Attorney Michael Feinberg of law firm Karr Tuttle Campbell was our guest for the July 30 CEOtoCEO live stream event. He was on hand to help explain some of the intricacies of bankruptcy law, and its usefulness as a negotiating tool. Michael preceded his presentation by observing that this was the first day he had worn a suit in months, as COVID-19 has placed a hold on legal proceedings and extended casual Fridays to the entire week.
Michael began by emphasizing that Chapter 11 bankruptcy filings can be a strategic negotiating tool, and not necessarily a last resort for troubled businesses running low on cash. A successful use of Chapter 11 to renegotiate with lenders will often require a significant amount of capital to see through to the end.
Michael mentioned as an aside that the recent moratorium on evictions has spurred negotiations between landlords and tenants, but landlords are generally not granting rent abatement. Rent reductions and deferrals are being granted, and landlords are especially willing to renew leases with tenants, so renegotiating rental agreements is a good possibility for renters right now.
When a company files for Chapter 11 protection, it may be allowed to either assume or reject their executory contracts, which includes leases, employment contracts, licenses, or any agreement with performance obligations on both sides. In the case of leases, rent owed prior to the filing date may not need to be paid, but rent owed on the lease after the filing date must be paid. (Some districts are currently not requiring this rent to be paid in filings made due to COVID-19.) If the renter rejects the lease, the rent obligation is limited to rent owed for up to one year after the filing, even if the lease extends beyond that point. If the renter assumes the lease, the renter can simply pay any unpaid rent, or can reassign the lease, potentially at a profit. This is a powerful negotiating tool renters can use to obtain favorable terms on their leases.
In essence, Chapter 11 filings have three main purposes:
- Reorganize the business, obtain improved terms on contracts, and improve company health.
- Sell the business (or part of the business) while maintaining its operational viability.
- Liquidate the assets of the business (with more control than Chapter 7 filings provide).
Michael pointed out that banks are motivated to help businesses with the first two options, since taking collateral is usually a loss for banks as they are not able to obtain good prices when it is sold.
The benefits of Chapter 11 filings are numerous, and businesses can file based on different objectives. Michael pointed out the following advantages of a Chapter 11 filing:
- Can stop all debt collection against the debtor. (This includes judicial and non-judicial actions, and efforts to collect made after filing will be penalized.)
- Can allow debtor to assume or reject executory contracts. (This includes employment contracts and collective bargaining agreements.)
- Can allow debtor to restructure secured and unsecured debt. (Holders of unsecured debt will be motivated to renegotiate repayment terms with companies filing for bankruptcy protection.)
- Provides a favorable forum for negotiating tax obligations. (Michael pointed out that bankruptcy judges can be strict and unforgiving with the IRS, often to the benefit of the debtor.)
- Allows the debtor to change the capital structure of the company. (Companies can use filings as an opportunity to buy out owners and make the company more attractive to outside investors. Equity holders are the most junior credit holder, and will be motivated to negotiate when a filing is made.)
A Chapter 11 filing requires planning and may entail significant expense, so it is something that should be considered long before a company is having issues meeting expenses. Cash is the key consideration, and businesses considering making a Chapter 11 filing will need to make certain that they will be able to continue paying employees, purchasing supplies, and preserve the interests of any equity holders who will remain with the company.
The earlier in the process that the company consults with a bankruptcy attorney, the greater the leverage it will have in negotiating with creditors, the healthier it will be when the process is completed, and the greater the positive impact the company will obtain from the process.
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