Bankruptcy is a unique tool that companies can use to restructure their debt, says Doris Kaelin, Of Counsel at Berliner Cohen.
“If creditors are getting aggressive, a company may decide to file Chapter 7, which offers an automatic stay of any actions, and let a trustee liquidate the assets,” she says. “But with Chapter 11, the officers, directors and investors believe there is a business worth saving and they can reorganize the company.”
Smart Business spoke with Kaelin about the types of bankruptcy for a business.
What different types of bankruptcy are there?
Chapter 7 is a straight liquidation; the business has typically ceased operating and control is given to a trustee appointed by the court. The trustee liquidates the assets and pays creditors in accordance with bankruptcy code priorities.
In contrast, Chapter 11 affords the company the ability to remain in control. The existing management, officers and directors continue to operate. A reorganization plan is put forth for how the company will emerge from bankruptcy. A company may also decide to liquidate some or all assets in Chapter 11, where greater value can be achieved than under a Chapter 7 straight liquidation. For example, with technology companies, the intellectual property often requires the know-how of the employees. A sale of assets in Chapter 11 may fetch a much higher price than in Chapter 7, because the buyer can hire the seller’s employees. In Chapter 7, employees no longer may be available for hire.
Why would a business choose bankruptcy?
Normally, when a company files Chapter 7, it has explored all alternatives, including a restructure, sale of its assets or new investment if there is still a business worth operating.
Sometimes businesses get sued and need the benefit of the automatic stay, which starts as soon as the business files bankruptcy.
If you are looking either to continue operating the business pending confirmation of a plan of reorganization providing for the restructure of the business, or to obtain approval of the sale of the company’s assets affording the benefits of a bankruptcy sale order, you may consider Chapter 11. Regarding the latter, a buyer may want to get the benefit of a free and clear order — an order approving the sale of assets to the buyer free and clear of liens, claims and encumbrances, a step a bankruptcy court may approve. That route may be taken because the buyer requires it. Bankruptcy could be the means by which to sell the assets.
How often can a business seek bankruptcy?
There are companies that have filed Chapter 11 more than once and successfully restructured the business. Sometimes the focus of the business changes and the company cannot continue with its current debt structure, so the bankruptcy process allows the company to restructure its debts and emerge stronger.
How expensive is bankruptcy?
Chapter 11 can be an expensive process. In Chapter 11, a company has to prepare monthly operating reports, file motions for court approval of transactions outside the ordinary course of business, and obtain the requisite votes and court approval of its plan to emerge from bankruptcy. There are a lot of things to be considered before a company goes that route, like is it really going to achieve what they need?
What are alternatives to bankruptcy?
If a company has financial difficulties, there may be non-bankruptcy options available. For example, a company can informally wind down outside of bankruptcy. Or it can utilize the assignment for the benefit of creditors’ process, a state law process that functions similar to a bankruptcy, where the company hand picks the assignee to liquidate the assets and pay creditors. Whether a company considers bankruptcy or other alternatives as options, it is important to talk to an insolvency professional sooner rather than later. You may have some options earlier that you may not have later.
If the company is a creditor in a bankruptcy filing, it is important to talk to an adviser to determine what may need to be done and to ensure that a deadline isn’t missed. There may also be an opportunity to purchase assets out of a bankruptcy case at a more favorable price.
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