Any time a company becomes unable to pay its bills, it creates a stressful situation for the ownership and management team. Often, those at the helm figure that their only alternative is to declare bankruptcy – either dissolving the business and liquidating assets (through a Chapter 7 filing) or reorganizing debt through the court system (Chapter 11).

Either of these can involve a long legal process with extensive costs, thus reducing the size of the assets the firm’s creditors can salvage. For more, read What Is the Difference Between Chapter 7 And Chapter 11 Bankruptcy?

Before deciding that bankruptcy is your only solution, consider some of the other options at your disposal, including an out-of-court workout or pursing an assignment for the benefit of creditors.

It’s always a good idea to consult a qualified bankruptcy attorney who can provide advice tailored to your specific business. Your best bet is a lawyer who is certified by the American Bankruptcy Institute (click here for its state-by-state resource list) and, if possible, has a referral from someone whose professional judgment you trust.

Negotiating Outside of Court vs. Chapter 11

Sometimes, a management team believes the business can survive if it’s able to receive more favorable loan terms from its creditors – for example, a better interest rate or lower payments. This can be possible through a Chapter 11 bankruptcy filing, in which the court-approved trustee reviews the firm’s financial statements and monitors the reorganization plan. The downside is that these proceedings can be extremely expensive and onerous.

An alternative for companies that hope to stay in business long-term is an out-of-court workout. In some respects, the arrangement is similar to a Chapter 11 bankruptcy. The company has to come up with a plan to get back on track financially and pay back all or some of its outstanding debt. This requires scrutinizing financial documents and finding ways to cut expenses or sell non-essential assets in order to generate positive cash flow.

The main difference between the two strategies is that workouts are much less rigid. Whereas bankruptcy involves a very specific, detailed legal process, out-of-court agreements enjoy considerable latitude. The key is that the business develops a sound restructuring plan that all of its creditors can agree upon.

Hiring an experienced turnaround specialist can increase the odds of success. These consultants can help you decide whether a workout is viable and, if so, develop a strategy creditors will find agreeable. They know how to prepare necessary documentation, such as business valuations and cash flow projections, and suggest specific ways to boost revenue or cut expenditures. A turnaround firm may also help line up financing from lenders or equity partners that serve troubled businesses.

The drawback of a workout is that it requires a consensus among creditors. If only one or two balk at the proposal, the business may have no option but to file for bankruptcy and use the power of the courts to force concessions.

The ABC Alternative vs. Chapter 7

Sometimes reorganizing debts is unachievable and the business has no choice but to close its doors. Here, too, there are options. The obvious course is to use Chapter 7 of the bankruptcy code. Any assets without a corresponding lien are put in the hands of a trustee, who supervises their sale. The trustee then distributes the proceeds among the creditors. (See File Chapter 7 Bankruptcy.)

However, there is an alternate path businesses in this situation may want to consider. An "assignment for the benefit of creditors," or ABC, enables the business to sell its assets itself, which can bring distinct benefits to both the ownership and its creditors. The state has marginal oversight over the process, but generally affords the company significant leeway in the liquidation process.

Having greater control is a potential plus for business owners because they can give extra attention to debts for which they’re personally liable. This is particularly important in the case of sole proprietorships and partnerships, where the owners are responsible for the firm’s liabilities.

It’s often a good deal for the creditors, as well. Those managing the business understand its assets and the market for those assets better than a trustee. They may be able to secure a better sale price when they’re in charge of the process. An ABC also costs creditors less time and money than a bankruptcy, so they may see it as a favorable solution.

Unlike bankruptcies, ABCs come under state law. As such, the rules vary from one part of the country to another. In some states this approach is rather common, whereas ABCs are rare in others. A qualified bankruptcy attorney will know the statutes where you live and be able to provide appropriate counsel.  

Selling the Business

Some businesses are worth more than the sum of their assets. This is especially true of companies that have a strong brand or a loyal customer base, but happen to go through hard times for whatever reason. If that’s the case, think about selling the entire business rather than shedding its assets individually.

Keep in mind that this is no easy task for an organization that suddenly can’t pay its creditors. Yet there are investors who specialize in buying distressed business they believe can be turned around. Take, for example, a local grocery chain known for its superb product quality that happened to expand too quickly. The right buyer might find the capital to keep the company afloat while it pares back less profitable locations.  

Some companies choose to work with a business broker whose job is to facilitate such transactions. The better brokers will be able to identify the most likely buyers and manage negotiations if a party shows interest in the company. It’s no sure thing that you’ll find a willing buyer, but it may be worth a shot if you’re convinced the firm has enduring value.

The Bottom Line

Any business that finds itself in a tough spot financially should think through the alternatives to bankruptcy. A knowledgeable bankruptcy attorney will be able to look at the relevant issues for your organization and explain the pros and cons of each option.

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