Wednesday, December 21, 2011

Liquidating in Chapter 11 versus Chapter 7

So you have a business that needs liquidating?  What's the best way to do it?  There is the classic Chapter 7  route, which after all is the liquidating chapter of bankruptcy, but there is also something known as a "liquidating Chapter 11" bankruptcy. Why would anyone choose to use the reorganization chapter of bankruptcy to wind down a business?  The answer is that sometimes there is more value for everyone when business assets are sold off as part of a going concern rather than at a bankruptcy garage sale by an trustee in Chapter 7.

First the basics: if you do it correctly, Chapter 11 allows the existing business owners to stay in control while the business is marketed for sale. Business owners often like this because they can remain in control and keep existing employees on staff (including themselves).  The advantage to creditors is that the business owners are often the only ones who can really run the business as a going concern.  Chapter 11 is premised on the concept that there is sometimes more value in an operating business than in a sale of its parts.  That's why reorganization exists in the first place.   If this is true in a particular case, that's why selling all the assets of business in a Chapter 11 is permitted: the net proceeds, even after factoring the increased costs of case administration, are greater than a straight liquidation.

The process of selling the assets of a business in Chapter 11 includes many challenges.  Here are some:
  • Any blanket lien holder, like a bank with an interest in cash collateral, must be dealt with.  Usually it's necessary to convince such a lender that Chapter 11 route will result in full payment of their claim.
  • The business may need cash to operate after filing bankruptcy.  In which case, debtor-in-possession financing must be obtained.  This is sometimes comes from the proposed buyer of the business assets.  However, there obviously timing issues at play when a business is running so low on cash that basic operations are imperiled.
  • A buyer must be found and the procedures for counter-bids must be fair.
  • The price for the assets must in most cases must pay off all secured debt.  That is because of, among other things, credit bidding, but there is a possible exception for sales via a confirmed Chapter 11 plan.  
  • The debtor may have to negotiate a deal with the committee of unsecured creditors to pay them a partial dividend from the sale or the sale may be tied up in litigation in the bankruptcy court.
  • The estate must be administratively solvent.
This is just a quick treatment of some of the issues involved in selling a business through a Chapter 11 plan. If a business has real value it makes sense to consider this option. In the right case, everyone can benefit.

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