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Monday, April 27, 2020

What’s the Next Step When You Run Out of Options?


Not many businesses have been unaffected by COVID-19. Even those providing much-needed products or services face financial challenges and must take immediate steps to preserve cash for a long-term recovery period.

Let’s assume that you’ve done everything right to weather this disruption. You reduced headcount and/or reduced salaries by as much as 25%. You’ve communicated with your creditors to try to extend terms. You’ve taken advantage of every possible benefit available and have received the funds.

But what if, unfortunately, it looks like that isn’t enough? What if the rent has still not been paid, your bank is unwilling to negotiate any further, your HR person just asked you again about the unpaid healthcare invoice that includes employee trust funds, and you don’t see a path forward?

You need to weigh your options. But first, you need to think about your goals for the future. Do you want to maximize your company’s value? Create an opportunity for your employees to keep working? Build a transition/soft landing for your technology and intellectual property? Once you’ve figured out your priorities, you can start to determine the appropriate strategy.


Four Tools to Consider

There are four tools that distressed companies with diminishing funds can utilize: (1) restructuring debt, (2) a managed wind-down/liquidation, (3) a general assignment for the benefit of creditors (ABC), or (4) a bankruptcy.

The right choice depends on your goals and current financial position. It’s also important to consider all the tools to make an informed decision. Keep in mind that advisors who specialize in one area tend to promote their specialty, so bankruptcy lawyers will encourage bankruptcy, ABC specialists will recommend ABC, etc. (To get an unbiased recommendation, it helps to work with an advisor that offers all four options.)


Option 1: Restructuring Debt

Debt restructuring makes sense if you think your company could survive if you change the terms on your outstanding debts — like moving to interest-only payments for a period of time. You hire a professional to go over your current debts and renegotiate the terms with your creditors, so you can avoid going into a bankruptcy or an ABC, where they might end up receiving less. You also avoid the hassles and costs of a court process.

Restructuring debt gives you the flexibility to negotiate different types of terms with different creditors. For example, you can offer a key supplier terms that align with your go-forward plan (e.g. payment over time), while offering a different payout to another vendor you don’t plan to work with again (e.g. lower payout now). In a bankruptcy or an ABC, you don’t have this flexibility and need to treat creditors equally ― for example, everyone gets 50 cents on the dollar today for the settlement.

For debt restructuring to be a viable option, you must have something positive to bring creditors to the table. For example, you could be getting new funding to make a lump settlement, but it is contingent on getting liabilities down, or you have a major project coming up, so you can start making debt payments again later. If you can’t show creditors that they will be better off, they won’t have an incentive to negotiate.


Option 2: Managed Wind-Down/Liquidation

You can use a managed wind-down if you’d like to shut down your business and can pay off all your existing debts. Either you have enough cash on hand or you will after you sell some assets. With this approach, you don’t go through a formal or court process. You just pay off your creditors. Once that’s complete, you enter a formal dissolution to end the business.

A managed wind-down is not as simple as it seems. So it’s still best to have a professional oversee the process, because they can handle everything more quickly and efficiently, including following up with state and federal authorities. Your advisor will know exactly what documents need to be filed for the dissolution, what final returns need to be put together, what licenses need to be cancelled, etc. They’ll also watch out for the kinds of problems, like contingent liabilities, that could get you in trouble post-dissolution.


Option 3: General Assignment for the Benefit of Creditors (ABC)

An ABC is a state-level process, similar to a federal bankruptcy: An insolvent company liquidates their remaining assets to pay off creditors. However, it has several key differences.

First, an ABC is often less expensive. The process is dictated by state law, but in the roughly 35 states with established ABC laws, you will likely pay five to 10 times less by going through ABC versus a Chapter 11 bankruptcy. The ABC process also gives you more control, because you get to choose an assignee. This person manages your remaining assets and figures out how to monetize everything to pay off the creditors.

As a result, you can pick someone who understands your industry and can maximize your value during the insolvency. With Chapter 7 bankruptcy, the courts pick a trustee to handle everything, and this person may not know anything about your business.

It’s also easier for the ABC assignee to sell assets. You can market assets before the ABC and sell them right away to free up some cash as you go through the process. With bankruptcy, you have to get court approval to sell assets, which can take months.

The downside of an ABC is that every state has different rules, and some are better designed than others. (California and Delaware are two of the best.) Also, you need approval of the shareholders to go into an ABC and the secured creditors to sell their collateral. If they don’t support this move, you cannot proceed.


Option 4: Bankruptcy

There are two types of bankruptcy for businesses. Under Chapter 7, you shut down the business and a panel trustee is appointed to eventually pay off your creditors out of your remaining assets. Chapter 7 might be your only option if you don’t have the funds to wind down or restructure your debt and your creditors/shareholders won’t accept an ABC, but creditors typically get little.

Under Chapter 11, you need to develop a plan ― that creditors will agree to ― to renegotiate payments on your debts and keep your business running or sell the assets through an extended auction-type process. Recently, Congress refined the rules for small-business Chapter 11s and created a “Subchapter V” election to reduce the cost and time of bankruptcy. This was originally limited to companies with $2.7 million in liabilities or less, but under the CARES Act, the limit has been raised to $7.5 million.

There are situations when a bankruptcy can work out better. If you have a larger, complicated business, having a court available may allow you to force agreement. If you have multiple leases, bankruptcy gives you the ability to get around the contract terms to reassign the lease — allowing you to sublet to another tenant. In an ABC, you still need to follow the language of the lease, which could restrict your ability to assign it.

And if you have a complex debt structure with different classes of bonds, bankruptcy can force a modification to different payment terms, whereas ABCs cannot. Due to the increased number of filings that are taking place and the delays in the courts caused by the COVID-19 crisis, however, bankruptcy cases are likely to take longer.

The best choice often depends on the size of the firm. ABCs usually make more sense for lower and middle market companies worth less than $50 million or deals that need to move more quickly. Bankruptcy makes more sense for larger organizations, especially if they have multiple leases or a more complicated debt structure.


Whatever You Do, Don’t Delay

For all of these strategies, the earlier you start planning, the better. By talking to a professional as soon as you know you’re in trouble, you keep your options open. If you wait too long and don’t have the cash to negotiate for a debt restructuring or plan a managed wind-down, you might have no other choice than to enter an ABC with no plan or declare Chapter 7 bankruptcy and shut down.

Have questions or want to learn more? Contact Armanino’s Restructuring team. To find the latest regulatory updates and other information on running your business during disruption, visit our COVID-19 Resource Center.

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