Out-of-Court Workouts

 

 Overview of Workout Restructuring Plans

            An out-of-court workout serves as an alternative to a Chapter 11 or Chapter 7 bankruptcy filing. Workouts involve restructuring a business’s debts without involving the courts through negotiations with creditors. Much like a Chapter 11, the debtor business will negotiate with each creditor to resolve their financial impasses. Out-of-court workouts can be preferable to Chapter 11 bankruptcy filing if:

            The debtor business has relatively few creditors with whom to negotiate;

            No individual creditor is overtly hostile or aggressive towards the debtor business;

             The debtor business’s corporate organization and debt structuring are relatively straightforward;                and

            The debtor business has had good relations with these creditors in the past.

             If any of the preceding conditions are not present, an out-of-court workout may not be possible. Further, while some companies may benefit from an out-of-court workout, many are simply too complex, or the conditions are not right to sort out the business’s affairs without the assistance of a bankruptcy court.

            That said, assuming there is still adequate time for negotiations, it is generally best practice for a company to attempt a workout with either some, or all, of its creditors before resorting to a Chapter 11 or Chapter 7 petition.

Structure of a Workout

            While a workout restructuring plan occurs outside of the Bankruptcy Court, in many ways, the negotiations incorporate and mirror the substantive law of the Bankruptcy Code. The workout discussions may be referred to as negotiating in the shadow of the law, meaning that the possibility of a Chapter 11 case forces the parties to negotiate based on their relative expected outcomes if a Chapter 11 petition had been filed. As such, the parties’ expectations under a possible Chapter 11 filing become a useful framework for handling the out-of-court negotiations.

            Because there is no court proceeding in place, it becomes incumbent on the debtor business to approach each of its creditors and negotiate terms in an organized and timely manner. Under a classic composition agreement, creditors who agree to participate in the composition will receive similar treatment, but since there is no requirement for participation, creditors who do not agree will not be affected by it.

            For example, assume that Company A is indebted to creditors B, C, D, and E as general unsecured trade vendors. Company A proposes paying each of its creditors 50% of the total amount of its individual claim amount over the course of 36 months, in full satisfaction of all liabilities. B, C, and D agree to this composition, but E does not. E is unaffected by the agreement between A, B, C, and D. E will not receive the monthly payments as provided for in the composition but will be free to attempt collection through any creditor remedy available. Thus, one creditor may receive substantially more than the others or even collapse the whole plan through holding out. However, the holdout creditor may also receive nothing if collectible company assets are not readily available for creditor remedies.

            Through a restructuring support agreement, the debtor may also pre-negotiate terms of reorganization with a creditor that will be binding in a later filed Chapter 11 case.

Summary of Benefits and Costs

             As stated above, while out-of-court workouts save the costs and time associated with Chapters 11 and 7 filings, there are still costs to consider. Examples of some of the advantages and disadvantages of workouts are as follows:

            Advantages:

                        Avoids much of the costs of a Chapter 11 case for both the debtor and creditors;

                       Gives debtor and creditors more control over the disposition of the debtor’s assets than in a                          Chapter 7 filing;

                        Debtors may avoid any stigma attached to a bankruptcy filing;

                        May provide debtor with the opportunity to pre-negotiate terms of an anticipated Chapter                             11 with select secured or priority creditors; and

                        Workouts provide more privacy to the parties because their dealings are not disclosed                                   publicly, as they would be in a bankruptcy case.

             Disadvantages:

                        Will not work in every situation because a debtor cannot bind dissenting creditors;

                        There is no “automatic stay” (statutory injunction) to protect the status quo and prevent                                 aggressive creditors from undermining the workout plan;

                        The debtor generally has less leverage over creditors compared to the parties’ relative                                     standing in a bankruptcy case;

                        Creditors may insist on including onerous language in forbearance agreements that could                             hamper a debtor’s ability to successfully reorganize in a subsequent Chapter 11 case.

                        Unless the parties are undertaking a UCC Article 9 secured asset sale, they have little                                     ability in a workout to sell assets of the debtor free and clear of all liens and encumbrances;                           and

                        Since many workouts are not successful, engaging in such discussions may delay or hinder                           an inevitable Chapter 11 or Chapter 7 filing.