Sometimes a distressed business’ best path forward is to take advantage of the benefits of bankruptcy. Bankruptcy is a legal declaration of a debtor’s inability to meet and pay their liabilities, and it can play out in three ways. Chapter 7 involves a trustee liquidating the debtor’s assets for cash and making distributions to creditors. Chapter 11 allows a business to continue operations by following a court-approved reorganization that involves an incremental repayment to creditors. The third option, out-of-court restructuring, is an avenue that is less often publicly discussed because it unfolds behind closed doors. Out-of-court restructuring is a bankruptcy approach that is confidential, less expensive than a Chapter filing, and provides the debtor with more flexibility.
In an out-of-court restructuring, an informal creditors’ committee is formed and those participants define the parameters of the negotiation, including what payments can continue being made, allowance of interest, and other factors that would become more uncertain in a judicial process. As a result, the debtor maintains more control over its business. It also avoids public exposure, keeping its reputation and intangible value intact. Creditors benefit from the debtor’s ability to keep operating to the best of its ability, since creditors are relying on the business’ future earnings to satisfy debts. Out-of-court restructurings are designed to quietly stage a struggling company’s turnaround.
The process can be initiated by the debtor or by its financial creditors. Typically, the largest financial creditor will chair the steering committee. Each participating creditor must agree to refrain from taking action against the debtor that is outside of the restructuring process. These agreements, however, are short-term, allowing creditors to pursue other solutions if progress is not being made. As the restructuring and negotiations progress, non-financial creditors typically continue to get paid: employees, trade creditors, landlords, etc. The process is unaffected by the availability of court time and other judicial constraints, so it can move quickly.
Steering committees comprised of financial creditors typically engage accountants, financial advisors, and lawyers to assist. An out-of-court restructuring also requires an independent, third party to appraise assets and perform a business valuation that can withstand scrutiny. These resources help to facilitate restructuring negotiations and are crucial to maintaining the confidence of the creditors’ committee.
Whether you are a trustee, a member of a creditor committee, or head of a distressed company, no out-of-court restructuring proceedings should begin or proceed without regular valuations to support your efforts. Out-of-court restructurings often require more effort. There is a larger time commitment and negotiations involve many stakeholders. Asset appraisals and business valuations ensure that all parties feel comfortable working toward a solution that, despite its inherent complexity, ultimately protects everyone’s privacy and best interests.