A Workout Without the Mess: When is Article 9 Restructuring the Right Path?

In any distressed credit, the senior lender’s objective is straightforward: preserve collateral value, avoid unnecessary cost and litigation and maximize recovery.

Out-of-court solutions are therefore almost always preferable. The longer a distressed situation drifts into litigation, bankruptcy or contested proceedings, the more value is consumed by professional fees, operational disruption and collateral deterioration. What matters most to the lender is whether the underlying enterprise can still produce value, and whether that value can be preserved long enough to capture it.

As restructuring professionals increasingly observe, the economics of traditional judicial processes have become increasingly difficult for lenders to support.

One increasingly effective way to do that is through a pre-packaged Article 9 restructuring, in which the lender uses the secured party sale process not simply to dispose of collateral, but to transition the operating business into a new entity capable of preserving enterprise value to improve collateral shortfall recovery outcomes from within the new entity.

“The administrative costs and expenses of putting a company through a Chapter 11 continue to grow each year. Locking in the key players and fashioning a bank’s exit via an Article 9 Restructuring can efficiently limit the costs and remove the unpredictability inherent in judicial proceedings,” says Aaron Hammer of Kilpatrick Townsend & Stockton LLP.

In many middle-market situations, the operating business itself still works. Customers remain. Revenue continues. Employees and management understand the business. What has broken down is the capital structure surrounding the enterprise.

When excessive leverage, junior debt or accumulated vendor obligations overwhelm the balance sheet, the operating entity may no longer be able to function effectively inside its existing structure. Left unresolved, that pressure begins to erode the very enterprise value the lender is trying to preserve to maximize recovery or facilitate a sale process.

This is the environment in which an Article 9 restructuring may offer the right path when the underlying enterprise remains viable but the capital structure has failed. The lender’s recovery will be maximized not simply by disposing of collateral efficiently but by preserving the enterprise value embedded in the operating business itself.

Article 9 restructuring provides a practical mechanism for addressing that situation. Rather than attempting to rehabilitate an unsustainable capital structure, the lender facilitates the transfer of the operating business into a new entity with a viable balance sheet.

When structured correctly, Article 9 becomes more than a foreclosure remedy. It can function as a lender-led restructuring process designed not only to resolve a distressed credit efficiently, but to preserve enterprise value in a way that can materially improve recovery outcomes.

Structuring the Outcome Before the Sale

The defining feature of an Article 9 restructuring is that the outcome is largely arranged before the secured party sale occurs.

Rather than initiating a distressed asset sale in a public auction format and hoping a viable buyer appears, the lender leverages an advisor or transactional restructuring partner to identify the purchaser, establish asset valuation and coordinate financing for the acquiring entity in advance. Additionally, a turnaround consultant will also model the potential for deficiency balance recovery from the new operating entity, staking the incumbent senior lender in newco’s renewal. Once those elements are in place, the secured party sale proceeds under the statutory framework of the Uniform Commercial Code.

Of course, the framework also requires borrower alignment: by creating the opportunity for existing ownership to participate in the future performance of the new operating entity, the transaction can replace the zero-sum leverage of a bankruptcy threat with incentives to cooperate in preserving the business.

That pre-packaged structure changes the dynamics of the resolution.

Instead of a business operating under prolonged uncertainty while a sale process unfolds, the transition to new ownership can occur quickly and with minimal disruption. Customers remain in place. Employees continue working. Vendors continue supplying the business.

It is still a secured party sale. But it is a secured party sale designed to preserve value rather than simply dispose of assets.

“In many distressed situations today, merchant cash advances are layered into the capital structure, and that creates an additional complication for any orderly sale process,” says Michael Petrecca of Rise Alliance. “MCA providers typically do not observe senior lender standstill provisions, and their use of UCC 9-406 notices to intercept receivables can abruptly shut off operating cash flow, often crippling the business before a viable restructuring or sale process has a chance to take hold.”

The Importance of the Right Buyer

In many middle market situations, the highest value buyer is not a distant strategic acquirer or a distressed investor. More often, it is someone already close to the business, an experienced operator, a senior manager or an industry participant who understands the business’s customers and operations.

These buyers frequently represent the best opportunity to preserve enterprise value because they can keep the business running with minimal disruption.

Article 9 restructuring allows lenders to structure the transaction around that type of buyer. Because the transaction is pre-arranged, the lender can ensure the business transitions to a capable operator who can maintain relationships with customers and suppliers while stabilizing operations.

When that happens, the recovery outcome often improves dramatically.

For the senior lender exiting the distressed credit, the result is a structured resolution. The collateralized portion of the loan is repaid through the asset sale, while the business transitions into a capital structure that can support its operations going forward.

The lender exits the collateral position while preserving the enterprise as a path to further recovery beyond the asset’s value.

Recovery of Deficiency Shortfalls

Perhaps the most underappreciated aspect of Article 9 restructuring is the opportunity it creates to recover more than the collateral’s immediate value.

In a conventional distressed sale, the lender typically receives whatever the assets bring at closing and writes off the remainder. Once the collateral is gone, the recovery path usually ends.

Article 9 restructuring allows lenders to approach the situation differently.

Because the new operating entity begins with a clean balance sheet and sustainable financing, it may be able to support additional recovery of collateral shortfall deficiencies in the form of a performing junior note below the take-out ABL.

“The ability of the incumbent lender to potentially recover deficiency loan balances over time under an Article 9 structured exit is obviously one of the headline benefits of this methodology,” says Justin Barr, a former Special Assets Director with Carter Bank and Trust.

That structure allows the lender to participate in the business’s future performance rather than walk away entirely.

Two recent transactions illustrate how this dynamic can play out.

In one case, a commercial HVAC contractor with approximately $15 million in annual revenue defaulted on $4.2 million in senior bank debt while carrying an additional $1.5 million in junior secured debt and roughly $1.75 million in accounts payable. Despite producing about $1.5 million in EBITDA, the operating entity’s capital structure had become unsustainable.

Through a pre-packaged Article 9 restructuring, the assets were sold to a new operating entity financed by an asset-based lender at approximately $2.9 million. The bank carried the remaining $1.3 million deficiency as a subordinated note in the new entity. By eliminating the junior debt and unsecured obligations that had been draining cash flow, the business’s secured debt coverage ratio improved from 0.85x before the restructuring to 1.61x afterward.

A similar dynamic occurred in the restructuring of a $35 million diesel distribution business that had defaulted on $6.2 million in bank debt after fuel price volatility compressed margins and strained working capital. Through a private Article 9 sale, the assets were acquired by a key operator with financing from an asset-based lender at approximately $4.35 million.

The bank converted its remaining $1.85 million deficiency into an interest-only subordinated note tied to future performance benchmarks. Once again, the restructuring removed roughly $4 million in junior debt and payables that had been burdening the business. The business’s secured debt coverage ratio improved from approximately 0.8x prior to the transaction to roughly 1.7x afterward.

In both cases, the bank’s recovery did not end when the assets changed hands. The lender preserved the possibility of recovering the deficiency through the continued operation of the business.

One-Two Punch: Where Operational and Transactional Turnaround Meet

In many distressed situations, the first professionals engaged are operational turnaround advisors, often referred to as financial advisors or “FAs.” Their role is to stabilize operations, manage liquidity and work with creditors to restore the business to financial health.

A common challenge is that these advisors are frequently brought in after the capital structure has already become strained. Much of their effort is spent managing creditor pressure, negotiating with vendors, and aligning stakeholders under tight timelines. This is the central challenge posed by distress to an ‘organic’ or operational turnaround.

Certainly, in many cases, operational turnaround may still offer a viable path. But if the capital structure proves too burdensome to rehabilitate through negotiation and operational optimizations alone, a transactional solution in the form of an Article 9 balance sheet restructuring can deliver a clean balance sheet as a new foundation for business renewal.

Operational turnarounds strive to stabilize and recover a distressed business; however, this often requires access to responsible sources of capital and financing. Without adequate working capital, the company cannot meet its turnaround goals or address or renegotiate obligations in good faith. However, distressed businesses often have balance sheets that prevent turnaround professionals and the business from accessing the required capital. In these situations, a transactional approach that restructures the company’s assets into a new entity with a clean balance sheet can provide the solution that the turnaround professional and the business are seeking. An Article 9 restructuring can reset the balance sheet and preserve enterprise value, giving the financial advisor or turnaround professional a far stronger foundation on which to complete the turnaround.

This is where Article 9 transactional restructuring can play an important role.

A pre-packaged secured-party sale allows the operating business to transition to a new entity with a sustainable balance sheet. In that environment, the senior lender may see a more credible path to recovering collateral shortfalls from a new operating entity than from the existing distressed borrower. When a turnaround advisor can demonstrate potential recovery, this can create an incentive for the bank to exit the collateralized portion of the loan to an asset-based lender, while looking to the new entity for additional recovery of the deficiency. In situations where the shortfall might otherwise block a refinancing, that recovery path can help overcome a traditional bottleneck in bank-to-ABL transitions.

In that scenario, the turnaround advisor often continues working with the business on the other side of the transaction, now able to guide the company based on operational judgment rather than the constraints imposed by legacy liabilities and creditor parity requirements.

Critical vendors can be retained. Nonperforming contracts or leases can be left behind. Working capital can be secured under a sustainable financing structure.

How These Transactions Actually Come Together

Executing this type of restructuring requires more than simply invoking Article 9 rights. These transactions are inherently transactional rather than procedural. The statutory framework under the UCC has existed for decades, but historically, it was most often used for end-of-life liquidations or narrow going-concern sales in which a buyer already existed. What a restructuring methodology around the secured party sale offers is a practical framework for aligning lenders, borrowers, purchasers and new capital around a shared transactional outcome.

Once a lender determines that a distressed operating entity may be a candidate for a secured party sale process, the practical challenge becomes aligning the stakeholders necessary to complete the transaction. Buyers must be identified. Financing must be arranged. The borrower’s cooperation must be secured. Asset valuation must be established, and the process must satisfy the Uniform Commercial Code’s commercial reasonableness standards.

In practice, lenders often rely on restructuring intermediaries to coordinate that effort.

A bank’s transactional restructuring partner acts not as a fiduciary, but as a transactional facilitator, balancing the interests of the lender, borrower, purchaser, and incoming financing sources. Their role is to structure a transaction in which each stakeholder has a reason to move forward, and the preservation of the business itself becomes the organizing principle of the process.

Historically, distressed situations default to a zero-sum dynamic. And value erodes while the parties assert their respective positions.

A transactional restructuring process changes that dynamic. Instead of a standoff among stakeholders, the process aligns them around the potential upside of a new operating entity. When the parties see a path to preserve the enterprise and participate in its future performance, the conversation shifts from conflict to transaction.

And when that shift occurs, recovery outcomes tend to improve.

A Tool Hiding in Plain Sight

Article 9 has long existed within the commercial lending framework, yet it is still frequently viewed as an asset disposition mechanism rather than a restructuring tool.

In practice, it can function as both.

When the underlying enterprise remains viable, but the capital structure has failed, a pre-packaged Article 9 restructuring allows the lender to transition the business into a new operating entity before value deteriorates further. The result is often a faster resolution, a preserved enterprise, and a materially improved recovery path for the senior creditor – all while avoiding judicial process, carry costs, holding costs and reputational risk.

When used in the right circumstances, Article 9 restructuring offers lenders a practical way to resolve distressed credits while preserving enterprise value and improving recovery outcomes. For banks facing situations in which the business still works but the balance sheet does not, this may be one of the most effective out-of-court tools available.

Adam Duso is the chief executive officer of Second Wind Consultants, a consultancy that focuses on business preservation through strategic short sales. Adam has acted as the company’s director of consulting, a senior workout consultant, and a variety of other key roles for the company throughout his 13-plus year tenure at SWC. 

Robert DiNozzi serves as chief growth officer for Second Wind Consultants, overseeing brand strategy and value-added relationships with lenders, investors, business intermediaries and other stakeholders. Prior to Second Wind, DiNozzi spent 15 years in Hollywood as a feature film producer and executive, overseeing the creative development and structured finance of film projects at MGM, Paramount, Warner Brothers, Walt Disney, Universal and other studios and production entities, including Ron Howard’s Imagine Entertainment and Kopelson Entertainment.