$500,000 per day!

 

bankruptcyIn some of our discussions with the owners and managers of troubled companies, we often hear: “If I can’t work things out, I’ll just declare bankruptcy.”

By bankruptcy, they mean Chapter 11, which allows the debtor to reorganize the company by submitting a plan of reorganization that is acceptable to the creditors and approved by the bankruptcy court.

A Few Things To Think About …

But there are a few things to think about before playing the bankruptcy card so easily. The former general counsel of American Airlines, in a talk recently, talked about the “almost unimaginable” costs of Chapter 11 bankruptcy. At one point, the airline was spending $500,000 per day on legal and professional services costs.

While, of course, Chapter 11 reorganization for a smaller or mid-sized company won’t approach the staggering number of an American Airlines, it is still extremely expensive relative to the size of the business.

Why So Expensive?

The reason a Chapter 11 bankruptcy is so expensive is because it involves two separate elements:

1. a reorganization plan and

2. a debt repayment plan.

The reorganization plan has to convince the court and your creditors that the business can make a profit in the near future. This plan must be supported by reliable data. Then you have to show a budget where you outline how you can repay your creditors over the next several years.

And then you will have to negotiate the terms of the plan with the court and your creditors. While that is going on, your budget has to allow for the payment of your attorney’s fees, your creditors attorney’s fees and for financial advisors on both sides.

Chances Of Success …

The success rate in Chapter 11 bankruptcies is extremely low, meaning that a very low percentage of reorganization plans actually obtain court approval. Depending on size and financial capability, experts put the number between 20 and 30 percent. Thus there is a high chance that the company will spend a lot of money putting together the plan and attempting to persuade the court, but fail to do so and end up in Chapter 7 liquidation.

In 2014, 6,903 businesses filed for restructuring under Chapter 11 while 18,184 businesses simply liquidated their operations under Chapter 7. Both filings were down substantially over previous years.

Are There Any Alternatives?

It is important to note that a number of Chapter 11 filings end in a 363 sale of assets. In Washington and other states, there are significant alternatives, such as an assignment for the benefit of creditors, or general receivership that provide the same results at significantly less cost.

Legal and financial insiders say the sources of money available to distressed companies have changed significantly in the past five years. Traditional banks have been augmented by a system of private equity firms and hedge funds, creating a private out-of-court restructuring program for companies that they think have long term viability. These groups are often shoring up or purchasing the debt of companies to insure their survival.

Don’t Suffer From Egoruptcy …

A famous business book, in years gone past, coined the term “Egoruptcy” which is defined as allowing your ego to get in the way of your financial health.  And many companies that otherwise could have been preserved have gone the route of Chapter 7 or liquidation because management was “sure” that they could “save” the company through Chapter 11. As a result, they did not understand or explore the many alternatives.

Money Is Available …

In today’s competitive banking climate, money is more available for businesses with problems than ever before.  At the same time more loans and equity investments are failing to close, pushing companies to or over the edge, because many companies are not presenting themselves well to lenders and investors.

Just as each business is different and has its unique business practices, lenders and investors each have their unique requirements. Companies are best served in understanding these requirements by examining all of the available financial alternatives, and perhaps by seeking outside financial advice in making the best decision.