A common dilemma that faces owners and advisors when a business in Texas becomes distressed is whether to pursue an out-of-court workout or Chapter 11 bankruptcy to reorganize the business. Many factors play into the decision: Are creditors willing to work? Can the business get adequate liquidity? Is there enough time to implement a viable plan? And ultimately, will the business survive?
For many mid-market business owners in Texas, this decision affects not only the outcome of the business but their own personal liability exposure, their employees, and what they owe to their creditors.
Out-of-Court Workouts: A More Flexible Alternative
An out-of-court workout is a restructuring of the business that takes place outside of bankruptcy court. In these situations, the business continues to operate and attempts to negotiate with one or more key creditors (often major lenders, vendors, and landlords) to modify the terms of its obligations.
There are several advantages to pursuing an out-of-court workout. The primary advantage is confidentiality; it avoids the expense, publicity, and paperwork of a formal bankruptcy case, protects relationships with customers and suppliers, and helps maintain morale among employees. It is generally cheaper and faster than a Chapter 11 bankruptcy, and the company remains in possession and control without court involvement.
The disadvantage of an out-of-court workout is that it requires participation by creditors, who must agree to the proposed restructuring. In addition, there is no automatic stay, no cramdown provision, and no vote by creditors to approve the restructuring. Therefore, these types of workouts work best where there is a small group of creditors, a clear plan to improve operations, and time to negotiate.
Chapter 11 Bankruptcy: Benefits and Limitations
A Chapter 11 bankruptcy is a more formal type of bankruptcy case in which the court oversees the reorganization of the business. When a business files for Chapter 11 bankruptcy, it receives an automatic stay, which generally stops creditors from collecting money, foreclosing on property, shutting off utilities, or bringing lawsuits against the business. This gives the business an opportunity to focus on reorganizing its business while remaining in possession and control.
A Chapter 11 bankruptcy case provides the business with several tools that are not available in an out-of-court workout. It can reject burdensome leases and other executory contracts; obtain financing; and cram down dissenting creditors, i.e., force them to accept the terms of the reorganization plan, even if they don’t agree to those terms. Additionally, a reorganization plan can be confirmed even if it is objected to by a class of creditors as long as it meets the applicable provisions of Section 1129 of the Bankruptcy Code.
The main disadvantage of Chapter 11 is that it is public and requires the business to file schedules and statements disclosing its finances. There is also an increased cost of professionals, such as attorneys, accountants, U.S. Trustees, and possibly creditor committees. Moreover, it can take months or years for the bankruptcy case to conclude and the business to emerge from bankruptcy, during which time it operates subject to court oversight.
Which Type of Restructuring Should You Choose?
1. Creditor Concentration
A significant consideration is the number and type of creditors. If a majority of the company’s debt is owed to one or two lenders who are amenable to a workout, an out-of-court restructuring may be a more efficient approach. But if there are dozens or hundreds of trade creditors, bondholders, or potential litigants who all need to agree on the terms of a workout, a voluntary restructuring may not be practical, and a Chapter 11 proceeding with its power to bind all stakeholders may be needed.
2. Available Liquidity and Time
If the company still has enough liquidity to weather several months, there may be time to pursue a workout. But if it only has enough cash to make payroll next week or if a critical vendor has refused further deliveries until it is paid, or if the lender has issued a notice of acceleration, the automatic stay afforded by Chapter 11 may be necessary to keep the lights on. A financial diagnosis within days of the decision, including a 13-week cash flow forecast, will help determine how much time there is and what options are likely to succeed.
3. Stakeholder Posture and Litigation
A significant factor in deciding whether to file for Chapter 11 is the attitude of the key stakeholders. If a lender has already retained a restructuring lawyer or lawsuit, the prospect of a consensual workout will become much less likely. If there are pending transfer claims, landlord disputes, or other litigation, a Chapter 11 case may offer a more favorable environment. Evaluating the posture of the various stakeholders is essential and requires more than a financial model. It must involve discussions with the major stakeholders themselves.
4. Viability of the Enterprise
Finally, the viability of the enterprise itself will play a role in choosing among the alternatives. If the core business can still generate sufficient cash flow to support a restructured capital structure, either a workout or a Chapter 11 proceeding might be appropriate. But if the enterprise is no longer viable, the focus may instead be on selling the business or winding down operations in an orderly fashion. A Chapter 11 case can facilitate a Section 363 sale or a liquidation and the distribution of proceeds to stakeholders in accordance with statutory priority.
Hybrid Approaches: Prepackaged and Pre-Negotiated Chapter 11 Plans
In some cases, the best option is a hybrid of both approaches. For example, a pre-packaged Chapter 11, or ‒prepack,– allows the company to negotiate a restructuring plan with its key creditors prior to the Chapter 11 filing. Once the plan is executed, the company files for Chapter 11 and seeks expedited court approval of the plan. This approach combines the consensus-building and speed of a workout with the automatic stay and binding effect of Chapter 11.
Similarly, a pre-negotiated Chapter 11 plan allows the company to negotiate the terms of its restructuring plan with its major creditors before filing the petition, though it does not necessarily achieve full agreement with all stakeholders. Both prepacks and pre-negotiated Chapter 11 plans can shorten the time and expense of a Chapter 11 proceeding by resolving many of the major issues before the case is filed. These approaches are often well suited to companies that have a manageable number of creditors and a relatively straightforward plan for restructuring their obligations.
Choosing among these three options requires a thorough understanding of the company’s finances, creditor dynamics, industry context, and applicable legal framework. A restructuring advisor can assist by quickly assessing the company’s financial condition, engaging with creditors, developing and implementing a strategy, and maintaining focus throughout the process.
At Tittle Advisory Group, our restructuring engagements are led by our principal, John Tittle, Jr., a former Deloitte Partner and public-company CFO with over 35 years of experience in the field. When a business is in financial trouble, how quickly and well a decision is made can make all the difference.
Frequently Asked Questions
How long does a typical out-of-court workout take?
In many cases, a workout can be accomplished within 60-120 days if the workout involves a small number of creditors. However, workouts may require six months or more, especially if stakeholders are less cooperative or the restructuring proposal lacks credibility.
Will filing Chapter 11 cause my business to close down?
No. The purpose of a Chapter 11 is for a business to continue operations while in restructuring. A debtor-in-possession typically maintains possession and control of its property and operations, while developing a plan of reorganization subject to confirmation by the Bankruptcy Court.
If a lender has already accelerated a loan, can I still pursue a workout?
Yes. A lender may accelerate a loan as part of an effort to increase their leverage. A lender may agree to remove the acceleration if you agree to additional terms. If a lender has initiated a foreclosure action or appointed a receiver, you may still need to file for Chapter 11 in order to obtain relief from the automatic stay.
What do I need to know in order to determine if a workout or Chapter 11 is appropriate?
To determine the best path forward, you will need to gather as much information as possible about your company. That includes financial statements, a balance sheet, accounts payable aging, a 13-week cash flow projection, customer and vendor concentration, pending litigation, and the ability of the business to meet existing and restructured obligations through cash flow.
How much more does a Chapter 11 cost versus a workout?
The costs associated with a Chapter 11 are generally much higher than those for a workout due to legal, advisory, U.S. Trustee, and other costs such as committee costs. The cost must be considered in light of the value of obtaining the benefits of an automatic stay, confirmation of a binding plan of reorganization, and the ability to reject contracts that would otherwise be onerous.
Conclusion: Making the Right Choice, Quickly and Carefully
Choosing between an out-of-court workout and Chapter 11 is a critical decision for any Texas business in financial trouble. There is no ‒right– or ‒wrong– answer to this question. A company’s decision to pursue a workout or Chapter 11 will depend on factors such as creditor behavior, available liquidity, stakeholder willingness to cooperate, and the value of the business.
Texas mid-market businesses that are facing financial distress or change should act quickly. Indecision can consume cash flow, erode the confidence of lenders and vendors, and decrease the value of the business. The first step is conducting a quick assessment and choosing a path. Whether that path ends up being a workout, a Chapter 11, or something in between, the goal is the same ‒ making informed decisions backed by solid analysis, executing those plans carefully, and measuring success.
If you or your company are in the midst of financial distress or change, contact John Tittle, Jr. for a confidential meeting. You can reach him at tittlefinancial.com or by calling (214) 341-6043. Tittle Advisory Group is led by the principals with over 35 years of restructuring experience providing the financial expertise needed by Texas businesses facing challenging times.