Business insolvency has been increasing over the last few years and continues to be a significant problem in Oklahoma and across the US, with increased business bankruptcy filings through 2010 and sustaining elevated levels in 2011, according to the American Bankruptcy Institute.
As has been widely commented upon, many businesses have been subject to the stress of sustained weaker consumer and business demand, a faltering global economy, as well as stressed balance sheets. All of that contributes to some business owners having to make tough decisions when trying to resolve issues with creditors that have the potential to cripple their business.
In times of business insolvency, Chapter 11 bankruptcy has long been a tool for the business owner to negotiate with creditors, but it is only one tool in the toolbox and should only be used when other options have been explored. Chapter 11 protection can be expensive and erode substantial “value” from the business, including intangible values, such as brand equity, goodwill and business relationships, which often represent a significant piece a company’s valuation.
In many cases, if a company’s balance sheet is not strong enough, with available unpledged assets, then the company may not make it through Chapter 11, unable to fully finance the process. While the average lifespan of a Chapter 11 case is now only 8.5 months, according to Grant Thornton, it still remains a costly and complex process.
Asset Sale alternative
While Chapter 11 filing is an option for stressed companies as well as distressed companies, it should not be viewed as the only option, with many business owners and their advisors instead pursuing an asset sale. This can be a complex issue, due to liens and other liabilities that need to be worked out, but if all parties agree that a restructuring outside of bankruptcy leaves a bigger pot to settle liabilities, and there is confidence in the restructuring plan and the company’s ability to deliver on that plan, then stakeholders may reach consensus to negotiate and preserve higher value outside of bankruptcy.
In terms of buyers and investors to finance an asset sale, there are increasing numbers and quality of both equity investment groups and strategic buyers that actively look for stressed investment opportunities, and while they may end up investing at a discount to fair value, this discount may be preferable to the liquidation value further down the road. As a business owner weighs up their options, they also need to consider the value of time and risk of the bankruptcy process.
In some cases, an improved solution is a halfway step, having a fiduciary such as a Chief Restructuring Officer or a Receiver, to oversee and manage the restructuring process. You could have a scenario where secured creditors receive payment more quickly, in consideration of a haircut on their loan, while still leaving a viable business to payback funds to unsecured creditors over time. Oftentimes, this approach results in more cash being returned to both secured and unsecured creditors than Chapter 11, as the cash-generating parts of the business are allowed to move forward more quickly and increase the likelihood of a successful turnaround.
Even if a business were to cease operations, there are often better alternatives than liquidation, if creditors have patience, confidence and trust in the plan, and allow an asset sale to strategic investors and accept proportional payments over time.
Section 363 alternative
Another alternative to Chapter 11, is a Section 363 sale within the bankruptcy process. The decision to use a 363 sale should be made on a case by case basis, but the underlying goal of a 363 sale makes sense – to quickly and effectively deal with a business’ past liabilities and allow the core business to survive. Section 363 can be a faster version of the bankruptcy process, while still ensuring a sale free and clear of all previous liens and liabilities. Under Section 363, a fully negotiated asset purchase agreement is presented to the Court for approval, which may have been arranged before or after the filing for bankruptcy. This purchase offer sets the bar for any other prospective buyers to come in with competing bids, subject to a defined set of rules.
Weighing up a 363 sale, particular points to consider include: i) whether there is a likely potential buyer lined up; ii) what is the relationship between shareholders; iii) are there other governance issues that could block a sale; iv) is there likely to be cooperation among parties to achieve consensus; and v) does the business have greater value as a going concern than its assets alone (liquidation value)? A business owner also needs legal counsel to review federal and state rules and relevant case law.
As with any tool, there are advantages and disadvantages to a 363 sale, and we would recommend talking to a bankruptcy attorney and advisor. In speaking with them and trying to find the best option, consider the time value of money, build a financial model, conduct scenario analysis tests and think through the implications of every alternative before making a decision.