Quite often when a business experiences financial difficulties, the “knee jerk” reaction is to seek out advice on the filing of a bankruptcy case. In many cases, bankruptcy is not necessarily a good solution. The filing of bankruptcy can adversely impact on a business’s customers and market share, trigger related entities’ and individuals’ guaranties on the same obligation, and most importantly, be unable to adequately address the underlying business problem. With the ongoing collapse of commercial real estate and upswing in deficiency judgments, the bankruptcy option is becoming more commonplace. Ironically, the filing of bankruptcy may not be possible for many debtors, since many bankruptcy lawyers will often require at least $50,000 or more for an initial retainer to file a Chapter 11 voluntary petition. Often a business is also not in a position to hire a restructuring specialist to manage the problem. Listed below is a brief survey of possible avenues to address a financial crisis.

A. Private Workout

If a business is experiencing financial difficulties but desires to continue in business, a private workout or “composition” may be desirable. The workout in its simplest form is an agreement between the debtor and its creditors to restructure the business’s debt, quite often extending the time and amount for payment. It can be quick, confidential and most certainly less expensive than a Chapter 11 bankruptcy. Current management maintains control of the business and no judicial supervision is required. Verifiable financial disclosures are key, and potential Chapter 11 scenarios will need to be developed and shared with creditors to convince them that continued litigation will be a fruitless exercise. However, holdouts can jeopardize the success of a workout – there is no automatic stay to prevent existing litigation from proceeding. If enough creditors hold out, their refusal will likely compromise the willingness of other creditors to reduce and/or agree to take payments over time.

B. Private Liquidation

If it is not possible or desirable to continue business, existing management may consider to simply wind down and liquidate the business themselves under state dissolution laws. Honest communication to all creditors will again be necessary, typically containing financial disclosures, a timetable for the wind down and a request for submitting creditors’ claims. The debtor should make itself available to discuss the liquidation to any creditor that inquires. Appropriate corporate filings to dissolve the corporation will be required to be filed with the Secretary of State’s Office. The process is relatively inexpensive and no public filings or disclosures are necessary. However, since there is no automatic stay, creditors could potentially disrupt the process, but that is often not the case. Once noticed, the debtor proceeds to liquidate assets, determining creditors’ claims and making pro rata distributions to the creditors. This process has the advantage to end the existence of the debtor’s business entity.

C. Assignment for Benefit of Creditors

If there are substantial assets and the company is able to secure the cooperation of its secured creditors, the Assignment for Benefit of Creditors (“ABC”) offers a private way to liquidate the company quickly and efficiently. Under an ABC, the business’s assets are assigned to an assignee who is then authorized to liquidate the business pursuant to state law. The assignee also has limited powers to pursue claims on behalf of the estate. Using a neutral third-party to oversee the sale of assets and resolution of claims against the debtor lends credibility to the integrity of the process. Quite often, creditors discover that they receive a larger and quicker distribution in an ABC than under a bankruptcy proceeding because of the reduced costs and time necessary to carry out an ABC. However, holdout creditors are still able to pursue litigation if unsatisfied with the process and management loses direct control over the liquidation process.

D. Chapter 7 Bankruptcy

This the traditional way of conducting a liquidation of a company, requiring the filing of bankruptcy schedules and statements, meetings with the Chapter 7 trustee and creditors, and complying with bankruptcy laws. Management loses complete control over the wind down and the insiders may be subject to formal discovery and public proceedings to answer questions about the debtor’s assets and liabilities. Although this procedure requires more time and expense, the automatic stay prevents creditors from continuing or commencing litigation against the debtor and most creditors will accept the outcome of the bankruptcy and “move on” upon the bankruptcy trustee’s independent review and investigation. Depending on the outcome of the sale of assets, creditors may or may not receive any recovery in the bankruptcy. The Chapter 7 trustee determines how to settle claims and distributions are made as required by the Bankruptcy Code, after the payment of the fees and costs of administration of the case.

E. Chapter 11 Bankruptcy

This is the ultimate option for restructuring of a business. The automatic stay prevents creditors from pursuing the debtor and/or its assets while the debtor formulates a plan of reorganization that can be confirmed over creditors’ objections upon compliance with statutory provisions contained in the Bankruptcy Code. Typically, the debtor’s management continues to stay in control of the business and its efforts to reorganize, although the debtor is required to file bankruptcy schedules and statements and comply with various reporting obligations to the U.S. Trustee, the Court, and creditors. It may take a year or two before the case is resolved one way or another and can become quite costly in terms of professional fees and costs. On the other hand, Chapter 11 cases that are planned with a clear exit strategy can be efficient while preserving the enterprise, restructuring the business and providing for the payment of some debt from future profits.

A bankruptcy attorney or restructuring specialist should discuss all these alternatives early in the process to select the proper course of action that is most likely to succeed in solving the distressed company’s predicament.

Peter C. Califano, Esq. is the head of Cooper, White & Cooper’s Bankruptcy and Creditors’ Rights Practice Group.

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