Stephen Selbst, Partner, Herrick, Feinstein LLP
Stephen Selbst, Partner, Herrick, Feinstein LLP

Negotiating a path through Chapter 11 is never easy. The increasing costs involved, combined with changes in bankruptcy practice make it more difficult to reorganize successfully, particularly for small- and medium-sized businesses, which are less able to bear the costs of bankruptcy and often have a smaller management team to handle the increased workload involved. Typically, debtors with larger balance sheets have a greater chance of success. Debtors can defy this grim arithmetic by following these key steps to a successful restructuring.

Identify the Issues

The goal of each bankruptcy varies, depending on the debtor’s unique financial and/or operational challenges, its relationships with its shareholders, lenders, trade creditors and customers and the outlook for its business. For some companies, the underlying business may be solid but over-leveraged. In other cases, the debtor may need to close or sell unprofitable lines of business or locations. Other businesses may face structural cost issues, such as unprofitable contracts, burdensome collective bargaining agreements or unsustainable pension obligations. The debtor’s first objective is to identify all of its challenges.

Develop a Restructuring Plan

Next, the debtor’s task is to develop a restructuring plan that addresses those challenges, whether financial, operational or managerial. The plan has to be sufficiently detailed, financially realistic and devoid of unreasonably optimistic assumptions or projections. The debtor also needs to recognize that, like a prospectus, the plan is a sales document, designed to convince skeptical audiences that the debtor understands its challenges but can execute its plan.

Obtain Lender Support

Any restructuring plan must be validated by creditor review, starting with the debtor’s most senior lenders. Assuming that the senior lenders offer their verbal support, the best practice is to enter into a plan support agreement, under which the debtor and the lenders agree to support the reorganization strategy in a Chapter 11 case. Then, the debtor will seek similar approval from other creditors. It may not be possible to have all creditor groups enter into plan support agreements before beginning the case, but as more parties commit to support the restructuring strategy, the debtor’s chances of success improve.

A debtor that faces opposition from its senior lenders has a low likelihood of success. That doesn’t mean the debtor must cede control of its restructuring or acquiesce to all of the lenders’ demands, but it does require finding compromises. A quarrel between the debtor and its senior lenders sends the message that the debtor is not in control, which can have a negative effect on negotiations with other creditors. Conversely, senior lender support adds credibility to the debtor’s restructuring plan, which helps recruit support from other constituencies.

Market the Assets

Many bankruptcy cases involve asset sales under section 363 of the Bankruptcy Code, and often, the debtor has identified a prospective buyer (called a “stalking horse”) for those assets before it commences its Chapter 11 case. If there is a stalking horse bid, the debtor has two goals: maximizing the value of its assets and minimizing the post-bankruptcy marketing period. Bankruptcy courts have discretion in setting the bidding procedures for approving a sale; there are no statutory or regulatory guidelines. Demonstrating that the debtor has engaged in a thorough and professional pre-bankruptcy sale process, and that the stalking horse bid is the result of that work, is the best way to persuade the court that a short post-petition marketing period is best.

The debtor needs to convince the court that the investment banker or other sales agent had the knowledge and experience to handle the engagement, that the marketing campaign was aimed at the proper potential buyers and that the market was aware of the sale. If the debtor is successful, the court will approve a relatively short post-bankruptcy marketing period. But if the court determines that the debtor’s efforts were not thorough or professional, its remedy will require a longer marketing period at greater expense.

If a sale of assets is part of the strategy, that process should start as soon as the debtor obtains approval for the core of its restructuring plan. The debtor should retain an investment banker or other selling agent to identify potential buyers, produce a sales memorandum, set up an electronic data room and develop a selling timetable. The goal of the sale strategy is to find one or more stalking horse buyers for the debtor’s assets prior to commencing the bankruptcy case and to demonstrate to the court that the debtor has fully and fairly marketed its assets before entering Chapter 11.

Address Conflicts

Conflicts and litigation are a frequent source of delay and expense in Chapter 11. Real or alleged conflicts are rarely a surprise; the debtor is usually aware these conflicts exist. However, there are strategies to reduce the likelihood that resulting litigation derails the Chapter 11 case.
The first way to diffuse conflict is through disclosure. If there are known conflicts or asserted claims, the debtor should disclose them to the bankruptcy court in its first-day pleadings. During the restructuring process, the debtor needs to be regarded as an honest, and where possible, a neutral party in disputes among the parties.

Another potential solution is for the debtor to conduct an independent investigation. If the debtor can conduct and complete its investigation prior to Chapter 11, it can disclose the results when the proceedings begin. Alternatively, particularly where the debtor’s management or shareholders are alleged to have conflicts, the debtor may seek the appointment of an examiner at the beginning of its case. By doing so, the debtor acknowledges the problem and turns the investigation over to a neutral party. While an examiner’s investigation will take time and generate expense, having a court-approved neutral party conduct the investigation rebuts any argument that the debtor’s internal investigation is a whitewash.

Prepare for Bankruptcy

While the debtor develops its business strategy, it needs to engage in the parallel process of preparing for Chapter 11 with the goal of ensuring the continuity of the debtor’s post-petition operations and making the Chapter 11 case as invisible as possible to vendors, customers and employees.
Rumor, confusion and gossip are part of every Chapter 11 case, so a key element of bankruptcy preparation is developing a communications plan. The debtor has to be active in providing as much timely and credible information as is possible to critical customers and vendors as well as its employee base. The debtor should have a prepared message by the petition date containing the purpose behind the filing, its goals in Chapter 11 and the projected timetable.

The debtor should also create a restructuring website and keep it updated with copies of all relevant court documents, claims, contact information for the professionals and customized information and messages for employees, customers and vendors.

As part of its restructuring strategy, the debtor will need to develop credible and conservative projections of future performance. Failure to meet projections in Chapter 11 can be disastrous, with repercussions ranging from defaults under the DIP loan to loss of confidence in the debtor and its management team.

Establish a Timetable

Studies have shown that the expense of any Chapter 11 case results from the time spent in bankruptcy, so the debtor needs to minimize that time. The only way to accomplish that goal is to set a timeline as part of the planning process itemizing each major objective, the target date for achieving that objective, the people responsible for meeting that deadline and the prior preliminary steps, if any, to accomplish. While post-petition variances from the schedule are inevitable, having a timeline gives the debtor an important tool to manage the process and expectations throughout the case.

Execute the Strategy

Every Chapter 11 case will have unexpected developments. A debtor can improve its chances of success by creating a strategy, obtaining lender approval, marketing its assets (where necessary), addressing conflicts and communicating clearly with all parties about its strategy and intentions. Without those steps, the debtor faces a high risk of becoming another Chapter 11 failure.