Chapter 11 of the U.S. Bankruptcy Code has become the “quick sale” chapter. Traditional reorganizations where debtors emerge from bankruptcy leaner, having shed burdensome assets with a deleveraged balance sheet and a fresh start, are fewer and farther between.
Most debtors wait too long before they file a Chapter 11 petition, and waste too much time pre-bankruptcy trying to effect a sale or refinancing of the business. When debtors do resort to a bankruptcy proceeding — often at the last possible moment — the potential value and benefit of that proceeding have been diminished. The cash burn has continued too long. Assets have depleted to the point where the secured lender simply wants out. Too often, the debtor commences its bankruptcy case at a point when it is too weak to benefit from what Chapter 11 has to offer and long after it has a realistic chance to reorganize.
This scenario has only increased the lender’s leverage over the debtor when the Chapter 11 case is finally being planned, which is evident in the terms and conditions of the debtor-in-possession (DIP) financing or cash collateral order. This coincides with the peak of the investment banker’s, chief restructuring officer’s or financial advisor’s frustration that there are no alternatives to DIP financing and/or use of cash collateral from the pre-petition lender.
Debtors often suffer from a syndrome which is guided by the thought that if the lender gives just a bit more time, the business will turn around, there will be a successful sale of the company, or a friend will invest. In many instances, the debtor fails to take sufficient, definitive proactive steps that will result in a turnaround, sale or infusion of new capital. Thus, it has little leverage when the lender “recommends” that the debtor file a Chapter 11 petition. Lenders are typically reluctant to push a debtor into bankruptcy unless and until that option is the only resort. Lenders may be concerned about lender liability issues, and most debtors have difficulty seeing the upside of Chapter 11 and loathe the idea of a bankruptcy filing.
Sometimes the best thing that a lender can do for a borrower is push for a filing sooner rather than later — when the debtor still has availability under its credit lines, sufficient assets to comfortably provide adequate protection of security interests and enough credibility to argue that Chapter 11 will enable it to restructure. Too often, by the time the debtor files its bankruptcy petition, the lender is frustrated, the investment banker has deal fatigue and the cash burn has continued for far too long to enable the debtor to fully utilize Chapter 11 to fix its business and promulgate a plan of reorganization.
Expedited Sale of Assets
When the case commences, debtors increasingly assert on day one that a “Section 363” sale of assets and business must take place on an expedited basis and close within a much abbreviated time period or else the world will come to an end. In this common scenario, the debtor never has an opportunity to use the resources of Chapter 11 — lease rejection, sale of assets not necessary to an effective reorganization, claims estimation and cram down — to rehabilitate its business. The justification for an expedited sale process is the allegedly thorough pre-bankruptcy restructuring efforts and the current financial or liquidity crisis which supposedly prove that the debtor is at the end of its rope, all of which would have been much less had the debtor commenced its case sooner.
Once the “sale case” has started, the creditors’ committee struggles to “catch up” and rapidly learn about the pre-bankruptcy efforts of the debtor’s professionals. It is not easy. Every committee asserts that the sale process in Chapter 11 moves too fast and that, with more time, there would be better alternatives. Usually, there are not. The committee is left to search for causes of action and other means of inducing, or extorting, the secured creditor to free up dollars for unsecured creditors.
A Return to Restructuring Roots
I believe in Chapter 11 and in the likelihood that it facilitates a company’s ability to reorganize and restructure. I do not believe that a rapid fire “Section 363” sale should be the end of the road for an honest debtor. However, at the same time, I recognize that a lender’s patience can wear thin and that no lender can be expected to sit by and watch as it gets deeper into the danger zone.
Local rules or a statutory amendment can further the goals of Chapter 11 by requiring a minimum number of days — I suggest 75 — between the petition date and the date on which there can be a sale of the debtor’s assets in bulk. First, this minimum waiting period assures that there is a better informed creditors’ committee. Second, it reduces the pressure on the court to respond to alleged emergencies before the parties in the case, other than the lender and the debtor, are adequately informed. Finally, it guarantees that the debtor has an opportunity — albeit a relatively brief one — to utilize and benefit from the tools that the Bankruptcy Code provides. Of course, hopeless, hemorrhaging debtors, lenders and creditors’ committees may resort to motions for relief from the automatic stay or to convert the case to one under Chapter 7.
It is acknowledged that lenders should not suffer twice, once before bankruptcy and once post-petition. However, that is easily addressed. Lenders have many tools with which to convince a borrower to file a voluntary petition sooner rather than awaiting further erosion. Those tools include, but are not limited to, covenants and forbearance agreements. This effectively guarantees that the debtor will have an adequate opportunity to pursue rehabilitation and reorganization in Chapter 11. The debtor may have less time in its out-of-court mode to prove itself, or it will have to commence the restructuring/sale process sooner, but that sacrifice is made up by having precious time to benefit from the Chapter 11 toolbox.
Since the Bankruptcy Code was amended by BAPCPA in 2005 to include section 365(d)(4)(B)(i), which requires greater certainty for lessors of nonresidential real property that the debtor will make a decision to assume or reject the lessor’s lease within 210 days after the petition date absent the lessor’s consent to any further extensions, secured lenders and debtors routinely incorporate that time period in establishing milestones in DIP financing orders. For example, prudent lenders to retailers now take into account the time necessary to conduct a ”GOB” sale and the outside date by which leased property must be surrendered in backing into the latest possible date by which the debtor must find a buyer or else commence the liquidation process. Lenders also can take into account a minimum time period in Chapter 11 before a “Section 363” sale can be held.
For some borrowers, this will mean commencing a reorganization case sooner and acknowledging that Chapter 11 is the best solution. However, the tradeoff is that the debtor will have a greater opportunity and ability to benefit from Chapter 11 to demonstrate that a turnaround or restructuring is feasible. The greater ability derives from a debtor that enters Chapter 11 before it has held out for so long trying to avoid bankruptcy that it is unable to utilize the tools of the Bankruptcy Code. In effect, this only moves up the combined out-of-court and in-court process. It does not necessarily extend it. Rather, it would facilitate greater use of Chapter 11 for its intended purpose and would increase the likelihood of a successful reorganization. Debtors would commence their bankruptcy cases sooner, before their resources were fully depleted, and debtors would be better able to utilize the Bankruptcy Code’s tools.
Finally, courts should not penalize lenders for demanding more timely access to Chapter 11 by debtors. I am not promoting that Chapter 11 be skewed in favor of debtors as I have compassion for lenders. However, Congress’ intent should be carried out. Currently, Chapter 11 is barely the reorganization chapter. If giving debtors a real opportunity for a fresh start means that debtors and lenders simply have to start and end the out-of-court restructuring process sooner, then so be it.