This post is part of a series of posts entitled First Considerations for the Financially Distressed Business. For a comprehensive list of articles contained in this series, click here.
A. Far Less Expensive
Although out-of-court restructuring often involves an attorney, the cost of that attorney will be significantly less than if formal bankruptcy proceedings are initiated. This is because there are fewer steps for an attorney to take when negotiating directly with creditors. In a court proceeding, where courts often serve an intermediary function, attorney time is spent on drafting motions, researching, factual investigations, and appearing before the court. These costs are in addition to the negotiating work the attorney would normally be doing, work that is very similar to an out-of-court restructuring.
Additionally, the court related fees and costs are removed from the equation as well. For example, the filing fee for a chapter 11 bankruptcy alone is $1,716, with a few hundred to a few thousand dollars paid to the chapter 11 trustee every quarter as the bankruptcy progresses, depending on the amount of the debtor’s quarterly disbursements. None of these costs are present when a debtor chooses to restructure outside of a bankruptcy.
B. Avoid Messy Investigations/Litigation
Out-of-court restructuring serves to stymie the flow of litigation based on the unpaid debt by offering the creditors an opportunity to agree to a mutually beneficial outcome. This discourages debtors from needlessly litigating issues, because the outcome is only binding if all parties agree to it.1 It also discourages tactics that serve to delay or expend resources, encouraging efficiency among the creditors and discouraging exhaustive investigation.
This is true as a general matter, but is dependent on the actual agreements between a debtor and their creditors. In certain cases, an out-of-court restructuring plan may allow for a majority, or a super-majority, of creditors to agree in order for the result to be bind. All of this is part of the negotiation with multiple creditors.
Because of the formal, public nature of bankruptcy proceedings, filing can have the unintended consequence of putting the intimate financials and affairs of a company on display. In contrast, an out-of-court restructuring can remain private among the restructuring company and its creditors. While different businesses would be affected by this in different ways, it generally is a net benefit to keep business affairs private. This is especially true of a business that is already on the verge of insolvency, where prospective creditors may grow wary of doing future business.
C. No “Clawbacks” of Money – Preferential Transfers
A preferential transfer occurs in bankruptcy when a debtor makes a payment to a creditor, for a prior debt, within the ninety (90) days before the bankruptcy filing is made, while the debtor was insolvent, and the payment allows the creditor to receive more than it would have had the payment not been made and results in the creditor receiving more than it would have in a bankruptcy liquidation. By default, these transfers are avoidable, meaning the trustee can, subject to various creditor defenses, require creditors to pay the money they received for their debt back to the estate. In an out-of-court restructuring case, these preferential transfer avoidance actions rarely occur. This has both positive and negative aspects. It benefits the debtor because it allows payments to be made to creditors and encourages creditors to openly deal with the debtor. It also prevents further litigation over preferences, one of the most common in-bankruptcy litigations. However, it is not without drawbacks, since preferential transfers serve to prevent creditor behavior that may deplete the estate and further harm the debtor’s chances of actual financial recovery. As a result, although situational, debtors may want to consider whether preferential transfer avoidance actions would be necessary in their particular cases, and thus more helpful than harmful.
D. Faster Process
While some aspects of bankruptcy are relatively quick compared to other legal disputes, it still takes significant time to proceed through and complete the bankruptcy process. In some instances, the debtor may require court approval prior to a sale of some its assets. This would require a motion from the debtor justifying the sale, an opportunity for creditors to review and object to the motion, a possible hearing on the motion, and then an order from the court. These steps could take weeks to fully complete, which may interfere with the asset sale in the first place! Out-of-court restructuring is not burdened by the need to give all parties notice, opportunities to be heard, and a hearing. Instead, the debtor can act quickly and flexibly in ways that interest it, without having to wait to do so.