Distressed businesses that are facing severe financial difficulties often think that only bankruptcy, whether a Chapter 11 reorganization or Chapter 7 liquidation, can solve their problems. While bankruptcy is certainly an option, it may not be the only—or even the best—path to restructuring, financial stability, or an otherwise orderly closing of business operations. Bankruptcy can be costly and time-consuming and, in some instances, result in more harm to stakeholders on both sides of the creditor-debtor relationship.

There are numerous non-bankruptcy alternatives for distressed businesses. While each will come with pros and cons, those alternatives can provide advantages to various stakeholders over a traditional bankruptcy filing.

When considering the alternatives to bankruptcy, practitioners should, at the very least, evaluate the following alternatives: 1) Receivership, 2) Assignment for the Benefit of Creditors, 3) UCC Article 9 Sale, and 4) Compromise with Creditors and Out-of-Court Workout.

Receivership

A receivership is an alternative to bankruptcy, which features court oversight of the operation or liquidation of a distressed business and its assets. A receiver is an officer of the court, holding the property as a custodian and fiduciary during the pendency of the receivership, who is tasked with preserving and maintaining assets, preventing waste, and preserving value pending final adjudication. In state court, a receiver is most often appointed at the request of a secured creditor that fears that its collateral will be dissipated or otherwise harmed by the debtor.

Assignment for Benefit of Creditors

In an assignment for the benefit of creditors (“ABC”), the distressed business assigns all of its assets to a neutral third party who takes title to such assets “in trust,” sells them, and distributes the proceeds to creditors according to their relative priorities. An ABC offers some of the same advantages as a Chapter 7 filing or liquidation under 11 U.S.C. § 363. It provides a structure for the liquidation of assets, but with a more streamlined process that takes less time to complete than a bankruptcy, while allowing input from both the business’ management and its creditors. Even though the assets are assigned to the neutral third party, it does not stop any litigation against the business. An ABC is also similar to a receivership with the use of neutral third party, but that third party is not necessarily appointed or supervised by the court.

The laws governing ABCs vary greatly from state to state, with some states having statutory schemes and others using common law or not using the process at all, with and without court’s oversight of the proceedings. While the assignee has discretion on how best to liquidate the business’ assets, whether through a liquidation or a bulk sale, the assignee has a duty as a fiduciary to act diligently to maximize the return for the creditors.

UCC Article 9 Sale

A secured creditor’s remedies under Article 9 of the Uniform Commercial Code include repossession, disposition, and retention and acceptance of collateral to satisfy the underlying obligations. A secured creditor may pursue these remedies with a debtor’s consent in “friendly” situations, but ultimately the debtor’s consent is not required. After obtaining possession of the collateral, pursuant to Section 9-610 of the UCC, a secured creditor may dispose of its collateral via a UCC sale, which can be either private or public. A UCC sale could also be an attractive option for a distressed business as debtor’s acquiescence to surrender of the collateral and the sale may provide the debtor with an important leverage, especially if the debtor or other obligors seek to extinguish their personal liability.

Composition Agreements, Exchange Offers, and Out-of-Court Workouts

While not always a realistic option for a distressed business, restructuring its balance sheet directly with creditors, as an out-of-court “workout,” can offer great efficiency and cost savings, and minimize any detrimental effects on the business, as compared to bankruptcy. The ultimate goal of a workout is to negotiate a consensual solution with the creditors to adjust the business’ obligations to pay liabilities, or their timing, to be more in-line with the available cash flow.

The form that a workout takes depends on the specific nature of the business’ financial distress and capital structure but typically involves a reduction in the principal amount of debt and/or an extension of the maturity of debt, and possibly the issuance of new equity. Composition agreements can be used with multiple creditors of a distressed business, whereby each of the creditors enters into the arrangement agreeing to be paid a specified amount, possibly on a deferred schedule, in full satisfaction of the debt. Exchange offers are similar to composition agreements, except the creditors would be a specified class of creditors, like bondholders of specified class of lenders.  

While composition agreements and exchange offers allow a business to restructure its balance sheet without the time, expense, and publicity of a bankruptcy proceeding, they also have some disadvantages when compared with bankruptcy proceedings. Specifically, they cannot bind non-consenting creditors and do not provide distressed business with the Bankruptcy Code’s protections, such as an automatic stay or the ability to reject burdensome executory contracts.

If you are interested in a more comprehensive discussion of this topic, please review our recent article on the topic published by The Review of Banking & Financial Services, or contact one of the authors directly.