Keep Your Client Out of Chapter 11
Although the restructuring might be accomplished either through
the informal process of a consensual restructuring (known as a “workout”)
or through the formal process of a court-supervised voluntary reorganization
under chapter 11 of the Bankruptcy Code, in most instances a financially
troubled company first should attempt to negotiate a consensual
restructuring of its obligations. These are some of the reasons
why:
- Avoidance of Stigma and Potentially Harmful Disclosure
Although
the filing for protection under chapter 11 may carry less of
a stigma than it once did, it still tends to erode the confidence
in the company’s prospects. A chapter 11 filing
may be interpreted that a workout was not possible because the
principal creditors lack confidence in the company’s future.
A consensual restructuring indicates a willingness by the company’s
creditors to work with the company to solve its financial problems
outside the bankruptcy court and reflects a judgment that the company
can be put on sound footing.
- Procedural Simplicity
By filing for protection under chapter 11, a company commits itself
to extensive disclosure about how it operates, with whom it does
business and on what terms, and all its financial and operational
problems. All settlements, agreements, and initiatives must be
approved by the bankruptcy court. Under a consensual workout restructuring,
negotiations are flexible, private and can be conducted quickly.
- Reduction of Expenses
In chapter 11, the debtor normally is responsible for the fees
and expenses of the attorneys, accountants, investment bankers,
and other professionals. The more formal reorganization process
in chapter 11 inevitably results in a more intensive use of professionals
than in an out-of-court restructuring. A workout can impose fewer
transaction costs on the company.
- Diversion of Management Time
At the very time a troubled company most needs management to intensify
its efforts to improve business operations, management is required
to devote much of its energy to the process of financial engineering.
Unlike a workout, in which management typically negotiates with
a select group of creditors, chapter 11 brings all creditors into
the process and confers upon unsecured creditors a position of
power and prominence.
- Delay in Implementing Business Decisions
The
chapter 11 process also may significantly compromise management’s
ability to act expeditiously. Because business activities outside
the ordinary course require court approval, which may not be quickly
obtainable, business opportunities may be lost.
- Management’s Ambiguous Position
Chapter
11 also makes the position of management somewhat ambiguous.
Outside chapter 11, a company’s management normally is a
fiduciary of the company’s shareholders. Once a company files
for reorganization under chapter 11, however, management also becomes
a fiduciary of the company’s bankruptcy estate and may owe
fiduciary duties to the company’s creditors.
More information about the book Reorganizing
Failing Businesses,
Revised Edition, Volume 1
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