Magnify Money recently interviewed Bob Dremluk, one of our corporate/litigation partners, for a piece about Chapter 11 bankruptcy and restructuring.
The interview, which can be found in full HERE, initially focuses on how Chapter 11 generally works including the automatic stay that halts collection or foreclosure actions, formulation of a plan of reorganization regarding the treatment of unsecured and secured debt, the function of a creditors’ committee and the discharge of debt. Here are some of the highlights –
Why File Chapter 11
According to Dremluk, there are a number of events that can prompt a company to file for Chapter 11. In some cases, it could be due to the company facing financial difficulties or operational issues.
Personal Assets May be Exposed
One of the points Dremluk mentions is that while the principals of the debtor are usually not personally liable for company debt, they can be liable if they have guaranteed the debt or pledged personal assets on behalf of the company.
Act Timely Before Problems Become Too Hard to Fix
There are a number of issues facing a troubled business that should be considered before filing Chapter 11. Dremluk cautioned that one of the reasons why a company’s chances of reorganizing can be significantly reduced is because the company failed to timely seek legal and financial advice.
“When a business is in financial trouble, it may not immediately be time to file for Chapter 11, but it could be time to contact an attorney and start reviewing options. “As soon as signs of financial distress appear, a company should consider its options. Bankruptcy may be one,” said Dremluk.
Dremluk noted that one of the biggest mistakes he sees business owners make is waiting too long to reach out to an attorney: “Waiting until the last minute to reach out [makes successful emergence] much more difficult. If you’re an owner of a company and you’re starting to see problems, reach out sooner rather than later.”
The Automatic Stay
One of the initial benefits a business owner will experience after voluntarily filing for Chapter 11 is that an automatic stay is placed on all collection, foreclosure and repossession activities. But this is no time to relax and enjoy that removed pressure — instead, it’s time to create a viable plan for a successful reorganization.
Plan of Reorganization
Creating this plan is the most important part of the process, according to Dremluk, because it gives the company a target to reach for. “Without a target or exit strategy, I’ve seen companies file Chapter 11 and then flounder because they are directionless,” he said.
Dremluk said that companies creating a reorganization plan need to explore all the what-ifs, including the possibility of selling [assets] or resolving outstanding litigation. If these options are part of the plan for reorganization and they fall through, Dremluk said that the reorganization plan may no longer be viable and this could mean the case is converted to a Chapter 7 and an appointed trustee may operate the business or liquidate assets and close the case, potentially leaving the business owner without the option of emerging with their business intact.
Ideally, the goal is to emerge from a Chapter 11 successfully — of course, success can mean different things to different companies. Dremluk noted that generally, the objective is to have a company able to reorganize its business and emerge from bankruptcy with its problems behind it.
Dremluk added that“the company will be able to discharge debt, resolve claims and emerge with a cleaner balance sheet and a lot of its other issues behind it.”
Bankruptcy Asset Sales– An Alternative Strategy
But in some cases, it may be about reducing debt so the business can be sold. According to Dremluk, in those situations, “[the] company would file bankruptcy to clean up problems and become attractive to another buyer. Soon after filing it would put itself up for sale, more often than not have a stalking-horse bidder — a buyer who is prepared to buy.” When there is a stalking-horse bidder (one who is bidding on a bankrupt company’s assets), the offer is still presented to the court and subject to higher and better offers. In the end, the successful bidder would own the company and its assets and the debtor will be out of the picture.
Get Professional Advice to Help Manage the Company
“Companies [sometimes] end up considering bankruptcy because they are in financial distress, and part of the reason for that may be that management is unable or unskilled in grappling with problems the company is facing,” said Dremluk. Whether the issue is that company management isn’t proficient at solving problems or that the company has over-expanded and isn’t able to correctly operate a business this large with their current structure, Dremluk said that bankruptcy gives them the opportunity to correct their course.”
“Bankruptcy gives the business a chance for a pause and to reassess what they’re doing and how to do it better, “he said
“What makes Chapter 11 so powerful is that it allows a company time to get their business on the right footing. With Chapter 11, said Dremluk, “[a] company can deal with [unsecured]/secured claims and sell assets over a period of time instead of in fire sale situation.”
Best Interest of Creditors Test
“One important aspect of the reorganization plan is that it needs to be in the best interest of creditors in order to get approved which means that treatment of creditors under the plan must be better than they’d get in a liquidation,” said Dremluk.
Bankruptcy Forms and Pleadings
The article also contains a detailed list of official forms and pleadings that must be filed in connection with a Chapter 11 case including financial reports such as a balance sheet, statements of operations and cash flow and a list of creditors and describes the filing fees.
Can Be Costly for Smaller Companies
In summary, Dremluk notes that in his opinion “[c]hapter 11 has become too expensive for most companies to file, and lenders have also reached the point in their analysis where they don’t want to support a company for a long time. They’d rather have a company liquidate and take their losses,” However, Dremluk also provided a possible solution by noting “that fee arrangements and advanced budgets for attorney fees might help a filing company’s chances of success” —something Culhane Meadows can address based on its unique business model.
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