Bar News - July 17, 2009
How a Bankruptcy Can Actually Save Your Client’s Company
By: Peter N. Tamposi
To most business people (and frankly to most lawyers) the word bankruptcy conjures up images of circling buzzards, liquidations and layoffs. Alternatively, many think of the lumbering, expensive and seemingly endless reorganizations of Enron, Worldcom and the like, which many perceive to be a venue reserved for massive and well-funded companies. With proper planning, however, bankruptcy reorganization can be a great tool to quickly get your client’s business back on track. In this article I will discuss just a few of the ways your client can use a strategic bankruptcy filing to strengthen its core business and succeed in these troubled times.
To get the most out of bankruptcy reorganization, proper planning is essential. A filing that is reactive to outside pressures, such as a foreclosure or sudden credit freeze or bank setoff often does not allow the time to plan a beneficial outcome and execute on it with precision. Such filings occur frequently because of the automatic stay provided by the bankruptcy code, which immediately ceases all collection activities, including attachments and foreclosures.
Rather than being reactionary, it is better to plan the outcome of the case while your client’s credit partners (be they trade creditors or secured lenders) are not in default and still willing to conduct business. Then you can help your client map out a restructuring ahead of time and file from a point of relative stability. Businesses don’t always have this luxury, but the further you can plan ahead, the better your client’s chances of success.
What are some of the outcomes that may be achieved with proper planning? The most obvious component of a successful restructuring is a decrease of secured debt (such as a mortgage) and unsecured debt (i.e. with no liens or mortgages), both of which can be achieved through a plan of reorganization. Generally speaking, a debtor can often reduce its secured debt obligations to a level that is slightly greater than the actual value of its business.
At the same time, unsecured debt, whether simple unsecured loans like credit cards, trade credit and even legal judgments, can be collectively reduced to a fraction of their pre-petition amount and paid out over time. These features of reorganization allow a debtor to shed a debt load that a solvent business with similar cash flow simply cannot support. Such a restructuring can literally save an otherwise doomed company, allow your client’s business to keep its employees – often saving jobs and creating new business for the creditors whose debt you’ve reduced in the bankruptcy.
Rejecting executory contractsAnother useful function of a bankruptcy is that it allows a debtor to reject what is known as executory contracts – these include real estate and equipment leases (whether the debtor is the lessor or the lessee). Not only can such a lease be rejected by the debtor in bankruptcy, but the damages that would normally flow from such a breach can be limited in duration and treated as general unsecured claims, which may be paid a fraction of the value of those claims. In fact many of the larger bankruptcies in recent history were filed in large part to downsize by shedding leases for unprofitable store locations; absent a bankruptcy, damages that would otherwise arise from rejecting the leases would have been unmanageable.
Selling assetsFinally, one of the most frequently used features of a Chapter 11 is the ability of a debtor to sell all or part of its assets free and clear of all liens, claims and encumbrances (a so-called section 363 sale). This allows a buyer to purchase, for instances, a division of a company or a series of assets that are otherwise saddled with a debt load that they cannot support. Many of today’s Chapter 11s are filed in large part to achieve a sale of assets and maximize the value of those assets, rather than have them foreclosed upon by a lender in a liquidation sale.
In addition, such a sale has the benefit of being approved by the bankruptcy court, significantly limiting or eliminating claims for successor liability against the buyer. Many sophisticated buyers of troubled assets or troubled companies would not contemplate purchasing a business outside of a 363 sale and they have become routine in the both the larger merger and acquisition markets, as well as in the conveyance of small local businesses. No other method allows a purchaser to obtain ownership of an operating business without also acquiring liabilities.
Taking a critical look Before considering bankruptcy, however, your client must take a realistic and critical look at the company; a bankruptcy will help save a company that is overleveraged only if the company has a viable business. If sales are off and products have become obsolete or too expensive to produce, a Chapter 11 filing is not the answer - it will not cure poor underlying business problems or management issues; the fundamentals must be in place to gain the full advantages of a Chapter 11.
These represent only a few advantages of business reorganization. Like everything else, there are risks involved. However with proper planning and the assistance of competent professionals – both legal and accounting – the advantages of a bankruptcy can be extraordinary.
Peter Tamposi is a partner at Donchess, Notinger and Tamposi, P.C. and may be reached at email@example.com.
The CLE on Bankruptcy is scheduled for Sept. 30.