Chapter 11 Bankruptcy Uses and Strategies—What Can Be Accomplished?
Prognostications of an impending recession are appearing in regular dispatches ranging from daily news media to quarterly economic reports. Like the Great Recession, the if and when of any recession will only be answered after it has occurred. Moreover, these conclusions are simply an aggregation of the particular experience of a wide-range of industries, and diverse and distinct companies within those industries. What is true today for each of those individual companies is that their particular economic ecosystem is changing rapidly, and often with increasing financial challenges.
Chapter 11 bankruptcy is an important and powerful tool to address financial challenges that a company and its owners, directors or officers may be facing. Chapter 11 is frequently the baseline or backdrop against which many out-of-court agreements with lenders, creditors or other parties with interests in the capital structure are negotiated. When agreement cannot be achieved, a Chapter 11 may need to be commenced to bridge to a later agreement or impose a desired outcome.
So it is incumbent upon a company and its decision-makers to understand Chapter 11 (and alternatives) so as to develop and implement a strategy to achieve the desired goals, beginning with evaluating and negotiating initial agreements with lenders or other parties. It is also incumbent upon lenders, other constituents or buyers of assets to understand the Chapter 11 process to inform their own assessments and decisions.
The rights afforded a company that commences a Chapter 11 bankruptcy case can be broken down into three categories: (I) the entry into bankruptcy, (II) sale of assets and (III) confirmation of a plan. While at risk of oversimplification, the rights and privileges granted to a company at each stage can be summarized as follows:
I. The Entry Into Bankruptcy
In connection with the filing of a bankruptcy case, certain rights are available to give the company a breathing spell to stabilize operations and determine whether a reorganization or sale can be accomplished, including:
a. The automatic bankruptcy stay, which immediately springs into effect and protects the company and its assets from collection;
b. The use of cash or other collateral of a secured lender with agreement or upon showing that use does not harm a lender’s economic interest in collateral;
c. Post-petition financing with agreement of existing lenders, or without agreement if the financing is subordinate to existing debt or, in limited circumstances, senior to existing debt with order of the Bankruptcy Court;
d. The suspension of debt payments;
e. The suspension of past-due payments to landlords and other general creditors; and
f. The suspension of past-due payments and, for a limited period of time, future payments to equipment lessors.
II. Sale of Assets
A sale is one of the primary reasons a company may elect to file a Chapter 11 case. With bankruptcy court approval, the rights available to a company (and buyer) may include:
a. Approval of sale process and procedures to provide certainty, such as a “stalking-horse” bid with break-up fees, and to foster competition, such as an auction with over-bids;
b. Sale of assets free and clear of all liens, claims and encumbrances;
c. Assumption and assignment of leases and contracts, including those with anti-assignment provisions;
d. Rejection of undesirable leases and contracts; and
e. Additional protections for good-faith purchaser such as mooting of appeal of order approving sale.
III. Confirmation of a Plan
The classic exit from a Chapter 11 filing is confirmation of a plan of reorganization (or liquidation). In connection with confirmation of a plan, a company may:
a. Restructure payment terms with secured and unsecured creditors by acceptance of 50 percent of the creditors in each class provided they hold two-thirds of the dollars in that class;
b. “Cram down” or impose restructured payment terms on objecting creditors by paying the present value of those claims over time;
c. Discharge any debts to creditors that will not be paid under a confirmed plan;
d. Obtain releases of claims against insiders or affiliates in certain circumstances;
e. Recapitalize the company by injecting new debt or capital with certainty about its uses, priority and treatment; and
f. Retain existing equity by paying creditors in full or providing new value.
While the legal protections afforded by a Chapter 11 bankruptcy are simply not available under any other circumstances, the process has its own unique challenges. Among these limitations and disadvantages are that the Chapter 11 process is a public process, requires Bankruptcy Court approval for many acts, and involves significant time and expense. These drawbacks may render bankruptcy an impractical or undesirable option. Nonetheless, understanding the rights afforded and strategic advantages available through the Chapter 11 process remains critical to any company in distress.