Reorganization

A company may be able to continue in business if it can restructure its debt or its equity. Typically, the company will be unable to pay the debt in full or will need additional time to make the payments. It can try to reorganize in a Chapter 11 or negotiate out of court agreements with its creditors. While working out its existing debt, the company still must be able to pay current expenses and fund any cash shortfalls.

Out of court negotiations

A company may be able to work with its lenders and other creditors regarding its debts without a formal court proceeding. The Company may be able to negotiate reductions in the payment amount, or extensions of time to make payments. Agreements can be negotiated on an individual basis with each creditor or as a single agreement with a group of creditors.

Benefits:

  • Less costly
  • Less public – no court filing or public disclosure of information
  • More flexible — able to work with creditors on individual agreements More control – management controls the negotiations
  • Business continues to operate
  • No court supervision

Risks:

  • No stay of litigation while negotiating
  • No ability to force creditor or lender to accept the agreement
  • Creditors may still pursue collection actions or litigation
  • Limited ability to make changes to equity structure
  • No court supervision

Chapter 11

A Chapter 11 gives a company a breathing spell to reorganize its business. The company’s management remains in place at the beginning of the case. The company will have a period of time to propose a plan of reorganization for repaying the debts in whole or in part. Litigation and collection actions against the company are stayed when the bankruptcy is filed. Creditors will have to show cause to the court to continue any litigation. No payments are required for most debts due before the bankruptcy until the plan is approved. The company still must be able to pay its current expenses as they become due however.

In Chapter 11, the company will operate in the ordinary course without prior court approval. But, court approval will be required for certain major transactions, for example, new financing, sales of the business, or out of the ordinary course. Court approval will also be needed if a lender has a lien on the company’s cash.

The typical company will have an initial period of 4 months (the exclusivity period) when only the company can file a chapter 11 plan. (There are different rules for small companies with less than $2,200,000 in debt and for single asset real estate companies.) A Chapter 11 plan has both business elements and legal requirements. The company will need a business plan to show how it will provide for the repayment or restructuring of its debt. The plan will also have to satisfy certain legal requirements to be approved by the court. Creditors typically will be grouped in a plan into classes to vote on the plan. A majority of creditors in a class can bind any creditors in the class who don’t vote, or who vote against the plan.

Benefits:

  • The company gains time to work through its problems.
  • Litigation and collection actions by creditors are stayed.
  • The company management continues in control initially
  • Majority of creditors can bind dissenting creditors in a plan
  • Special provisions to shed burdensome leases or contracts

Risks:

  • The company gains time to work through its problems
  • Litigation and collection actions by creditors are stayed
  • The company management continues in control initially
  • Majority of creditors can bind dissenting creditors in a plan
  • Special provisions to shed burdensome leases or contracts