07 Jul How is a Chapter 11 Bankruptcy Different than a Workout?
I was talking with a management consultant who has worked for years with small- and mid-sized businesses who were facing financial hardship. He has helped many turn around, and seen others fail. Although he had a sense of what Chapter 11 bankruptcy was, he did not understand what it did for a troubled business and why it was an important tool that could help some small- and mid-sized businesses survive economic downturns.
There are several protections Chapter 11 bankruptcy offers a business that are just not available to businesses that are trying to deal with financial hardship outside of bankruptcy:
The Automatic Stay: The moment a business files for bankruptcy, the automatic stay kicks in. The automatic stay prevents creditors from taking any actions to collect on their debt. That means that businesses involved in bruising litigation or facing collection efforts by judgment creditors get an immediate reprieve. While these issues will ultimately need to be dealt with in a Chapter 11 plan, a business can get breathing room to make the decisions it needs to reorganize.
Reject Contracts: A Chapter 11 debtor can reject unfavorable leases or contracts. This allows a business to downsize, get out of above-market rents, close locations or negotiate more favorable deals with new suppliers.
“Cram Down” Loans: Secured loans can be “crammed down” to the value of the collateral that secures them, and new interest rates set.
Accumulate Cash: The Debtor can stop making payments on pre-petition debts, allowing it to accumulate a surplus that can help the business afford the cost of its bankruptcy and strengthen the business after bankruptcy.
Reorganize Debts: One of the most powerful features of Chapter 11 is the possibility of paying a greatly reduced amount to unsecured creditors, and paying that over time.
Debtor-in-Possession (“DIP”) Financing: The Debtor can sometimes borrow funds through a Debtor-in-Possession or DIP loan that will put the new lender in a “super-priority” position ahead of existing lien holders.
While some troubled businesses can turn around outside of bankruptcy, Chapter 11 bankruptcy offers additional tools that can make the difference between success and failure. Although the costs of Chapter 11 (attorneys’ fees, quarterly fees to the Court, sometimes even creditors’ committee fees) are high, for many businesses the benefits of the unique Chapter 11 tools outweigh them.
Deciding whether Chapter 11 makes sense for a troubled business is not an easy or obvious decision.