California’s “Stay-at-Home” order and resulting lockdown to confront the Corona Virus (also known as “Covid-19”) pandemic forced most businesses— except those deemed to be essential—to shut down as of March 19, 2020 until Governor Gavin Newsom issues a new order to end the Stay-at-Home order. With the end of the lockdown uncertain, most businesses face the uncertainty of when they can re-open and when their revenues will return to pre-lockdown levels. The longer the lockdown lasts, the greater the issue becomes; how soon businesses can re-open will vastly affect how fast their cash inflow will return to pre-lockdown levels. A Chapter 11 Bankruptcy case is a good option for a business to obtain more time to regain their footing.
Even with the Federal Government introducing the Paycheck Protection Program (“PPP”) and the Economic Injury Disaster Loan (“EIDL”) under the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) to provide federally guaranteed loans to small businesses (i.e. businesses with less than 500 employees) to help them stay afloat during the lockdown, no one can predict how long it will take for businesses to recover.
Before the lockdown, the most likely reasons for a business to file bankruptcy were:
- An Industry-Wide Recession. Businesses with a high fixed-cost structure in a price competitive industry (meaning prices for the goods and/or services a business provides change based on decisions by competitors), such as airlines and railroads, benefit from a Chapter 11 Bankruptcy when they cannot keep up with the industry standards. When their revenue drops due to industry price wars or from lack of demand in a downturn, these businesses fail to generate revenue to pay their fixed costs and operate at a loss. They file for Chapter 11 Bankruptcy in order to avoid paying their debts until their pricing improves, which helps them to save cash and earn a profit. For instance, Delta Airlines filed for Chapter 11 Bankruptcy in 2005 after losing $10 billion, allowing it to recover and become America’s third largest airline.
- Unexpected Inflation Increases Costs. In 2000 and 2001, electricity suppliers to California manipulated the electricity market to increase electricity prices. Pacific Gas & Electric (“PG&E”) paid more for wholesale electricity than PG&E could sell at retail. This caused PG&E to operate at a loss, incur billions of dollars in debt, and eventually file for Chapter 11 Bankruptcy. By filing for Chapter 11 Bankruptcy, PG&E was able to change its operations and make a profit to fund its operations, pay its debts, and leave bankruptcy.
- An Unexpected Liability. In 2017 and 2018, wildfires in Northern California destroyed billions of dollars in property. PG&E faced over a thousand lawsuits seeking to resolve claims resulting from the wildfires. Again, PG&E filed for Chapter 11 Bankruptcy, allowing it a forum to resolve and pay these claims. This case is ongoing.
- Lack Of Access To Capital. In 2009, General Growth Properties (“GGP,” a real estate investment trust) owed $25 billion to its lenders in a real estate downturn. GGP missed a loan payment (a default) because it was unable to acquire a lender and obtain funds to make the payment. This default forced GGP to file for Chapter 11 Bankruptcy wherein it obtained a new lender and sold new equity to fund its plan to leave bankruptcy.
- Overleverage. Hedge funds bought the company iHeartMedia by borrowing $16 billion. The hedge funds planned to grow iHeartMedia’s cash flow in order to repay the debt. However, there was no growth in radio ad sales, causing the company to experience a loss. After reducing debt to almost $6 billion in 2017 and 2018 by filing for Chapter 11 bankruptcy, the company generated cash flow over $400 million. In the bankruptcy, the company’s old shareholders were wiped out and new stock was issued to pay the creditors who were collectively owed over $10 billion in debt. Thus the bankruptcy filing enabled the company to recover and the creditors became the company’s new shareholders.
- Competitive Threats. The author of this article assisted a debtor who lost many customers to a competitor, which meant a severe loss of the debtor’s revenues and cash flow. The debtor filed a Chapter 11 Bankruptcy to gain time to rebuild its customer base and improve its profits. The bankruptcy filing resulted in an increase in revenue and customers to reduce costs from economies of scale and assisted the debtor in its recovery.
- Poor Investment. The author of this article assisted debtor who invested several hundred thousand dollars in a call center to handle take out orders for the debtor’s restaurant chain. The orders did not materialize to pay for the center, causing the debtor significant losses. This required the debtor to file a Chapter 11 Bankruptcy and sell the chain to pay the debts incurred in financing the call center.
- Unexpected Business Disruptions. Disruptions such as the travel industry’s depression after the September 11, 2001 terrorist attacks; serious medical conditions occurring to a business’ owners and/or key employees; overturn of ownership or key employees; divorce or other family issue; temporary construction; and natural disasters, such as floods, storms, earthquakes, fires, and pandemics.
Some of the advantages of a Chapter 11 Bankruptcy Case are: (1) existing management will have more time to operate the business to determine whether it can be reorganized or must be sold; (2) existing management can run the debtors’ business while it attempts to recover; (3) management can sell assets at their real value, instead of being liquidated piecemeal in a Chapter 7; (5) the debtor can acquire new financing while having time more time to recover; (6) debtor can resolve its tax issues and the judge takes into account the debtor’s ability to pay such taxes; (7) minimized litigation; (9) the debtor can cease paying interest on most debts; and (10) the debtor can receive a discharge (i.e. forgiveness) of its debts.
Another advantage to a small business debtor (a business that owes less than $2.8 million in claims) in a Chapter 11 Bankruptcy case is that the debtor is not subject to the onerous financial reporting requirements that are required of larger businesses.
Real estate projects may also file a Chapter 11 Bankruptcy case in order to take actions to salvage a bad investment, a loss in demand for the property, or to sell it as so determined.
While filing a Chapter 11 Bankruptcy case has significant advantages, it’s not without its risks. Some of the disadvantages to a Chapter 11 Bankruptcy case are (1) the Court has to approve all decisions that are not part of the “ordinary course of business,” such as buying and selling non-current assets, rejecting or assuming leases, using a lender’s cash collateral, hiring employees, and approving new contracts; (2) monthly financial statements must be prepared and filed with the Court; (3) scrutiny by creditors and the U.S. Trustee; (4) general unsecured creditors may form a committee to object to the debtor’s decisions; and (5) the cost to confirm a Chapter 11 reorganization plan can be significant.
A Chapter 11 Bankruptcy is usually better for a business than a Chapter 7 Bankruptcy because a business that files a Chapter 7 Bankruptcy is shut down by the U.S. Trustee and sold piecemeal without discharging the debtor’s debts.
A potential debtor needs to understand the Chapter 11 Bankruptcy process because it could benefit the debtor but does impact how management operates. Before filing a Chapter 11 Bankruptcy case, bankruptcy counsel will meet with the debtor’s management to prepare about 100 pages of bankruptcy schedules about the debtor’s assets, liabilities, equities, contracts, and business prospects, and discuss a plan to exit the bankruptcy system.
The debtor has to file motions on the first day of the Chapter 11 Bankruptcy case in order to obtain court approval to pay wages to employees and hire bankruptcy counsel and accountants. During the bankruptcy case, the debtor’s management pursues actions to improve cash flow and maximize the amount of cash needed to pay the debtor’s creditors in a reorganization plan.
The debtor leaves bankruptcy after having a period in which it establishes that it can make money to fund a plan. This period usually grows as the debtor’s financial performance improves, thereby indicating that the debtor has the potential to recover, but shortens as the performance wanes. Then the debtor must prepare a reorganization plan and a disclosure statement (the equivalent of an annual report) and send them, along with a ballot, to creditors whose rights are impaired by the plan so that such creditors can vote on the plan. If at least ⅔of the impaired creditors (i.e. the creditors whose contract with debtor is altered) vote and ½ vote in favor of the plan, then the debtor goes forward to prove to the bankruptcy judge the plan should be approved. Without this vote, the bankruptcy judge can still confirm the plan over the objections of the creditors.
Once the plan is confirmed, the debtor makes the plan payments. When completed, the debtor receives a discharge and the case will close. This is the same process for either an individual or a large corporation.
American history is replete with success after a bankruptcy. Henry Ford and Milton Hershey saw their first two companies go bankrupt. Walt Disney’s first film company went bankrupt. Donald Trump filed for Chapter 11 Bankruptcy for four of his business entities: Trump Taj Mahal in 1991; Trump Plaza Hotel in 1992; Trump Hotels and Casino Resorts in 2004, and Trump Entertainment Resorts in 2009.
If your business does not have the means to pay its debts and expenses and it needs legal protection from creditors to stop collection action, contact bankruptcy attorney Dixon Gardner at Madison Law, APC for a free consultation on whether a Chapter 11 Bankruptcy Case is a good option for your business.