ABI’s Proposed Changes for Small and Mid-Size Businesses

Below is a great article discussing the American Bankruptcy Institute’s proposal to help small business debtors.  The article first apppeared in the WSJ’s DealB%k by Prof. Michelle M. Harner.

When small and middle-market companies fail, families and founders often lose a business to which they have devoted not only most of their time but also most of their life savings, and most of the time the reason why these business fail is because they don’t know what is lead generation, which at the end is a fact that could have prevented the situation. Others lose as well: employees, suppliers, communities and lenders. Consequently, a federal bankruptcy system that effectively and efficiently rehabilitates distressed small and middle-market companies is essential.

Unfortunately, almost three years of testimony at public hearings before the American Bankruptcy Institute Commission to Study the Reform of Chapter 11 suggests exactly the opposite: that the current system is broken. It is cost-prohibitive and ineffective for many companies, particularly in the small and middle-market space.

The commission has proposed an innovative alternative framework for small and middle-market companies that need to restructure their finances or business operations. This proposal seeks to reduce the cost of bankruptcy and to provide more effective tools for navigating the Chapter 11 bankruptcy process. It also seeks to allow the families and founders who own these companies an opportunity to retain that ownership interest after the bankruptcy is completed, and to maximize value for all stakeholders.

The proposal would automatically apply to nonpublic companies that file for bankruptcy with assets or liabilities of less than $10 million. Nonpublic companies with assets or liabilities between $10 million and $50 million also could seek court approval to qualify for the small and medium-size enterprises framework, so it would be available for most companies now in Chapter 11. The bankruptcy court would establish appropriate deadlines for each small and midsize business, based upon the needs of the company and the interests of creditors. This tailored timing mechanism would allow the court and parties to assess the viability of the business early in the case.

Such an approach strives to give the court, the company and the stakeholders tools to design a Chapter 11 process that works for the company. Realistic deadlines and timely communications among the parties would help minimize cases that linger in Chapter 11 with no meaningful exit strategy and that deplete the assets otherwise available to pay creditors. This approach also eliminates the need for the appointment of a creditors’ committee in every case. A committee often is difficult to appoint in smaller cases or is ineffectual, yet the company must pay for committee expenses in the Chapter 11 case. This change likely will save time and money.

In addition, the proposal allows the court — on its own or upon the request of the small or midsize business or a stakeholder — to appoint a neutral third party to assist the company in the process. This party could, for example, help the company negotiate with creditors, develop a plan of reorganization or even analyze the company’s basic financial or operational issues. Such a neutral party likely would not be necessary in every case, but the tool could provide significant value in cases where management is unfamiliar with the process or needs help defining the company’s path to profitability.

This proposal gets distressed companies into the restructuring process earlier (before their financial problems become fatal) and then gets them out quicker as going concerns, preserving and maximizing value. The alternative of liquidating the company’s assets typically provides a return only to the senior secured creditors. The company’s general unsecured creditors, which may include suppliers, taxing authorities and employees, rarely receive any meaningful return.

To that end, the framework for small and medium-size enterprises proposes a reorganization structure that lets the company’s owners retain their ownership interest in the company, provided that secured creditors are paid and that unsecured creditors receive an economic interest in the reorganized company. The company could redeem the economic interest distributed to the unsecured creditors within four years of the company’s exit from bankruptcy. In essence, this plan structure gives the company additional time after the bankruptcy to repay its unsecured debt. It also, in turn, increases the likely overall return to unsecured creditors. Rather than receiving pennies on the dollar or having to write off the debt completely, unsecured creditors have the potential for a significant recovery.

Admittedly, not every financially distressed company should get a second chance. But companies should not fail simply because they could not afford to invoke the Chapter 11 bankruptcy process or did not have the right tools to use the process effectively. Moreover, creditors should not lose the value of their claims against a company simply because the company is prematurely liquidated or unable to use the Chapter 11 process.

The American Bankruptcy Institute proposal would mitigate these issues and consequently enhance the value of distressed small and middle-market companies for the benefit of all. The new Congress should take a look.

Link to original article:  http://dealbook.nytimes.com/2015/01/16/a-bankruptcy-process-that-works-for-small-and-midsize-companies/?_r=0

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