A corporate bankruptcy occurs when a corporation is no longer solvent—that is, it cannot meet its day-to-day obligations. Sometimes a corporation becomes insolvent because of a liquidity crises but the underlying business remains strong. Such a corporation is likely to seek the protection of a Chapter 11 Bankruptcy as a going concern. Other times, a corporation is forced into bankruptcy because its business model has failed and even restructuring its debt will not allow it to emerge as a going concern. In that case, the corporation will enter either a Chapter 7 or a Chapter 11 Bankruptcy with the purpose of liquidating its assets and paying creditors in an orderly fashion.
In either case, whether a reorganization or a liquidation is necessary, the attorneys at JRFPC are experienced practitioners of bankruptcy law. We are ready and willing to help you restructure your business, evaluate the underlying economics of your business model, and walk you through the decision-making process as to whether a liquidation or reorganization is the right next step for your corporation.
Smaller companies and sole proprietorships have an additional option to often find themselves with more options in filing for bankruptcy which includes the same chapters mentioned above, but can also seek Chapter 13. This chapter is reserved for consumers and sole proprietorships that stipulate to a repayment formula that helps the company get back to profitability.
Types of Bankruptcy
A Chapter 7 Bankruptcy for a corporation is a liquidation. At the end of the bankruptcy case, the corporation will be unwound and all the corporation’s assets will be distributed to creditors. The corporation will cease all operations. In a Chapter 7 Bankruptcy, the Bankruptcy Court will appoint an interim manager who is responsible for managing the company’s assets and works on a formula to dissolve the company and distribute the proceeds to debtors. It is normally seen as the last step in folding a company.
Alternatively, a Chapter 11 or, more rarely, a Chapter 13 Bankruptcy will allow a corporation to restructure its obligations and take other measures that will allow it to pay creditors in an orderly fashion and emerge from bankruptcy as a going concern. The Bankruptcy Court appoints a trustee who runs the business on an interim basis until the company is profitable again and can to pay off its creditors.
Because a reorganization plan affects how and when creditors will be paid by a going concern, the creditors are allowed to vote on and approve a reorganization plan. The creditors form a committee that can have considerable sway over how the reorganization plan looks, and over the progress of adversary proceedings.
Factors that lead to Corporate Bankruptcy
Bankruptcy is not always a result of bad management. There are various ways in which a company may fall into bankruptcy even if it has done everything well. These could include prevailing market conditions, financing, natural disasters and other causes beyond anyone’s control. Some factors that can lead to bankruptcy include:
- Prevailing market conditions – Sometimes a company finds itself under intense competition as well as increasing hard economic times. Market conditions affect the overall income as well as the costs of running a business. Difficult market conditions can lead to a company failing to pay its debts in time and becoming insolvent. Sometimes market conditions are completely beyond the Debtor’s control; sometimes, however, market conditions are foreseeable and are incorporated into a prudent Debtor’s business plans.
- Expensive financing options – a company might enter into a situation whereby it needs financing desperately. Seeking short-term financing might result in the company choosing expensive or sometimes unsuitable repayment schedules. Sometimes this issue can be resolved outside of Bankruptcy Court via negotiation or debt restructuring.
- Poor decision making – CEOs and executives can make decisions that lead a company into insolvency. Bad management is commonly at least a partial cause of a corporation entering bankruptcy, especially in conjunction with adverse market conditions.
- Lack of institutional memory – Companies with high turnover, especially at management level, suffer from inefficiency and a lack of institutional memory. This factor can affect a company in some surprising ways, including but not limited to failed relationships with important creditors. Having institutional memory can help a corporation deal with long-time creditors and vendors to reach necessary payment deals and avoid bankruptcy.
- Natural catastrophes – When a hurricane or an earthquake hits an area, or a pandemic sweeps across the economic landscape, there are companies which might never recover. Bankruptcy may be an inevitable conclusion to such events and help the corporation and its employees to wind down the business in an orderly way even after chaos has caused it to become insolvent. Bankruptcy can also sometimes help a company come out of a natural disaster as a going concern if the underlying economics of the business are profitable outside the effects of the natural disaster.
- Tax and fraud-related issues – Sometimes an organization is forced to shut down operations when it is unable to pay its taxes or when company executives being involved in fraud. A bankruptcy will deal with the fraud claims in an orderly fashion as well as claims from all creditors.
Managing Business during Bankruptcy
Running a corporate entity during the bankruptcy period can be a challenge. All eyes are on the company to avoid making other poor decisions, and the management’s decisions are routinely scrutinized by the Court and the Creditor’s Committee. This can also be a tricky time to get new credit, new staff, or venture into new areas of operation.
Nevertheless, a good management team, in conjunction with outside experts including bankruptcy counsel, can use the time in bankruptcy, and the protections the Bankruptcy Code offers to a Debtor-in-Possession, to rebuild the business and emerge from bankruptcy stronger than ever. The attorneys at JRFPC are experienced in the ins and outs of operating as a Debtor-in-Possession, negotiating with individual creditors and the Creditor’s Committee, and helping a Debtor emerge from bankruptcy well-positioned to take advantage of an improved economic condition.
Chapter 11 – Business Reorganization & Restructuring
Reorganization does not mean the same thing for every business. In general, reorganization can be as simple as looking at how a business is run and introducing changes. It can also mean finding ways to extend the life of a company possibly facing imminent bankruptcy, or that has already been declared bankrupt. This kind of reorganization involves extending credit lines or negotiating with suppliers to continue providing materials to keep the organization afloat. Restructuring can also include reducing or increasing the number of branches, reconstituting the board, or even selling off shares to the public or a significant shareholder.
Finally, restructuring can—and usually should—also involve reshaping the goals and missions of the business to either focus on key areas or expand to new areas that were not part of the main core business but that complement it and lead to new profit opportunities.
In short, restructuring looks different, and means something different, for each potential Debtor. What remains key in any restructuring is to take advantage of good legal and business advise. The attorneys at JRFPC stand ready to be your partner in the process of reorganization, working by your side to streamline your organization and its finances, and to work with business experts to determine the best path forward for your business.
Steps of Reorganizations
Most of the reorganization steps start internally, and if a business is big enough to have an internal legal advisor, they will initiate this step together with the management. If there is no internal legal counsel, an external legal firm with bankruptcy experience should be hired to advise the business in this process.
Once a legal process commences, and the Bankruptcy Court rules that there is a need for reorganization, the Debtor will implement a reorganization Plan. Through the Plan, the company begins to pay its creditors and attempts to change how it collects and uses its finances. In a Chapter 11 bankruptcy, there may be a Creditor’s Committee that will weigh in on these decisions as well.
Things to look out for before you reorganize your company
Before a company reorganizes itself, there are vital issues that our attorneys look out for to ensure the company can and should emerge as a going concern and not slide back into insolvency. A proper analysis of the organization’s economics and business model includes looking at numerous aspects of the business to explore ways and means of introducing changes, and whether such changes would be sufficient to change the company’s outcome. A competent legal team will manage this process and, if bankruptcy is necessary, work with the Bankruptcy Court and Creditors to ensure an optimal result.
The following questions are key to successful reorganizations:
- Does the organization have the capacity to remain afloat? One way to think about this question is to suppose that the company were debt-free and had no other obligations. Would it be a viable business if not for its debt and obligations? If the entire industry has failed because of changing technology, for example, the business might not be capable of continuing even in the most favorable conditions. In other words, a company that makes typewriters when the world has switched from typewriters to computers probably does not have the capacity to remain afloat unless it fundamentally changes its business model. The typewriter industry has essentially failed because of changing technology. On the other hand, a steel manufacturer might need to change how it manufactures steel, or restructure its debts and obligations, but the demand for steel continues despite some changes in how it is used.
- Is the business model being used the main reason it failed? The reorganization team should look at how the company has been conducting business and where it is focusing its efforts. If most of the sales were coming from one area of focus, they might recommend casting the net wider. This is part of the restructuring plan that can lead the company into new areas and adopting a new business model. For example, a typewriter manufacturer might explore whether it can stop making typewriters and start manufacturing laptop computers.
- Would the company shareholders achieve more if the company was liquidated rather than extending its life? Sometimes, the most economically prudent step is to unwind a company rather than change its business model or attempt to restructure it. Rather than waiting until all the value of the company has dissipated, our attorneys might recommend immediate liquidation to shield the owners and shareholders from losing the value of their work.
- Is there an option for merger and acquisition? Some business organizations move into mergers as a way to avoid bankruptcy. The right merger opportunity can provide a path to revising a failing business model and opening up new areas of focus or production. Mergers and acquisitions can provide some of the same restructuring opportunities as bankruptcy, but it can also be equally disruptive to the company and its employees. Determining whether a merger is either feasible or ultimately profitable requires careful analysis by the restructuring team of business and legal experts.
Depending on the results of the above analysis, restructuring can lead to the following beneficial results:
- Reduce operational costs. Operational costs include employee compensation, the cost of running multiple locations, redundant overhead, and more.
- Improve its competitive advantage. Restructuring can shift the business focus to the core business of the organization or to more profitable areas, while eliminating less profitable ventures.
- Prepare for a merger with another company. When a new company comes on board, there are casualties, mainly managers and staff. This means a company that merges with another has to reduce cases of duplication of roles and tasks and jobs overlay. Streamlining a company’s workforce during a reorganization makes it a more attractive target for acquisition.
- Weed out some dead wood, including inside the board. Some organizations are run by boards and executives who aren’t in tune with the mission of the organization, or do not lend strength and vision to help the company move forward and adapt to changing times. Restructuring helps introduce some new energy and new ideas in running the company.
- Introduce new technologies. Part of restructuring to make a company more efficient includes adapting to and adopting new and more efficient technology. Sometimes this effort involves laying off some staff or even adding new business sectors that will push the organization to greater heights.
- Introduce a new strategic partner. Acquiring a strategic partner is not always the same as entering a merger or being acquired, although . Instead, with a strategic partner a company engages with a new partner to get into new areas of focus. The partner can also be a merger. When this happens, the company needs to restructure its goals and mission to be in tandem with the new partner.
In sum, whether a business should liquidate or reorganize as a going concern depends on numerous factors. Some of those factors are within the business’s ability to alter or control, and some are not. Analysis of the business’s status, needs, and opportunities should be done by a team including the business’s leaders, consultants, and expert legal counsel. At JRFPC, our attorneys are ready to assist whether your business is a sole proprietorship or a major corporation, as we have experience at all levels.