Most businesspeople get a knot in their stomachs when they think of bankruptcy. The reasons for this, I believe, are twofold: They don’t have the basic knowledge about the implications of bankruptcy; and they feel a loss of control whenever they think about it.
This article attempts to dispel the myths about bankruptcy and provides some of the basics that will arm you if you are in the unenviable position of having to protect your company from it.
First, here’s some background. I am an investment banker, not an attorney. I was the owner, however, of a large CPA practice where, unfortunately and inevitably, some of my clients were either forced to declare bankruptcy or were trying to collect large accounts receivables from corporations that declared bankruptcy. Naturally, for specific advice on the subject, you must consult your attorney.
Second, I will discuss the most common form of bankruptcy under the federal bankruptcy statutes — Chapter 11. As a related note, the E-Commerce Times recently published an article about Donald Trump and his casinos, which appear to be heading for bankruptcy: Chapter 11 Sure Bet for Trump Casinos.
That article gave some insights into the possible affects of bankruptcy on Donald Trump’s casino creditors and on his ownership interest in those casinos. This article gives you some of the dynamics that occur in Chapter 11 and suggests ways that you can legally utilize the law in order to afford greater protection for your company.
Intent of Chapter 11
A company that has filed for Chapter 11 is referred to as a Debtor in Possession. This simply means that the bankrupt corporation is running the company under the watchful eyes of the Bankruptcy Court and the Bankruptcy Trustee, a federal employee who is paid to monitor the bankruptcy case to assure that the creditors’ interests are being protected and that the bankrupt company is complying with the provisions of the Bankruptcy Code.
The intent of the Code is to give the company time to restructure itself in order to make it a viable entity once again.
An ideal reorganization, from the perspective of the law, is one in which the bankrupt corporation (1) pays all of its post-petition debt (for example, debt that is incurred after the bankruptcy is declared) when it comes due; (2) pays a reasonable and fair amount to its creditors as part of the Plan of Reorganization (a plan that states how much the debtor corporation will pay to its creditors upon emergence from bankruptcy); and (3) exits bankruptcy as a stronger company and one that is economically viable.
Creditors’ Rights Under Chapter 11
Many creditors, upon hearing that one of their customers has declared bankruptcy, throw up their arms in frustration and just give up on the possibility of ever getting anything but a few cents on the dollar for their receivable. This is not only unnecessary, but it is also unwise. Creditors do have a say in Chapter 11 cases and can make their input more effective.
They can do this by having some representation on the Creditors’ Committee. This committee is composed of certain creditors of the company as of the date of the bankruptcy filing. Surprisingly, in many cases, a bankruptcy judge or trustee has to cajole and encourage creditors to serve on the committee.
Certainly, it is in your best interest to either serve on the committee or have input to the committee. Keep in mind that the creditors’ committee has a major say in approving the Plan of Reorganization. Remember that this is the Plan that directs the debtor corporation to pay so much on the dollar when it exits bankruptcy. Obviously, input into this committee is critical.
Vote by All of the Creditors
When the Plan of Reorganization is completed by the debtor corporation, it is mailed to all of the creditors for a vote. If the creditors approve the Plan, then the debtor corporation can emerge from bankruptcy. It should be obvious, then, that creditor participation is a must.
Priority of Claims
When a corporation declares bankruptcy, it must provide the court with a list of creditors by order of the priority of their claims. This produces a descending list of creditors from the most secured or preferred to the least secured or preferred.
For example, unpaid payroll taxes are on the top of the list with unsecured creditors at the bottom. In between are different categories of creditors depending on their priority. A mortgage secured by real estate will be high on the list of priorities, while a loan to the corporation by officers/stockholders will be among the lowest in priority.
Steps To Protect Your Company
1. Be sure that your company is included and appropriately prioritized on the initial listing of creditors of the bankrupt corporation. If it is not, consult your attorney immediately.
2. Take an active roll in the Chapter 11 proceedings. This means that you must attempt to get on the Creditors’ Committee and that you must attend the meetings of this committee.
3. You should also attend the court hearings to make sure that your interests are protected. Of course, bring your attorney to these hearings.
4. When it comes time to approve the Plan of Reorganization, be sure to vote, and make sure that your vote is properly weighed and weighted according to its priority and the amount of your claim.
In a previous article, Tools for Monitoring Your Customers’ Financial Health, I talk about how you can be proactive in watching over the financial well being of your customers. I gave you specific tools that, if employed properly and on a timely basis, can allow you to intercept a bad situation before it gets worse. Use these tools and be proactive in order to protect your financial interests.
Chapter 11 can be very challenging and frustrating. However, it also can be rewarding if you take an active roll in the process and do your best to understand what is going on. Good luck!
Theodore F. di Stefano is a managing partner at Capital Source Partners and can be contacted at [email protected].