Bankruptcy and Restructuring Basics for Company Leaders

Companies facing financial distress have more options today than ever before, and understanding those options is critical for business leaders navigating an increasingly uncertain economic environment.

During a recent Expert Webcast, Harold Israel joined Hon. Melanie Cyganowski of Otterbourg, Jay Goffman of Smith Goffman Partners, Cynthia Romano of FTI Consulting, and Boris Steffen of Province to discuss the economic trends driving an increase in restructurings, alternatives to traditional bankruptcy, and practical considerations for middle market companies evaluating their next steps. Key topics included:

Whether the market is at the beginning of a significant period of distress. Certain economic factors suggest that more companies are struggling, including the squeeze on small to medium-sized companies from the tariffs, the impact of geopolitical uncertainty on energy prices, higher interest rates, and the overall increase in inflation. While there is still plenty of liquidity in the system, and the stock market continues to perform well and fuel consumer spending, consumer debt is rising and the number of bankruptcy filings and out-of-court restructurings have increased over the last year.

Key out-of-court restructuring options in the middle market. These options provide alternate paths for distressed businesses that cost less than traditional bankruptcy and can better protect owners’ privacy. Experts are noting an increase in:

• Article 9 transactions, transactions whereby a lender exercises its rights under Article 9 of the Uniform Commercial Code to take possession of property that a borrower pledged to it to secure repayment of a loan. The lender then sells the property to a third party (or retains it for a period of time) and applies the proceeds to the loan.
• Assignment for the benefit of creditor (ABC). ABCs are a state-law insolvency process in which a financially distressed business voluntarily transfers its assets to an independent assignee, who liquidates them and distributes the proceeds to creditors according to legal priority. Only a borrower can commence an ABC, although it is usually done with the consent of its secured lender. Depending on the state, an ABC may or may not involve a court process.
• State court receiverships under the Uniform Receivership Act, a state law alternative to bankruptcy that has been adopted by 14 states. In these states, receiverships have some characteristics of bankruptcy (including the ability to sell property free and clear of liens and an automatic stay, although it is more limited than the one in bankruptcy) without the cost of a bankruptcy, including the cost of a UCC (see below) and certain reporting obligations. Receiverships are commenced by the lender as a way to avoid bankruptcy.

The appropriate restructuring path depends on factors including the company’s capital structure, creditor relationships, liquidity needs, desired timeline, and whether the objective is to reorganize, sell, or wind down the business.

Early warning signs, and why involving advisors early improves outcomes. Companies generally have more restructuring options when they address financial challenges before a liquidity crisis develops. Leaders should consult with advisors when they spot warning signs such as covenant defaults, declining cash flow, inability to refinance debt, key supplier pressure, customer losses, and increasing reliance on short-term financing. Early planning can preserve enterprise value, expand financing and restructuring alternatives, and improve outcomes for owners, employees, and creditors.

How to help middle market companies articulate the ultimate goal. Some small business owners want to sell the business. Other owners prefer to restructure the business and stay at the helm. Effective advisors work to understand the owner’s goal before selecting the appropriate path for restructuring to ensure owners are satisfied with the results.

While economic uncertainty is creating headwinds for many middle market businesses, today’s restructuring landscape offers a range of alternatives beyond a traditional Chapter 11 filing. Understanding these options, and engaging experienced advisors early, can help companies preserve value and position themselves for the best possible outcome.

The Bankruptcy Option. Bankruptcy, of course, remains an option when the above alternatives are not feasible or possible. The most efficient form of bankruptcy is often referred to as a “pre-pack” bankruptcy. In a pre-pack bankruptcy, the debtor negotiates and solicits creditor votes on a restructuring plan before filing for bankruptcy. Because key stakeholders have already agreed to the plan, pre-packs typically reduce costs, minimize business disruption, and enable a faster emergence from bankruptcy than a traditional Chapter 11 case.

The role of unsecured creditor committees (UCCs). In bankruptcy, a UCC, at the debtor’s cost, represents unsecured creditors, serving as a fiduciary to maximize recoveries and ensure fair treatment throughout the reorganization process. In large out-of-court restructurings, an “unofficial” or “ad hoc” committee serves a similar role. A committee typically consults with the debtor, investigates the debtor’s financial affairs, negotiates the terms of a reorganization plan or asset sale, and, in bankruptcy, may participate actively in litigation and other key proceedings on behalf of unsecured creditors. Because unsecured creditor committees often have significant influence over restructuring negotiations and asset sales, management teams should be prepared to engage with the committee throughout the process.

To watch the full webinar, click here. For more information on the many options available to companies facing financial distress, check out “To File or Not to File: Choosing Between Bankruptcy and Alternatives,” or reach out to Harold Israel or another member of LP’s Financial Services & Restructuring Group.