Bankruptcy as a tool for survival
What is bankruptcy?
It doesn't necessarily mean "it's over". It can be a valuable tool to buy time and restructure your business for future success. It's appropriateness depends on each unique situation. Call to discuss if it makes sense for you to consider.
It may make more sense because of a recent amendment to the bankruptcy code called the Small Business Reorganization Act.
The bankruptcy law provides two paths for insolvent* organizations:
Chapter 11 provides a mechanism for reorganizing the business with the goal of emerging from bankruptcy as a stronger, solvent business, able to carry on its operations. Upon filing, all creditors are “stayed” (stopped) from attempting to collect what they are owed other than through the bankruptcy process. Thus all creditor’s calls, nasty letters, and legal collection actions will cease. Management continues to operate the business as a so called “Debtor in Possession”, under the supervision of the bankruptcy court. This gives the debtor company the time needed to reorganize. Upon emergence from Chapter 11 by a confirmed Plan of Reorganization, the creditors have no further claim other than as agreed to in the Plan, which is often much less than their original claim.
Chapter 7 provides for the liquidation of all assets with the proceeds being distributed to the creditors according to the priorities of the bankruptcy code. Upon filing, a trustee is appointed to carry out the liquidation, and management has essentially no further role in the business. While creditors have the ability to force a for profit business into Chapter 7, that is not true for a nonprofit. Upon completion, creditors have no further claim on the organization, providing a clean wrap-up of the business with (if done properly) no lingering liabilities. Note: this does not absolve management or board members from any personal guarantees or personal responsibility for certain unpaid taxes, such as employee withholding and sales taxes.
Why to use Chapter 11…benefits
- Automatic Stay provides temporary relief from collection actions
- Opportunity to restructure balance sheet, reducing debt to a manageable level in order to continue to successfully operate
- Opportunity to merge and/or sell assets
- Ability to reject (or transfer) any undesired contracts, including leases
- Ability to close any no longer viable operations in order to preserve the whole
- Protecting the board and management from liability related to difficult business decisions, since all material actions need to be approved by the court.
Why not to file bankruptcy…negatives
- The “stigma” attached, especially to customers. This has significantly lessened in the last few decades, with many major companies successfully emerging from Chapter 11, and it’s likely that the reality of the current crisis will further remove any stigma
- The cost. Bankruptcy is legally and process intensive and therefore expensive. The motivation for the Small Business Reorganization Act was to provide a restructuring alternative that would actually work for small companies by making it cheaper, faster, and less complex.
- The drain on management time and resources. The complexity of Chapter 11 often means that management has difficulty managing the business while simultaneously managing the unfamiliar bankruptcy process. A Chief Restructuring Officer (CRO), working closely with top management and the bankruptcy attorney, can manage the bankruptcy and relations with creditors, freeing management time to actually run the business.
The decision as to whether to file bankruptcy is primarily a business decision (will the benefit outweigh the cost?), although an excellent bankruptcy attorney is critical to a successful outcome.
If you have considered filing bankruptcy or would like to discuss if it makes sense for your company, contact us.
* The terms “insolvent” and “bankrupt” are often used interchangeably, which is technically incorrect. An organization is often insolvent long before filing bankruptcy in the federal court, which in fact it may never do.
An organization is “insolvent” when it either cannot pay its bills as they become due, or its liabilities exceed its assets. The Covid-19 crisis followed by significantly higher interest rates drove many organizations, large and small, for-profit and nonprofit, into insolvency. When the crisis abates, insolvent organizations will either find a path back to successful, solvent operations, or cease to exist.