What Is the Difference Between Creditor Workouts and Bankruptcy?

September 21, 2020

Authors: Harold Israel and Sean Williams

As PPP funds begin to run out and businesses find themselves in a difficult financial situation due to COVID-19, companies will likely need to look into restructuring options moving forward.  While there are many restructuring options to consider, two of the most common are creditor workouts and bankruptcy.  Below are some of the differences between workouts and bankruptcies.

  • Timing – Generally, a workout with creditors will be completed significantly faster than a bankruptcy, given that workouts often involve only a few major creditors, as opposed to a company’s entire creditor body.  Bankruptcies take more time for three main reasons: (a) notice and a hearing is required for most actions taken by a debtor, (b) numerous parties can challenge the process, and (c) there are many reporting requirements that are not present in a workout.
  • Cost – A workout with creditors is less expensive than a bankruptcy.  Workouts are faster and involve significantly fewer professionals.  Also, in bankruptcy, debtors must pay filing fees, fees to the U.S. Trustee’s office, and may have to pay for the costs of a creditors’ committee’s professionals.
  • Disruption to Operations – Unless a company is public (or has publicly traded debt), a workout is between the company and its creditors.  Therefore, a workout usually has no effect on vendor relations and employee morale.  A bankruptcy is a public filing that may be covered by the media and may cause confusion to employees, customers, and creditors that may disrupt operations.
  • Ongoing Litigation – Other than negotiating the forbearance of an enforcement action by its creditor, a workout has no effect on ongoing litigation against a company.  On the other hand, upon the filing of a bankruptcy, an automatic stay comes into effect that immediately halts all ongoing litigation in bankruptcy, with some minor exceptions (primarily for governmental enforcement actions).  This stay allows a company to focus its efforts entirely on reorganization, without the distraction of pre-bankruptcy litigation. 
  • Binding Nature/Cramdown – By its nature, a workout can only bind the parties to the workout itself.  A plan of reorganization or liquidation that otherwise meets all requirements of the Bankruptcy Code binds all creditors, including those creditors that vote against the plan or do not vote on the plan.
  • Equity Considerations – It is rare that existing shareholders would give up control or equity in their company during a workout.  On the one hand, it is even rarer for existing equity to retain ownership and control after a bankruptcy unless the company can confirm a plan that meets certain stringent requirements.  Note, however, that subchapter V of chapter 11 of the Bankruptcy Code makes it far easier for owners to retain their equity in bankruptcy.

The choice of whether to handle a restructuring through a bankruptcy or a workout is deal specific.  While a workout is generally cheaper, less disruptive and faster than a bankruptcy, it is far less comprehensive and may leave certain issues unresolved.

The Financial Services & Restructuring Group at Levenfeld Pearlstein can discuss the pros and cons of the various options with you. We regularly counsel clients in restructuring, workout, and bankruptcy proceedings. Our prominent restructuring attorneys are keenly familiar with the market and strategic options, and maintain a vast network of connections, thereby enabling us to provide tailored advice that achieves unprecedented results in an efficient and cost-effective manner. Don’t hesitate to reach out if you have financial services or restructuring questions or needs.

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