Bridging the Abyss: Reorganization Without Bankruptcy

by Robert S. Bernstein, Esquire
Bernstein-Burkley, P.C.

The first step in determining whether or not a business can reorganize without formally filing for protection under Chapter 11 is to conduct a three part analysis. The business must analyze its assets, its liabilities and its future prospects.

Assets should be analyzed on both liquidation and fair market value bases. For example, retailers must analyze the difference between selling the products at retail to the consumer (100% of retail) or at liquidation (perhaps 10% of retail)

At the same time, there must be a complete analysis done of the debt and potential debt. Trade accounts, bank line, leases and tax debts must be reviewed. In a corporate situation, the principals must also consider the extent to which any of the debt carries personal responsibility, by way of a written guarantee or otherwise.

Third, there must be a realistic analysis and projection done of the business prospects over a foreseeable period of time. Within this analysis, the business must determine what assets not needed in the business can be sold, as well as review what capital is available, through additional credit lines or capital contributions.

Many times, business owners are so caught up in day-to-day operations of the company that the firm’s accounting professionals are the first to see the financial distress. These professionals can view the financial picture as a whole and advise their client/employer that there are problems to be addressed. CPAs are invaluable when analyzing the needs of the business plan.

At this point, the owners must develop the business plan, including contingencies, such as business not developing according to the plan or key agreements not being obtained. For some of these contingencies consultation with attorneys or CPAs versed in the bankruptcy law would be appropriate. These practitioners can aid the business owner by laying out options which may be “forced” on creditors under the bankruptcy laws. Knowing these options may assist the business owners (or their advisors) in the sometimes difficult process of negotiating extensions, deferrals and forgiveness.

For instance, we represented a group of creditors of a local coal company which began experiencing cash flow difficulties. Prior to our filing suits, the company met with its accountants and developed a “reorganization plan” to propose to us and the other creditors. With accountants present from both companies, the meeting resulted in a modified plan which was eventually accepted by the creditors.

If this process begins before creditors start putting severe pressure on the business, it is easier to do the analysis and initiate contact with creditors in a controlled, calm atmosphere. In this scenario, the business owners can concentrate on the key creditors, suppliers or customers. If certain creditors are pressing, customers worrying or suppliers hesitating, then those “fires” must be attended to first, before approaching the other creditors, suppliers, and customers. If the problem is a creditor, having a frank discussion about the alternatives and the future for the business should be helpful. This lets the business owners buy some time to put the overall reorganization proposal into effect.

Most creditors are sophisticated enough to know the filing of a Chapter 11 Petition can hold even the most secure creditor at bay for 30, 60, 90 days or more. Those creditors probably also know that advantages obtained by a creditor within 90 days before the filing of a Chapter 11 Petition can often be reversed by the Bankruptcy Court. The simple fact is a levy attachment or judgment obtained by a creditor that might be reversed as “preferential” is usually enough to convince a creditor to allow the company an opportunity to present a reorganization proposal.

Before approaching the unsecured trade creditors, it is helpful to have an agreement in place with the company’s bank and taxing bodies. It is also helpful to have lobbied the larger trade creditors in advance to receive their feedback on the reorganization proposal. If the deal is acceptable to the larger creditors (who have much more to lose), then they will probably help sell the smaller creditors.

It may be necessary and in the company’s best interest to allow the trade creditors to organize, to appoint a representative committee and hire a lawyer and/or CPA to monitor and advise them on the company’s progress under the reorganization proposal. While that may cost the company some additional dollars by way of attorneys’ or accountants’ fees, it will give the creditors a sense of security, knowing they have a representative following the progress. Often, the attorney selected is one who is already representing one creditor and not being hired by the company, and would probably enjoy greater trust by the group of creditors.

The CPA may be one who has a particular knowledge of the company or who is an insolvency specialist. Having such an accountant on board to verify the companys progress reports lends great creditability to those reports. Additionally, if the creditors have concerns about improper or “preferential” payments, their CPA can review and report promptly. Such prompt reporting helps to dispel rumors and ease tension that accompanies these situations.

If a reorganization proposal can be proposed and agreed upon by all of the creditors, agreements should be writing, so that all parties know their rights and obligations. The company’s attorneys and accountants should make every effort to have that agreement satisfy the requirements of a disclosure statement under the Bankruptcy Code. This allows the company to have the agreement qualify as an acceptance of a plan of reorganization in the event it must file a Chapter 11 enforcing the proposal against some dissenting creditors. This is often referred to as a prepackaged bankruptcy or “prepack”.

There may be times when a proposal is agreed upon by all of the secured creditors and a significant percentage of the trade creditors. In the event the company signs up all of those creditors and still cannot convince all of the trade debtors, the company may find itself in a position where it must file a Chapter 11 Petition. If the company has obtained agreement from more that 50% in number and two-thirds in amount of the unsecured creditors, it can then use the agreement as a prepetition acceptance of a plan of reorganization.

This plan, filed promptly with the filing of a Chapter 11, substantially shortens the process by using these prepetitions agreements as through they were ballots in favor of the Chapter 11 plan. Creditors may have some concern about that prepetition acceptance. If worded properly, the agreement can satisfy the company’s needs for the quick Chapter 11 option and can satisfy the creditors that it can only be used to support a plan least as good as the present plan.

Once the agreement is in place, it is extremely important that the company perform its obligations. If the company sees there will be a delay in performance or a default, every effort should be made to explain in advance to the affected parties and perform, to the extent possible, the balance of the obligations under the agreement. For instance, if a $50,000 payment is due to the trade creditors on June 1, but the company intends to cure the default or delinquency, if possible, the $40,00 payment should be made early to ease the pain of the delinquency.

Financial reports and other requirements must be met on a timely basis. By asking the creditors to cooperate in this “workout” the company is asking to avoid the administrative constraints of a Chapter 11 (trustees, reports, hearings, etc.). In exchange, the company must be prepared to meet its obligations. Financial and otherwise, to maintain and build the confidence of the creditors.

The ability to enter into a reorganization without a bankruptcy petition allows the company a great deal of flexibility in dealing with its problems, It avoids some of the problems caused by the addition of the layers of bureaucracy in areas of financial and other reporting. It also avoids the need to have CPAs, attorneys and other professionals go through that often laborious process of applying to the court for approval of the employment and their fees.

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