As in other facets of life, the answer to this question depends a great deal on how well you have prepared, as well as the quantity and quality of financial resources you start with. If an illiquid company stumbles into chapter 11 with little preparation, it very well could lead to a quick bankruptcy sale of the company, or even to a liquidation. Desperate firms casting about for solutions to their distressed problems rarely find a good outcome in chapter 11. Conversely, a company and its advisors may have planned well in advance, cut deals with all of the major constituencies and could then strategically file a chapter 11 petition in order to bind all creditors or to achieve a tax-efficient result only available in bankruptcy (think “pre-packaged” or “pre-arranged” bankruptcy).
5 Things To Keep in Mind If You File for Bankruptcy Protection
If you are just starting to think about the ramifications of financial distress, we have set forth some basic elements of the bankruptcy process:
- How You (and Your Company) Can Obtain Liquidity. A company will need quite a war chest to pay for all of the bankruptcy expenses, as well as to fund the costs of the operational initiatives required for any required turnaround. The sources for this could be cash (or readily monetizable assets) on hand, operating cash flow or external capital through what we call Debtor-in-Possession (DIP) financing.
- Know Your Options With Regards to Managing Your Secured creditors. If the company’s assets are encumbered by liens in favor of its creditors, the liquidity problem can become much worse. If the existing secured creditors consent to the use of their assets or to extend even more credit through DIP financing, there may be no issue here. However, if there are objections, In order to use the operating cash, the Bankruptcy Court will require that the company (now called Debtor) demonstrate that the secured creditors be “adequately protected”. In other words, the Debtor’s use of the secured creditors’ cash should not make such creditors worse off if there would be serious risk of loss. Failure to make such a showing may very well result in a quick sale or a liquidation.
- Learn How to Define Your Board & Managerial Goals and Strategies. One of the most fundamental duties of the Debtor’s Board and management is to develop a restructuring strategy and a path forward. Is the company to be reorganized in one piece? Or is it to be sold in one or more parts? How do the values obtainable correspond with the various tiers of liabilities? Are there any expectations for recoveries for any particular class of claims or interest holders, particularly “Old Equity”? What about potential lawsuits or other antecedent liabilities for Directors and management? A plan to deal with issues like these is essential.
- Do Bankruptcy Judges Implement Solutions? Contrary to popular belief, a Bankruptcy judge does not impose a solution onto the case, nor does such judge typically give much sympathy to parties complaining about how unfair it all is. The judge primarily calls “balls and strikes” based upon how legal motions and the facts fit into Bankruptcy law. For the case to actually get resolved, a debtor needs to lead the charge in getting the various constituencies to agree – and where agreement is impossible – to have the Court decide, generally after a hearing.
- How You can Retain Your Management One of the many risks in bankruptcy is the prospect of losing key members of management, particularly if the case drags on. For this reason, Bankruptcy Courts have become much more amenable in recent years to incentive structures where management receives significant bonuses upon completion of a successful restructuring.
Bankruptcy Is Not All Roses, But with the Right Team, Life will be A-OK
We don’t want to paint an overly-rosy picture of bankruptcy. It indeed can be a messy, highly contentious and unpleasant experience where lots of people lose lots of money. On the other hand, if a Debtor surrounds itself with the right professionals, most companies find that they can not only manage through the process without undue trauma but create opportunities for Old Equity, Directors and management to emerge pretty well (under the circumstances). And we add for the record that your friends will probably still speak to you after the company files for bankruptcy.