It’s daunting and alarming to know that your business is being targeted by debt collectors and creditors demanding payment. And it can be a cruel reality to realize that you or your business can’t handle a structure of debt obligations anymore. What’s a business owner to do in a situation like this? If you want to keep the doors open, it looks like you have two options: an out-of-court restructuring, usually called a workout, or Chapter 11, which for many smaller companies means Subchapter V. There are different ways you can restructure your business. And they all have advantages and drawbacks. Here is how the two compare.
A Negotiation with Your Creditors
A workout is just a negotiation with your creditors about debt reduction or getting more time to pay so you can pay what’s still owing going forward. Sometimes it’s called an “out-of-court restructuring.” It’s a way to stay out of the more complicated, formal and costly Chapter 11 process. It could be a simple workout involving just one or a few creditors. You bring in a seasoned restructuring lawyer, and can get back to running your business. Or it could be a very complex workout that involves hundreds of creditors. Here, you need a team of pros, all with different skills and talents.
Here is the part owners don’t expect. If all you have to say to your creditors is that you can’t pay them, why would they negotiate? In nearly every workout, it’s the credible threat of Chapter 11, implicit or explicit, and the creditor’s likely treatment in a hypothetical Chapter 11 case, that causes creditors to reach a deal. In other words, the workout happens “in the shadow” of Chapter 11. Chapter 11 is a tool used by the company to put pressure on the creditors to make a deal. That is why bankruptcy comes up even when the whole point is to avoid it, and why the person running your workout should be a highly skilled Chapter 11 attorney.
Chapter 11 Bankruptcy Filing
Subchapter V is a path within Chapter 11, so what follows applies to it. A Chapter 11 bankruptcy filing is a complex legal proceeding. No company enters Chapter 11 because it likes to, but when survival is on the line it can be the difference between future strength and liquidation. Filing gives you instant relief called the “automatic stay,” which stops nearly all lawsuits, collection actions and payments on debts from before the filing. This means businesses in litigation or facing judgment creditors get an immediate reprieve. The issues will still have to be dealt with in the plan. You now have the time and breathing room to assess profitability, make operating decisions, and design your reorganization plan. In most other respects, it is business as usual.
You can stop (and are often required to) paying pre-petition debts. This builds cash to fund the Chapter 11 process, the plan, and your future profitability. Once approved, the reorganization plan (which could eliminate debt, change payment terms and resolve all manner of disputes) becomes the new contract between the company and its creditors. The company emerges from bankruptcy with clear and manageable obligations.
There are also things you can do in a Chapter 11 bankruptcy that you can’t do in a workout. You can break leases or contracts: you can get out of bad leases (because the rent is too high), you can shut down a store or factory, you can renegotiate a contract. You can ”cram down” a secured loan to the value of the collateral that the loan is secured by. The interest rates can be set at new rates as well. Unsecured creditors can be paid a greatly reduced amount, over time. And the debtor may sometimes be able to borrow money in connection with the bankruptcy under a ”DIP loan” which puts the lender in a ”super-priority” position, ahead of existing lien holders, which gives lenders a strong reason to put new money at risk.
None of that exists outside of court. In contrast, out-of-court restructuring does not have the automatic stay protection, so creditors can still pursue collection actions. If one or more of your creditors chooses to pursue you for payment, they are free to do so. And the agreement you reach is voluntary: It only works if the creditors agree.
The Right Decision
So which should you choose? In most cases the right decision involves a significant determination that you must make based upon a number of factors. Of course, the first thing you should know is that a workout and a Chapter 11 case aren’t mutually exclusive. Often a company tries a workout first and files for Chapter 11 only if the workout fails. Some troubled businesses do turn around without bankruptcy. However, there are certain tools available under Chapter 11 that may make the difference between success and failure. The “costs” of Chapter 11 (namely, filing fees, legal fees and the U.S. Trustee’s quarterly fees, and maybe even creditors’ committee fees) are considerable but, for many businesses, well worth it.
At Delancey Street, we are a business debt settlement company, not a law firm. We negotiate with merchant cash advance funders, lenders and other creditors for less than the full balance owed. When bankruptcy, such as Subchapter V, is the better path, we refer you to a vetted independent attorney, and we tell you so on the first call, which is free and confidential.
