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News & Insights
January 18, 2021
What to Expect When You’re Filing for Bankruptcy
By Erik White, CIRA

Erik White, Managing Director, Harney Partners

Key Considerations To Help Business Executives Navigate The Reorganization Process

Businesses, both big and small, are facing unprecedented challenges from the COVID pandemic throughout the economy, with significant and persistent uncertainty regarding roll-out of vaccines and timing of getting back to ”normal”. The Paycheck Protection Program (PPP) helped many companies, but those funds were quickly exhausted. The upcoming “PPP2” should help too; however, the longer-term impact to businesses remains unknown. Many organizations will be faced with how they can reorganize to survive.

Bankruptcy is typically a last resort. While it is an effective means for some scenarios, other out-of-court alternatives should also be explored. This may include negotiating with lenders, vendors, or landlords; utilizing the government support; and/or seeking out new capital. When these options come up short, bankruptcy may be the only answer.

When Bankruptcy is the Only Option

Making the decision to file for bankruptcy is a huge decision not to be taken lightly. There is so much to consider when taking such a drastic step. First and foremost, keep in mind that chapter 11 bankruptcy is a daunting process for everyone because of the numerous uncertainties – not to mention intense demands on your time. In addition to continuing to manage your business in a difficult operating environment, you will also need to develop strategic plans, negotiate with stakeholders, find additional sources of financing and meet new reporting requirements. Hiring the right professionals, including legal counsel and a financial advisor or chief restructuring officer (CRO), can also enable you to navigate these complexities to reach the best possible outcome. There are many benefits of chapter 11 bankruptcy, but it should be utilized with purpose only after the out-of-court restructuring options have been exhausted.

Based on our experience helping many different types of organizations utilize the bankruptcy process, this article is designed to give business executives and managers an overview of the key components of the chapter 11 bankruptcy process and help walk you through the major milestones you’ll face as you restructure your debts and emerge from the bankruptcy with a fresh start.

Here are some ways to prepare yourself for bankruptcy, manage your employees and successfully navigate information requests from your bankruptcy professionals and external stakeholders.

1. Preparing For Bankruptcy

There’s an old saying: the more time you spend preparing for bankruptcy, the less time you’ll spend in bankruptcy. Starting with a good strategy in hand will effectively expedite the process forward. It will also convey your seriousness and sense of urgency to important stakeholders: the bankruptcy judge and court, your secured lenders, key suppliers, and other unsecured creditors.

Here are the elements that should go into your preparations:

Case Strategy

First, consider your goals. Begin by asking yourself the following questions to help determine what you want to achieve by filing for bankruptcy protection:

  • Do you want to reduce debt, stay a foreclosure or debt acceleration, shed burdensome leases or contracts, or sell the business in whole or in part?
  • Do you need external financing to achieve that result?
  • What creditors do you need to negotiate with early in the process?
  • Who has a lien on cash, and are they a willing, cooperative party?

In the grand scheme of things, bankruptcy is a process that pulls everyone into one room to agree on who is owed how much debt and when and how much will be repaid. The process gives everyone an opportunity to be heard. However, certain creditors will have louder voices than others from the circumstances of their claims or interests. When creating your strategy, it’s important to think through these relationships and their possible impact on your plans.

Implications of the Automatic Stay

When you file a chapter 11 petition, all assets and liabilities are transferred to a new and separate entity created specifically for the bankruptcy process: the “Debtor-in-Possession,” often referred to as the “Estate.” The Bankruptcy Code allows the Debtor-in-Possession to continue to operate and automatically implements a stay preventing creditors from pursuing collection efforts, giving the Estate the breathing room to move through reorganization.

It also means that while you’re in bankruptcy, you are prohibited from making payments to creditors, including employees and vendors, for debts incurred prior to the petition date (these are known as “pre-petition claims.”), unless explicitly allowed by an order of the court. However, you must stay current with post-petition obligations, including paying quarterly US Trustee fees and filing and paying all post-petition taxes.

Even though all payments for pre-petition claims are on pause during this time, you still have the statutory responsibility to preserve and maintain your company’s value so you can maximize your payments once you do begin to make them. This means officers and directors have an increased fiduciary responsibility during bankruptcy/insolvency to include the best interests (not just of equity holders), but of all stakeholders in your company, including creditors. This shift in focus can be difficult to make, but it’s important to keep in mind as you plan.

To avoid irreparable harm to the Estate, there may be some payments you need to keep making. In these instances, counsel will often file motions with the Court to obtain authorization to make certain pre-petition payments to creditors. To obtain Court approval, you’ll need to prove these actions will benefit the Estate and its creditors – for instance, by giving you continuing access to critical parts or materials.

Such payments may include:

  • Trust-fund taxes (such as payroll tax withholdings)– to prevent personal liability from falling to the executives
  • Insurance– to keep the Estate covered from potential losses
  • Utilities– to maintain essential utility services to continue operations
  • Employees– to maintain continuity of the work force and retain the institutional knowledge and operational capabilities
  • Critical vendors – In some situations, certain vendors serve a vital role in the success of the company – and won’t continue to do so without payment.
  • Warehousing or shipping companies – to pay companies that won’t release the Estate’s goods without payment
2. Communications And Negotiations With Creditors

Communicating with creditors during bankruptcy proceedings can be difficult, but it’s a key part of moving successfully through the process. In other words, do control the message, but don’t allow concerns about your brand and reputation to keep you from maintaining open lines of communication with everyone involved. Instead, be as prepared, proactive, and transparent as possible. This includes devising and following through with an internal messaging strategy that will reassure your employees and address their concerns.

Here are some critical communications for all Debtors-in-Possession

Noticing

Chapter 11 is a collaborative process that seeks to bring all stakeholders together and allow the business to reorganize under supervision of the Court. To restructure all of the debt obligations, you will create a Creditor Matrix and use it to notify all known parties who could possibly be owed money by the Estate of the bankruptcy case. This listing should include all potential creditors so they can all choose whether to participate – and so that no party can claim to have been excluded from the process.

This step is critical to a clean discharge of debt upon confirmation. The goal is to come out on other end with a joint obligation to the result – in which everyone involved is not only aware of your plan, but willing to abide by it. For example, we know of one organization that bought a company that had just emerged from bankruptcy, not knowing the company had failed to notify a customer with a pending lawsuit. Because the customer hadn’t been notified, the multi-million-dollar judgement in that case remained in force – and the new parent organization had to file bankruptcy again to address the resulting obligation.

Initial Debtor Interview and Creditor Meeting (knows as the “341 Meeting of Creditors”)

Within the first few weeks after filing for bankruptcy, representatives of the Estate must attend an Initial Debtor Interview to meet one-on-one with the US Trustee, a kind of early referee who assists the Bankruptcy Judge from a procedural perspective. In advance of the interview, you’ll provide the US Trustee information including asset and liability values, tax returns and proof of insurance. The US Trustee’s office will preside over the 341 Meeting of Creditors, which is an opportunity for creditors to ask the Debtor (and its professionals) questions about the situation and the vision and strategy for the case. This meeting is an important step to get right because it presents an opportunity to articulate your goals and cultivate goodwill with the creditors.

Unsecured Creditors Committee

For many businesses, there can be hundreds or thousands of unsecured creditors that have provided unsecured loans, goods or services to a company. The bankruptcy code provides for a committee of three to seven individuals to represent those interests during the chapter 11 proceedings. The Unsecured Creditors Committee (“UCC”) acts as a fiduciary for all unsecured creditors and is intended to make the process more efficient by allowing the Estate to negotiate with just one entity. The UCC retains legal counsel and sometimes hires a financial advisor in more complicated matters. These professionals will make information requests to conduct their own diligence and analysis to best advise the UCC. This committee can be an important player in the process, so it’s important to be responsive to its needs. This level of thoughtfulness can benefit you later in the process as issues – and alliances – shift and change.

3. Reporting And Analysis

The goal with reporting and analysis is to get a clean view of your pre- and post-petition accounting system. These reports are not always intuitive, so completing them can be a challenge.

Accounting System Cut-off

It’s important to get as accurate a snapshot as possible of your books and records by the petition date. To maintain this snapshot, you’ll need an accounting process that can identify and code invoices to post-petition or pre-petition periods.

Reporting Requirements

Statements and Schedules must be filed within 14 days of the petition date unless an extension is approved. This important reporting requirement details the Estate’s assets, liabilities, contracts and recent financial activity, including recent payments to creditors.

Monthly Operating Reports including income statements, balance sheets and cash activity, must be submitted by the 21st day following the close of the prior month. The US Trustee office is in the process of rolling out new reports that go into effect in June 2021. These new reports are aimed at striking a balance between providing stakeholders adequate information to monitor the financial condition of the company while not being too burdensome on the company.

Weekly cash flow reports may be required if a creditor has a lien on cash and has agreed to allow the Estate to use that cash collateral. This reporting describes how the Estate is spending the money and demonstrates that it is operating within the agreed-upon budget and timeline (typically 13 weeks).

4. Disclosure Statement And Plan Of Reorganization

All the steps we’ve discussed up to this point – preparing, filing, obtaining permission to continue specific payments to maintain the value of your business, then negotiating with creditors and developing an exit plan that addresses all debts – result in the plan of reorganization.

Plan of Reorganization

The Plan of Reorganization is essentially a contract between the Estate and its creditors that describes how and in what amount the creditors will receive in debt repayments. The plan can take any form – a liquidating plan, merger, recapitalization, etc. – as long as it follows certain requirements. Initially, the Estate has the exclusive right for 120 days to propose a plan of reorganization, which can be extended by the court to allow the Estate sufficient time to formulate, negotiate, and draft a plan so long as sufficient progress is demonstrated.

Disclosure Statement

The Disclosure Statement functions as a grand document that describes the plan, what has been achieved and what will happen going forward. This required document gives creditors enough information to evaluate the plan and vote on whether to accept or reject it.

The Disclosure Statement typically includes the following:

  • Background on the company and events leading to chapter 11
  • Progress made while in chapter 11
  • Summary of plan of reorganization including treatment of each class of creditor
  • Pro forma financial projections and liquidation analysis
  • Risks and alternatives
  • Overview of voting and confirmation process

The Court must approve the disclosure statement and voting ballots before any voting takes place.

Wrap Up

Bankruptcy is a daunting word, and one that conjures the idea of failure for many people. While chapter 11 should be your last option, it also may be your best way out of an untenable situation. Bankruptcy allows you to have a pause with your creditors and develop a plan to pay back creditors as much as feasible, while keeping an ongoing business operation.

It’s also an unfamiliar and often intimidating process that requires a great deal of work. Following the guidance in this article will help keep you focused on a clear path forward as you develop your plan, communicate and negotiate with your stakeholders, and complete all of your various reporting requirements.

When used properly, bankruptcy can stabilize your company and help you emerge stronger than ever before. If you need help, the Harney Partners advisory team includes CPAs, certified turnaround professionals, certified fraud examiners and forensic professionals with both technical expertise and credibility in the courtroom. We have the specialized knowledge and experience to help you chart your way through reorganization and become better positioned to succeed in a constantly changing market. Contact us today.

Disclaimer: This article is not to be used for legal advice. Speak with an attorney if you have specific questions about your situation.

Erik_White
Erik White, CIRA
Managing Director

Erik has amassed more than 14 years of experience in corporate finance, business restructuring, forensic consulting and asset management. He provides strategic advisory services, both financial and operational, to companies experiencing a complex transition.  From Fortune 500 to lower middle-market companies, Erik has the depth and breadth of knowledge and experience to support clients in distressed situations.