Episode 105 Business Bankruptcy

Business bankruptcy can be a common term in today’s world with the effects of the pandemic on the economy, and it has many struggling companies wondering just how it works. The first step for a business that is even considering filing for bankruptcy is to contact an experienced and reputable bankruptcy attorney to determine the exact path forward. This ensures that legal counsel is advocating for the client’s best interest regardless of the next steps required.

What A Business Bankruptcy Attorney Does

A proficient bankruptcy attorney should have a great deal of experience in many different aspects, primarily because no two businesses are the same and will likely not have the exact same plan for closure or recovery.

Some of the general services a bankruptcy attorney should have experience with can include:

  • Acting as counselors to businesses on both business debtors and creditors
  • Representing the debtor and creditors lending money to the debtor with a court approved plan called a debtor in possession loan
  • Assisting with sale or exit financing if a business is selling an asset in connection with the bankruptcy
  • Reviewing tax considerations before declaring bankruptcy
  • Discussing if there is a need to file bankruptcy or to avoid it
  • Determining the optimal timing for filing for bankruptcy if it is needed

These attorneys may also help with entities that amidst a bankruptcy want to buy the business as a whole or the majority, if not all of their assets. This is typically done via what is called a plan of reorganization in which a debtor prepares a plan, makes a disclosure statement, and files it with the court, and then sends a disclosure statement to creditors. Then the creditors will have a chance to vote. If the classes of creditors approve the plan and certain requirements are met, the court can in turn approve the plan and the debtor can either sell its assets or continue in business with an obligation to pay its creditors over time.

Another and probably more common scenario is when a new buyer purchases the assets, or a new shareholder comes in and takes over some, if not all, of the stockholder positions in the company, new money goes into the company and the creditors are paid from it, leaving the business free of the old creditors. This is generally considered a successful bankruptcy.

What A Business Bankruptcy May Not Restore

While many bankruptcy plans can cover a multitude of issues, there are some things that it may not be able to restore. For example:

  • The guarantee by a shareholder is not necessarily dissolved in the process
  • Tax obligations such as payroll taxes could leave some individuals unpaid depending on how the bankruptcy process plays out

Is Business Bankruptcy Right for Me?

If a business is in trouble, but not so much trouble that it would have to shut down and tell all their employees to go home, their shareholders not to expect any money, and the creditors that they will get what they get once inventory is sold for scrap, and as many accounts receivables are collected as possible, then bankruptcy might be a valid option.

Today, it is becoming increasingly common for a business in trouble to find themselves in that debacle due to temporary trouble from a temporary event they experienced or that affected the entire economy. A case in point would be the coronavirus crisis. Many hotels, restaurants and other businesses struggled greatly as a result of the pandemic, and if it had not been for PPP loans and other government subsidies, they may very well have gone under. Other businesses simply have hope that once things stabilize, people will go back to work and the economy will pick up again. There will be some businesses that struggled in the past two years that should be able to bounce back, sometimes with the help of the bankruptcy process.

For example, if creditors are ready to foreclose upon a business’ assets, the bankruptcy process can halt continuing collection activities. In other words, a lender for a hotel that had a first lien would not be able to foreclose. Without the bankruptcy process to stop this, lenders would be able to foreclose at will and this is something that should be avoided.

How Business Bankruptcy Works

If a business owns a property and believes they have a future despite a lender threatening to foreclose, it may be time for the business to reorganize, find a new lender and investors, and sell at least some assets to satisfy the lender.

A business that goes into bankruptcy then has to make arrangements to provide adequate protection to its creditors. Hypothetically, in the case of a real estate asset in which the business is dealing with a first lien holder, it requires them to make periodic payments. This does not necessarily mean the note would be paid off in total. If a business files for bankruptcy, a creditor cannot foreclose as the court mandates that as long as the business makes adequate protection payments (generally the interest that accrues and some depreciation allowance on the building), keeps their taxes current, and complies with pertinent ordinance and safety laws, they are usually allowed to continue to pay the creditor as the plan works out.

After this stabilization, the debtor must be able to fund itself. While a traditional bank may be hesitant to lend money due to the risk, there are provisions in the bankruptcy code that allow a court to say that future accounts receivable, inventory, and newly acquired assets will not be given to the traditional lender who has liens filed. Their liens will apply to the inventory and accounts receivable as of the day the bankruptcy entity files its petitions.

This generally means that any inventory required or accounts receivable after that would be unencumbered. This is a good thing because it allows a new lender to come in and make a secured loan. This can be called debtor in possession (DIP) financing in which a DIP loan is made, approved by the court, and the lender provides the money while taking new inventory, assets, and accounts receivable as collateral.

This turn of events may induce the legacy lender (the pre-petition lender – often a bank) to become the DIP lender. They are usually already familiar with the customer and the collateral, and they then have a stake in making sure the bankruptcy process works because they want to collect as much pre-petition debt as they can, meaning they have an interest in continuing that relationship.
This can result in striking a deal with the bank detailing the proof of claim, how much is owed, an agreement to that number, and an agreement that they have a lien position on those assets, but not newly acquired accounts receivable and inventory. In return for continuing to lend to the business, the bank will get the first lien. This is a common scenario going into bankruptcy.

Once foreclosure is abated and there is new financing coming in, a business will have to figure out their plan of reorganization. This means taking into account the following considerations:

  • Whether or not there are assets to be sold to continue the business
  • Whether or not new investors can come in
  • If existing investors will put up more money or value into the debtor so unsecured creditors can be paid

A typical plan makes arrangements to refinance real estate, big equipment loans, typically financed by long term debt. Then unsecured creditors from the pre-petition period are paid something. For example, it may look like a new investor coming in and arranging to secure the real estate and equipment assets while putting in enough money to pay the legacy or pre-petition unsecured creditors twenty cents on a dollar. The plan may then be approved and shortly after the investor puts in money, checks go out to the unsecured creditors.

However, in some cases where the long-term debt is stabilized and the unsecured creditors are paid through a liquidating trust where the ongoing future business takes some specified percentage such as 30% of their profits over the next five years. That percentage is then distributed to the unsecured creditors over the next five years, which may or may not be enough to pay the debt in full. Secured creditors generally get paid either the value of their collateral or the amount of the debt, whichever is less. However, the unsecured creditors can be more at risk because they may not get much at all.

For this reason, unsecured creditors get to vote. There are two different votes they have in order for them to be considered to have voted yes as a class.

  1. Identify how many unsecured creditors are there regardless of how much they are owed, and if 50% of those creditors vote for the plan, it passes the first hurdle.
  2. The second hurdles includes taking the list of unsecured creditors and scoring them by the amount of money they are owed, and there is a process to determine that. By that measure, two-thirds by the dollar amount of the class need to approve in order to meet the second hurdle. Some statutory requirements usually have to be met and there is a hearing, but generally speaking, if the unsecured creditors approve, the plan has got a good chance of being accepted. If unsecured creditors do not approve, and the other classes approve or at least one approves, then the court may do what they call a cram down, where they have a hearing to essentially determine if it is in the best interest of or is it equitable to allow the plan to go forward even without the approval of the unsecured creditors. If the plan is not allowed to go forward, either a business goes back to the drawing board and comes up with a plan that works, or the case is converted to a Chapter 7 and a trustee comes in and liquidates the company, which can be bad news for unsecured creditors because they may not get anything at all.

If you have additional questions about business bankruptcy, how it works, or how a business bankruptcy attorney can help, be sure to reach out before filing in order to better protect your rights and future.

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