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Bankruptcy & Restructuring - A Roundtable Discussion

Due in large part to the challenges brought on by the pandemic, Chapter 11 bankruptcy filings last year hit the highest level since 2010—a trend expected to continue throughout this year.

Bankruptcy and restructuring is complex, full of twists and turns. Yet for all the expense, blame, negotiation, compromise and introspection involved, the process does provide an opportunity for distressed companies to get their businesses and finances back on track.

For those companies that meet the challenges of bankruptcy and restructuring, there could well be a brighter future in store; for those that do not, a different outcome lies in wait. The Los Angeles Business Journal posed a series of questions on the topic to some local trusted advisors who work with struggling businesses to share their insights.

This was originally published in the Los Angeles Business Journal Bankruptcy & Restructuring - A Roundtable Discussion

What effect did the challenges of the past 15 months have on the bankruptcy and restructuring landscape?

Banner: Remarkably, the past 15 months did not result in the wave of bankruptcy filings that many bankruptcy professionals expected. Other than the notable large retail filings, mid-market bankruptcy filings have been few and far between. Many factors have likely influenced this unexpected outcome of the COVID-19 pandemic, including PPP and EIDL loans, the historically low interest rates and the various eviction moratoriums. Many businesses that would normally resort to a bankruptcy restructure in a poor economic environment were able to take advantage of these policies and programs to essentially weather the storm. Unfortunately, the low number of bankruptcy filings does not necessarily mean that less businesses were closing. What we have seen is that numerous retailers, restaurants and other businesses that would normally be able to reorganize in a bankruptcy cases in a more favorable economic environment were simply forced to permanently close their doors and/or liquidate in recent months due to the pandemic.

What are some signs that a business is struggling and that restructuring or bankruptcy might be a necessary path?

Banner: Just like for personal finances, once a business begins to struggle to pay debts as they come due, it is time to take a step back and evaluate your options. This rule of thumb is not always so obvious when operating a business, as prioritizing payment of debts is an often-organic process based on available capital. Nevertheless, if a company finds itself putting off payments to trade creditors in order to make payroll, or a company elects to extend repayment terms outside the ordinary course – for instance paying debts normally paid in 30 days to 60 or 90 days – these can all be signs of financial distress. Consulting with a bankruptcy professional once the early cracks begin to show is the best way to avoid a complete meltdown of a going concern.

At what point should a business consider hiring a bankruptcy or restructuring professional and what should they look for?

Banner: The earlier, the better. One common misconception is that a bankruptcy or restructuring professional need only be consulted as a “last resort” when a bankruptcy filing is imminent. To the contrary, when brought in at the early signs of financial distress, a bankruptcy or restructuring professional could be the key to avoiding a bankruptcy altogether. There are many options at a company’s disposal to address the source of financial distress, and sometimes a resolution is achieved through negotiating an out-of-court restructure with one, or a handful of a company’s creditors. Unfortunately, companies often seek help when many of the out-of-court options are no longer viable, or when crucial bridges with stakeholders have been burned.

What is the first thing a company should do if it plans to file for bankruptcy?

Banner: Immediately consult with a bankruptcy professional – but not just for advisement on the bankruptcy process, but to discuss the various options at the company’s disposal. To file, or not to file a bankruptcy is often just a small part of the equation. The company may want to consider out-of-court options, ranging from individualized negotiations with creditors to an assignment for the benefit of creditors (a process similar to bankruptcy done outside of a formal court proceeding). If a bankruptcy filing is more appropriate for the company, the form of that bankruptcy can be tailored to the needs of the company, whether it be a sale of the company or its assets, a reorganization, or a complete liquidation. The best route varies based on a company’s individual circumstances.

What are some bankruptcy pitfalls that businesses should avoid?

Banner: The moment a company begins to experience financial distress, close attention must be paid to the flow of cash. For instance, payments to equity holders or other “insiders” of the company made within a year of filing bankruptcy could be later clawed back through the bankruptcy process. Similarly, payments to any creditors within the 90 days before a bankruptcy could be clawed back as “preferential” payments to those creditors (to dissuade companies from paying off the creditor they like prior to bankruptcy). Those are only two examples of common pitfalls a company faces after a bankruptcy filing. Consulting with a bankruptcy professional early in the process can help mitigate the risks associated with the company’s financial dealings leading up to a bankruptcy filing by advising against problematic cash flow decisions before they are made.

What’s the best way for a distressed company to find a qualified buyer or financing in today’s market?

Banner: Companies are often surprised to learn that there is an entire field of professionals dedicated to the sale of distressed assets – whether it is the sale of restaurant equipment or the sale of a going concern with millions in annual revenue. In short, if there is a buyer out there, such professionals will find them. We have had great success over the years connecting clients with appropriate professionals in order to maximize the value of a distressed asset sale.

How does filing for bankruptcy impact the sale process?

Banner: Often, a sale through a bankruptcy is actually preferable to an out-of-court sale. The reason for this is that, under the Bankruptcy Code, a buyer is able to purchase assets “free and clear” of liens and claims encumbering the assets through a bankruptcy sale. This offers a buyer a tremendous amount of comfort and security, which typically cannot not be achieved outside of a bankruptcy setting. One of the challenges we face when representing a buyer outside of bankruptcy, whether by foreclosure or otherwise, is that creditors and other parties continue to go after a buyer for the liabilities of the seller. A “free and clear” bankruptcy court sale order, on the other hand, provides a near iron-clad defense to any such claims.

If a business is privately held, will a business bankruptcy hurt the owner’s credit score?

Banner: The effect of a company’s bankruptcy on its principal is a common concern we hear from client. The short answer is “No” a company’s bankruptcy filing should not affect a principal’s credit. However, if the principal’s personal financial affairs become intertwined with the company’s, there is a possibility of an adverse credit event. For instance, company credit cards are a common way that company debts make its way to an individual’s credit report. If a company credit card has your name on it, you should be concerned about personal liability. Also, principal’s often guarantee the debts of a company, which could lead to collection and lawsuits after the underlying company files bankruptcy. Any time you take on a debt for the company, you should consider what will happen if the company later files for bankruptcy.

Categories: Bankruptcy, Chapter 11, Distressed Sales, Trends