Alternatives to Bankruptcy

Christopher R. Kaup,  |  September 21, 2018

A frequently asked question by large creditors and business debtors is whether there are alternatives to a formal bankruptcy reorganization under Chapter 11. The concerns about bankruptcy often are the cost in attorneys’ fees and the time of the responsible officers of all parties in the case as well as the risks to the participants and their capital. The answer: Yes, there are several alternatives for both creditors and debtors.

4 Barriers to Bankruptcy Resolution

Although I have practiced primarily commercial bankruptcy during my career and have represented lenders, unsecured debtors and creditors, I am a firm believer that a large creditor and a debtor are far better off resolving disputes collaboratively and consensually. However, there are several serious impediments to a successful resolution:

1. A financially distressed company often has numerous creditors, many of whom are aggressive and may have filed lawsuits.
2. Achieving a satisfactory resolution with all creditors often is difficult, time consuming, expensive and may even be illusory.
3. The officers of many creditors have often lost confidence in and do not trust current management of the debtor corporation.
4. Existing management probably has little knowledge or experience in executing a work out and are often reluctant to make tough internal decisions such as layoffs or closing certain operations.

Out-of-Court Options for Bankruptcy

The out-of-court options for creditors and business debtors ranked from best to worst are:

1. Best option: Negotiate and agree on a plan to (a) restructure and pay the debt to the creditor, and then (b) have the debtor retain a qualified professional to implement that plan and settle other creditor claims and decisions on restructuring the business.
2. Next-best option: The creditor requires the borrower’s management to hire a qualified professional to change operations and negotiate with creditors.
3. Worst option: The creditor asks a court to appoint a receiver, a third party to take control of and operate the debtor company under court supervision.

The next sections will explain in more detail why negotiation out of court is always preferred over a court-appointed receivership.

Best Option: Negotiation as an Alternative to Chapter 11

A large creditor and a debtor company often can work out a settlement of a disputed debt and a payment plan if all the business people and the lawyers focus on a practical result. However, there are may be severe impediments that have nothing to do with those individuals.

1. Other lawsuits: First, the company will probably have delinquent obligations owed to a many creditors, several of which may have already filed lawsuits and may hold judgments.
2. Lack of trust: Second, officers of those creditors often do not trust management of the company because of many unfulfilled promises of payment.
3. Lack of experience: Third, the owners and officers of the troubled company have no experience with running a company in financial distress and making difficult decisions about operations during the very stressful which may mean the life or death crisis for the business.

For the same reason you would see a doctor if you have serious chest pains rather than diagnosing and trying to treat yourself with an aspirin, an owner of a troubled company should consult with and hire a professional who is experienced and skilled at solving financial, operational and debt problems for businesses.

A lender to or other large creditor of such a business has a vested interest in seeing that company retain the right professional to run the company and make the sound decisions in a dispassionate and objective manner during a time of crisis. That professional must be vested with the authority to make and implement all necessary decisions to restructure the company. She or he can then negotiate with aggressive creditors and lawyers with the credibility and force needed to obtain appropriate concessions and prevent litigation. He or she also will have the ability make and implement difficult internal decisions at the business, which will maximize the possibility of an out of court restructuring.

Next-Best Option: A Restructuring Consultant Works With Creditors

If the management of a borrower is unwilling to make the decision to bring in a restructuring consultant or give up control of the process, a lender or other creditor may be able to use provisions in existing contracts to require the retention of a restructuring professional. Assuming the existing agreements do not provide that remedy, a prudent creditor should include such a provision in a “Forbearance Agreement” or similar contract through which it agrees not to exercise certain remedies for a period of time.

Appointment of a Receiver

Finally, deeds of trust, security agreements and other loan documents often contain provisions regarding the appointment of a receiver in the event of a default by the borrower or certain other events. Some state and federal statutes also provide for the remedy of a receiver in certain circumstances. A receiver is a person appointed by a court to take over and operate a distressed business in the best interests of creditors.  He or she has duties and rights list in an often detailed court order. Ultimately, the receiver reports to the court and the parties have the right to seek intervention from the court as the case progresses.

The fees and costs of the receiver and her or his lawyer are usually paid by the operations of the business in receivership. The receivership process probably will be more expensive than the first two alternatives which is an incentive to achieve a more consensual solution.

Christopher R. Kaup is a shareholder with Tiffany & Bosco specializing in commercial bankruptcy and litigation. Lawyers at Tiffany & Bosco are experienced with all of these options as well as being quite knowledgeable about formal bankruptcy restructuring under Chapter 11 of the Bankruptcy Code.