similar to a Chapter 7, except it is quicker. Both the managers and the creditors have a say as well. The difference in an ABC is that litigation does not stop. Also unlike a receiver, the court does not necessarily appoint the assignee. The rules also vary: some states have statutes governing this process, some follow common law, and some don’t use it at all. You need to make sure your state permits it before going forward. The assignee has a fiduciary duty to the creditors to do his best to maximize the distribution.
The third is a UCC Article 9 sale. Under Article 9 of the Uniform Commercial Code, if the lender is secured, it can repossess, sell and, in some cases, retain the collateral in satisfaction of the debt. The secured party can do this with the borrower’s consent, such as in a friendly repossession, but it does not have to wait for the borrower’s consent. Once it has the collateral in hand, the secured party can sell it at public or private sale under Section 9-610. The borrower’s consent to the surrender of the collateral and to the sale may provide the borrower some important leverage, especially if the borrower or other obligors like guarantors have the goal of removing any personal liability.
All of These Methods Have Advantages and Disadvantages
All of these methods have advantages and disadvantages; so it’s important to know which one is right for your business. No one approach is invariably correct; each has benefits and drawbacks, and each can be advantageous to the stakeholders over a traditional bankruptcy filing. Before you file, consult with an attorney or other advisor familiar with these topics. And always know your options.
