What are the alternatives to bankruptcy for a struggling business?

When businesses begin to slide into serious trouble, they typically consider bankruptcy. However, bankruptcy is not the only answer. Depending on circumstances, it can be one of the most expensive, least attractive paths to restructuring, stabilization or an orderly wind-down. Any kind of bankruptcy, whether a Chapter 11 reorganization or a Chapter 7 liquidation, can be slow, costly, and damaging to both debtor and creditor alike.

Before a troubled business files for bankruptcy protection, there are a number of alternatives it should investigate. Each option has benefits and drawbacks, but they can serve the business and its creditors better than a bankruptcy filing.

At a minimum, a troubled business should consider four non-bankruptcy alternatives: a receivership, an assignment for the benefit of creditors, a sale under Article 9 of the Uniform Commercial Code, or a workout, in which the business persuades its creditors to ease off its debt.

A receivership appoints an officer of the court to run or wind down the troubled company and its property. That person may wind down or liquidate the company or try to manage it back into the black, depending on the court’s orders. The receiver is a custodian and fiduciary who steps in to run a business in order to prevent waste and preserve value until the court rules. Typically, you will see a receivership if a secured creditor is fearful its collateral will be dissipated, damaged or threatened. A secured creditor like this will normally seek this kind of relief in state court.

Assignments for the Benefit of Creditors

Up next are assignments for the benefit of creditors, or ABCs. In such an arrangement, the troubled company or debtor gives all of its assets to a neutral third party. This person or entity then liquidates those assets and pays creditors according to their priority. ABCs borrow some of the advantages of a Chapter 7 liquidation or a sale under section 363. Though they tend to be faster and simpler than bankruptcy, they also allow some input from management and creditors in the sale. Unlike a receiver, an assignee in an ABC need not be court-appointed or supervised. However, a big disadvantage of an ABC is that it does nothing to prevent litigation. Creditors can still sue for their debts during the process.

State law varies widely on ABCs: they work under a crazy quilt of state statutes and judge-made law, and several states don’t use them at all. Whether or not the courts supervise the assignee varies from state to state. Assignees can sell a debtor’s business piecemeal, through individual sales or a bulk sale. The assignee is a fiduciary who has a duty to maximize the recovery for creditors.

A Sale Under UCC Article 9

A UCC Article 9 sale is for secured creditors. The creditor may repossess collateral, sell it, or keep it as satisfaction of the debt. In more friendly cases, the creditor would act with the debtor’s consent, but consent is not needed. Under section 9-610, a secured creditor can hold a public or private sale. If the debtor does cooperate, it will tend to have more leverage, for instance to get the owner or other obligors released from personal liability. A sale under UCC Article 9 can be attractive to a distressed business.

A Workout

The last option is the workout, a non-bankruptcy restructuring of the business’s debts. Restructuring directly with creditors is not always realistic, but when it does work, a workout can be more efficient, cheaper and less damaging than bankruptcy. The goal of a workout is a consensual deal that changes how much or when the business pays so payments match its cash flow.

The shape of a workout depends on the kind of debt a business owes, and the kind of distress it’s in. One route is a composition agreement, an arrangement between a debtor and several of its creditors; each agrees to take a specified sum, perhaps to be paid later, as full satisfaction of its claim. An exchange offer is similar. But, rather than making the same offer to everyone, the debtor targets one class of creditor - e.g. bondholders or term lenders.

The biggest upside to a workout is that it avoids the time, expense and publicity of a bankruptcy. The downside is that non-consenting creditors can’t be bound. There is no automatic stay, so creditor litigation may be difficult to stop. There is no right to reject burdensome executory contracts.