If you own a business and the debts are piling up, the word bankruptcy has probably crossed your mind. More than 20,000 companies file for bankruptcy every year. Sometimes, bankruptcy is not your only option, and at other times, it may be your best option. At Delancey Street we are a business debt settlement company, not a law firm, and we negotiate with funders and lenders on behalf of owners every day. But if you decide you have to take that route, it’s good to know how things work. Here are eight things worth understanding first.
The first thing to know is that bankruptcy is not a “get out of jail free” card for a business that is under water. The bankruptcy system balances the rights of the debtor with the rights of the creditors. It is not perfect and sometimes seems unfair.
Second, bankruptcy carries a pretty negative connotation, and for good reason: when a company files, it is almost always because they do not have enough money to pay everyone they owe. But the bankruptcy system tries to make the best of a bad situation: By making everything transparent and encouraging the parties to work out a deal, bankruptcy has the potential to preserve value and bring everyone together. Both Delta and General Motors were able to reorganize in bankruptcy. So, despite all of the stigma surrounding the process, bankruptcy does have the ability to bring the parties together and bring a business back from the brink.
Liquidation or Reorganization
The third thing to know is how the money gets sorted. The bankruptcy code constructs a kind of ’estate’ of all of the assets of the company. Then it sorts the claims against that estate by priority. Then it distributes the assets according to that sortation. How that plays out is in large part determined by which type of case the company files.
Fourth, large business debtors have two choices: liquidation or reorganization. Chapter 7 is a final exit. The company’s assets are sold, the proceeds are distributed to creditors (subject to certain prioritizations), and the corporation goes out of business. Chapter 11 is a reorganization bankruptcy. The debtor may sell some or all of its assets, or it may offer a plan to pay and settle with enough creditors and bring the company out the other side as a going concern.
Fifth, Chapter 11 can work. For example, United, Delta and American Airlines all went through Chapter 11 in the mid-2000s and shed enough debt to survive. More recently, Sears, Pacific Gas and Electric and Toys R Us have all reorganized under Chapter 11. Once the plan is final and the court approves it, the company emerges from bankruptcy and continues as a going concern, usually in a stronger position than when it entered.
Time and Space
Sixth, bankruptcy gives every debtor at least two valuable things: time and space. Once you file for bankruptcy, the automatic stay begins immediately. Think of the automatic stay as a pause button that temporarily stops creditors from collecting debts, suing, and other collection-related actions. Creditors can request that the court lift the automatic stay, but they often have a high bar to meet. The goal is to give a debtor breathing room so it can decide on a real plan of action.
The seventh thing is the reach of the court. The court in the bankruptcy case has broad authority over any matter affecting the property of the debtor’s estate. This means that even the claims that aren’t closely connected to the bankruptcy itself fall under the bankruptcy court’s jurisdiction. In addition, the debtor can file a request to the bankruptcy court asking that any lawsuits against the debtor that don’t arise out of the bankruptcy itself also be put on hold, provided that the lawsuit has an effect on the assets in the estate. By getting all the interested parties around one table, the debtor is able to efficiently manage all the claims against the estate. The debtor then turns its attention to fixing all the problems that got it into trouble and makes the changes it needs to succeed going forward after reorganization. This includes the selection of contracts to assume and contracts to reject. Good debtors try to negotiate a global settlement with as many interested parties as possible, avoiding confrontation when they can, and offering ‘sweeteners’ to creditors on the fence.
The eighth point is one of the things that people forget: all of that power is balanced by strong creditor protections. The debtor has to publicly file details on all its assets and liabilities, sit for a bankruptcy deposition with creditors, and get court permission before doing many things outside its regular course of business. For an owner, that transparency cuts both ways. Everything you owe, every encumbrance on any asset, every lawsuit is now coming out of the bag. Having the right counsel, advisors and outside help can mean the difference. There are other checks, too: the unsecured creditors’ committee and the U.S. Trustee. If the creditors think that the debtor is not able to conserve the value of the estate, they can petition the court for an examiner or a trustee to take over the estate. They can even try to dismiss the case if they feel the debtor is taking advantage of bankruptcy. The debtor may be in the driver’s seat, but they’re only driving with the other stakeholders in the car to make sure they stay on the road.
Sustainable Way Forward
So what does all of this mean for you? Bankruptcy is a serious, court-supervised process, and it is not for the faint of heart. But it may be a valuable option for your business. It can give you a space to breathe and protect you from collectors while you get a firm grasp on the realities of your situation and see if you can create a sustainable way forward. If you are the owner of a company that is facing insolvency and looks like bankruptcy is a possibility, it’s a good idea to have a lawyer who understands the process. At Delancey Street we are not that lawyer, but when bankruptcy, such as Subchapter V, is the better path, we say so on the first call and refer you to a vetted independent attorney. If you don’t want to go through all of that, and you’d like to settle what you owe outside of court, that is what our senior advisors do: negotiate with your funders and lenders for less than the full balance. The first consultation is free and confidential.
