What to Expect When You’re Filing for Bankruptcy

By Erik White

Key Considerations to Help Business Executives Navigate the Reorganization Process

BankruptcyMaking the decision to file for bankruptcy is a huge decision not to be taken lightly. There is so much to consider when you’re taking such a drastic step. First and foremost, keep in mind that Chapter 11 bankruptcy is a daunting process for everyone because of the numerous uncertainties – not to mention intense demands on your time. In addition to continuing to manage your business in a difficult operating environment, you will also need to develop strategic plans, negotiate with stakeholders, find additional sources of financing and meet new reporting requirements. Hiring the right professionals, including legal counsel and a financial advisor or chief restructuring officer (CRO), can also enable you navigate these complexities to reach the best possible outcome.

Bankruptcy
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Based on our experience helping many different types of organizations move through bankruptcy, this article is designed to give business executives and managers an overview of the key components of the Chapter 11 bankruptcy process and help walk you through the major milestones you’ll face as you restructure your debts and emerge from the bankruptcy with a fresh start.

Here are some ways to prepare yourself for bankruptcy, manage your employees and successfully navigate information requests from your bankruptcy professionals and external stakeholders.

1. Preparing for Bankruptcy

There’s an old saying: the more time you spend preparing for bankruptcy, the less time you’ll spend in bankruptcy. Starting with a good strategy in hand will help push the process forward effectively. It will also convey your seriousness and sense of urgency to important stakeholders: the court, your creditors and key suppliers. Here are the elements that should go into your preparations:

Case Strategy

First, consider your goals. Begin by asking yourself the following questions to help determine what you want to achieve by filing for bankruptcy protection:

  • Do you want to reduce debt, stay a foreclosure or debt acceleration, shed burdensome leases or contracts, or sell the business in whole or in part?
  • Do you need external financing to achieve that result?
  • What creditors do you need to negotiate with early in the process?
  • Who has a lien on cash, and what has their stance been toward that debt?

In the grand scheme of things, bankruptcy is a process that pulls everyone into one room to agree on how debts will be repaid, and gives everyone a voice in that decision. However, certain creditors will have louder voices than others because of the way their loans are structured. When creating your strategy, it’s important to think through these relationships and their possible impact on your plans.

 Implications of the Automatic Stay

When you file a Chapter 11 petition, all assets and liabilities are transferred to a new and separate identity created specifically for the bankruptcy process: the “Debtor-in-Possession,” often referred to as the “Estate.” Bankruptcy Code allows the Debtor-in-Possession to continue to operate and automatically implements a stay preventing creditors from pursuing collection efforts, giving the Estate the breathing room it needs to move through reorganization.

It also means that while you’re in bankruptcy, you are prohibited from making payments to creditors, including employees and vendors, for goods and services received before the Petition Date. (These are known as “pre-petition claims.”) However, you must stay current with post-petition obligations, including paying quarterly US Trustee fees and filing and paying all post-petition taxes.

Even though all pre-petition claims are on pause during this time, you still have the statutory responsibility to preserve and maintain your company’s value so you can maximize your payments once you do begin to make them. This means officers and directors have an increased fiduciary responsibility during bankruptcy/insolvency to include the best interests (not just of equity holders), but of all stakeholders in your company, including creditors. This shift in focus can be difficult to make, but it’s important to keep in mind as you plan.

To avoid irreparable harm to the Estate, there may be some payments you need to keep making. In these instances, counsel will often file motions with the Court to obtain authorization to make certain pre-petition payments to creditors. To obtain Court approval, you’ll need to prove these actions will benefit the Estate and its creditors – for instance, by giving you continuing access to critical parts or materials.

Such payments may include:

  • Trust-fund taxes – to prevent personal liability from falling to the executives
  • Insurance – to keep the Estate covered from potential losses
  • Utilities – to maintain essential utility services to continue operations
  • Employees – to maintain continuity of the work force and retain the institutional knowledge and operational capabilities
  • Customers – to preserve goodwill and brand value by honoring rebates, coupons, gift cards and warranties
  • Critical vendors – In some situations, certain vendors serve a vital role in the success of the company – and won’t continue to do so without payment.
  • Warehousing or shipping companies – to pay companies that won’t release the Estate’s goods without payment
  • Cash management system – Depending on the complexity of the Estate’s bank account structure and cash management system, the Estate may request permission to continue to use their current cash management system. The Bankruptcy Rules require pre-petition accounts to be closed and new DIP accounts opened at approved banks.

2. Communications and Negotiations with Creditors

Communicating with creditors during bankruptcy proceedings can be difficult, but it’s a key part of moving successfully through the process. In other words, do control the message, but don’t allow concerns about your brand and reputation to keep you from maintaining open lines of communication with everyone involved. Instead, be as proactive and transparent as possible. This includes devising an internal messaging strategy that will reassure your employees and address their concerns.

Here are some critical steps you’ll go through to notify your creditors and begin to negotiate a successful resolution with them.

Noticing

Chapter 11 is a collaborative process that seeks to bring all stakeholders together and allow the business to reorganize under supervision of the Court and stakeholders. In order to restructure all of the debt obligations, you will create a Creditor Matrix and use it to notify everyone who could possibly be owed money by the Estate of the bankruptcy case and its key dates. This listing should include all potential creditors so they can all choose whether to participate – and so that no party can claim to have been excluded from the process.

This step is critical to a clean discharge of debt upon confirmation. The goal is to come out on other end with a joint obligation to the result – in which everyone involved is not only aware of your plan, but willing to abide by it. For example, we know of one organization that bought a company that had just emerged from bankruptcy, not knowing the company had failed to notify a customer with a pending lawsuit. Because the customer hadn’t been notified, the multi-million dollar judgement in that case remained in force – and the new parent organization had to file bankruptcy again to address the resulting obligation

Initial Debtor Interview and Creditor Meeting (341)

Near the beginning of the case, representatives of the Estate must attend an Initial Debtor Interview to meet one-on-one with the US Trustee, a kind of early referee who assists the judge from a procedural perspective. In advance of the interview, you’ll provide the US Trustee information including asset and liability values, tax returns and proof of insurance. The US Trustee’s office will then run the 341 Meeting of Creditors, which is an opportunity for creditors to ask the Debtor (and its professionals) questions about your situation and the vision and strategy for the case. This meeting is an important step to get right because it presents an opportunity to articulate your goals and cultivate goodwill.

Continuation of Services, Adequate Protection and Cash Collateral Impact

In cases in which you have leased a piece of equipment such as a truck or a piece of specialty machinery, the equipment itself may be the collateral for the loan. If that equipment declines in value because of ongoing use, however, loan payments may increase over time. To protect itself from that increase, the Estate needs to negotiate the amount of ongoing payments so it can continue to use the equipment.

Similarly, if one of your creditors has a lien on cash, the Estate will either need to reach an agreement with that creditor to use the cash collateral or will need Court approval to override the creditor’s objection. Frequently, the Estate and the creditor reach an agreement in the early stages of a case to allow the use of cash collateral in short intervals – say, two to four weeks – and on a specified budget.

Unsecured Creditors Committee (“UCC”)

For many businesses, there can be hundreds or thousands of unsecured creditors that have provided an unsecured loan, goods or services to a company. The Bankruptcy Code provides for a committee of three to seven individuals to represent those interests. The Unsecured Creditors Committee (UCC) acts as a fiduciary for all unsecured creditors and is intended to make the process more efficient by allowing the Estate to negotiate with just one entity. The UCC retains legal counsel and sometimes hires a financial advisor in more complicated matters. These professionals will make information requests to conduct their own diligence and analysis to best advise the UCC. This committee can be an important player in the process, so it’s important to be responsive to its needs. This level of thoughtfulness can benefit you later in the process as issues – and alliances – shift and change.

3. Reporting and Analysis

The goal with reporting and analysis is to get a clean view of your pre- and post-petition accounting system. These reports are not always intuitive, so completing them can be a challenge.

Accounting System Cut-off

It’s important to get as accurate a snapshot as possible of your books and records by the Petition Date. To maintain this snapshot, you’ll need an accounting process that can identify and code invoices to post-petition or pre-petition periods.

Reporting Requirements

Statements and Schedules must be filed within 14 days of the petition date unless an extension is approved. This important reporting requirement details the Estate’s assets, liabilities, contracts and recent financial activity, including recent payments to creditors.

Monthly Operating Reports including income statements, balance sheets and cash activity, must be submitted by the 20th day following the close of the prior month. The US Trustee office has specific reporting requirements and templates to use. These reports can be a challenge for private companies that aren’t accustomed to regular reporting to outside entities.

Weekly cash flow reports may be required if a creditor has a lien on cash and has agreed to allow the Estate to use that cash collateral. This reporting describes how the Estate is spending the money and shows that it is operating within the agreed-upon budget and timeline (typically 13 weeks).

4. Disclosure Statement and Plan of Reorganization

All the steps we’ve discussed up to this point – preparing, filing, obtaining permission to continue specific payments to maintain the value of your business, then negotiating with creditors and developing an exit plan that addresses all debts – result in the plan of reorganization.

Plan of Reorganization

The Plan of Reorganization is essentially a contract between the Estate and its creditors that describes how and in what amount the creditors will receive value. The plan can take any form – a liquidating plan, merger, recapitalization, etc. – as long as it follows a certain requirement. Initially, the Estate has the exclusive right for 120 days to propose a plan of reorganization, which can be extended by the Court to allow the Estate sufficient time to formulate, negotiate, and draft a plan so long as sufficient progress is demonstrated.

Disclosure Statement

The Disclosure Statement functions as a grand document that describes the plan, what’s been achieved and what will happen going forward. This required document gives creditors enough information to evaluate the plan and vote on whether to accept or reject it.

The Disclosure Statement typically includes the following:

  • Background on the company and events leading to Chapter 11
  • Progress made while in Chapter 11
  • Summary of plan of reorganization including treatment of each class of creditor
  • Pro forma financial projections and liquidation analysis
  • Risks and alternatives
  • Overview of voting and confirmation process

The Court must approve the disclosure statement and voting ballots before any voting takes place

BRINGING IT ALL TOGETHER

Bankruptcy is a daunting word, and one that conjures the idea of failure for many people. Yet while Chapter 11 should be your last option, it also may be your best way out of an untenable situation. Bankruptcy allows you to have a pause with your creditors, and develop a plan to pay back creditors as much as feasible, while keeping an ongoing business operation.

It’s also an unfamiliar and often intimidating process that requires a great deal of work. Following the guidance in this article will help keep you focused on a clear path forward as you develop your plan, communicate and negotiate with your stakeholders, and complete all of your various reporting requirements.

When used properly, bankruptcy can stabilize your company and help you emerge stronger than ever before. If you need help, our advisory team includes CPAs, certified turnaround professionals, certified fraud examiners and forensic professionals with both technical expertise and credibility in the courtroom. We have the specialized knowledge and experience to help you chart your way through reorganization and become better positioned to succeed in a constantly changing market. Learn more about our Bankruptcy & Insolvency services or Contact us today!

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Disclaimer: This article is not to be used for legal advice. Speak with an attorney if you have specific questions about your situation.

About Erik White

Erik White is Manager of Turnaround and Dispute Resolution at Bridgepoint Consulting, where he helps clients realign themselves with new strategic plans, crisis management and repositioning. Erik’s expertise includes evaluating business plans, developing financial models for recapitalization and restructuring, monitoring bankruptcy initiatives, identifying cost saving strategies and negotiating exit financing.

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