Alternatives to Filing Chapter 11: What Are the Other Options for Distressed Businesses?
By John Archer
For many businesses, a Chapter 11 bankruptcy filing may not be the best option. The expense of the process is significant, and most companies will not emerge with a confirmed plan. In most instances, if a company does not have financial wherewithal, with some amount of unpledged assets or equity, they will not be able to propose a plan that will garner approval by creditors and the court. They will likely spend their remaining resources fighting to retain control of their business and avoid conversion to a Chapter 7 liquidation. In light of this reality, what are some alternatives to Chapter 11 that distressed companies can consider to keep the business alive?
CASH MANAGEMENT PROCEDURES
Implementing cash management procedures to reign in non-essential spending will causes businesses to take a hard look at their operations. Evaluation of expenditures related to credit cards, marketing, travel and other non-essential spending may help control expenses and free up capital. This will also help companies focus on their core business and determine whether their financial problems are related to a single event or more fundamental problems.
COMMUNICATION WITH SECURED LENDER & POSSIBLE WORKOUT
For a distressed business, the largest threat is likely its secured lender who has the ability to foreclose on pledged collateral in the event of default. Banks, however, are not always quick to initiate court action to enforce their rights. Litigation can be an expensive and unpredictable process. Many lenders would much rather offer forbearance and give their borrowers an opportunity to seek alternative financing, secure a bridge loan or perhaps restructure management. Amending loan terms is also a possibility and banks can be willing to engage in a workout process with a borrower if the alternative is a foreclosure action or bankruptcy. If default on a secured loan can be satisfactorily addressed through the workout process, dealing with unsecured trade debt becomes much easier.
PROPOSALS TO UNSECURED TRADE CREDITORS
Unsecured trade creditors usually have very little recourse. Therefore, they are the category of creditor that is most likely to consider taking a reduced amount to resolve their claim. One option is to have counsel make a uniform proposal to the unsecured group to accept a pro-rated reduced amount in lieu of the creditor engaging in a lengthy collection action that may not result in any recovery. The upside for trade creditors is receiving funds quicker than they otherwise would in bankruptcy court. The administrative expenses and fees of a bankruptcy are also avoided, which may yield a higher recovery for unsecured creditors. In some cases, informal creditor committees are formed to negotiate broader resolutions with the distressed company.
RECEIVERSHIPS
In the event of default, businesses may have the option of consenting to a receivership with its lender. A receiver is a third-party appointed by the court to administer certain assets or, in some cases, operate distressed businesses. Typically, a receivership is requested by a secured lender in conjunction with a foreclosure and other claims. In most cases, the receiver will liquidate assets pursuant to a receivership order for the benefit of estate creditors, and the current ownership will likely lose control of the business. It is not typically an avenue to pursue reorganization. In some circumstances, however, the receivership may act as a pause and allow the debtor time to seek alternative financing or reorganize the business. Although more of the exception than the rule, there is a possibility that the secured creditor will engage in a restructuring of the debt and work with the business to help it emerge from the receivership. Receiverships are governed by Chapter 2735, et seq. of the Ohio Revised Code and applicable court order.
ASSET SALE OR EQUITY INVESTMENT OF STRATEGIC INVESTORS
A potential sale of some assets or equity investment from groups that focus on distressed businesses may be an option. The positives are infusion of much needed capital, but these types of investors are usually looking for fire-sale prices which may not align with a company’s hope to emerge from financial distress. Nevertheless, this may be an option for some companies that are open to new collaborations.
APPOINTMENT OF A RESTRUCTURING OFFICER OR TURN-AROUND SPECIALIST
Some companies may want to consider hiring a turn-around specialist or restructuring officer. Depending on the type of engagement, some turn-around professionals will assume the role of the chief financial officer and manage the finances until certain goals are achieved. In other cases, turn-around specialists may take on more of a consulting role providing recommendations based on a review of the finances and operations.
While there may be other options for companies to overcome financial distress and avoid liquidation, the above provides a summary of some of the most common alternatives to Chapter 11. Whatever path is chosen, businesses should consult their attorneys and financial professionals to determine the best option.
If you have questions or would like to discuss further, please reach out to John Archer at jpa@KJK.com or 216.736.7224, or contact any of our Banking & Finance professionals.