This installment of our series is required reading for the next, which attempts the audacious task of describing a “typical” chapter 11. And if you didn’t get it, the title of this installment, “Chapter 11—If You’ve Seen One, You’ve Seen Them All,” is intended to be sarcastic. That said…
When a company files chapter 11, its experience will bear some resemblance to every chapter 11 that came before. We’re not saying anything momentous here, but it’s important to understand why this is. Let’s try a metaphor.
Imagine you’re taking a road trip. You’ve been driving on the highway for six hours. You’re hungry. And you need to use the restroom. You see a sign for two restaurants you’ve never heard of, and a third for McDonald’s. The reason you might choose to stop at McDonald’s is because you pretty much know what to expect when you walk in. From the quality and cost of your meal, to the cleanliness of the restroom, you can expect a high level of consistency between the experience you’re about to have and the experience you’ve had at every other McDonald’s you’ve ever set foot in in the past. Is this a good thing? Does it make chapter 11 “better?”
Look, McDonald’s doesn’t sell the best food money can buy, but you know it will be edible and provide for your caloric needs. Its ambiance isn’t that of a restaurant with a Michelin star, but it’s a good bet that it will be clean, well-lit, and have Wi-Fi.
Consistency and predictability are good things—particularly when you’re tired, hungry, and in need of a bathroom.
You know who else is usually tired, hungry, and has a need of rest? The owners, directors, and/or senior managers of distressed businesses—as well as their creditors and other various constituents. And while there are a number of alternatives to chapter 11, an attribute of chapter 11 is that all parties, when contemplating or negotiating over one or more of those alternatives, can know the range of likely outcomes should they be unable to reach resolution without chapter 11.1 This isn’t to say all chapter 11s proceed exactly the same way (the same is true, of course, with respect to a visit to McDonald’s), but there is a general framework that enables experienced players to make excellent educated guesses.
Again, Reader, the main purpose of this installment is to provide a caveat to the next installment, in which we attempt to paint a general picture of a typical chapter 11. Yet there really is no such thing, so you must read the next installment with a grain of salt.2 Here are just some of the chapter 11 caveats you need to keep in mind when reading Installment #5:
|—||We think we already adequately covered this, but just in case we didn’t: chapter 11 is fairly consistent and predictable when compared to some of its alternatives. Another example of the ubiquitous truistic expression, “everything’s relative.”|
Uniform Law? Bah, Humbug
|—||Even though there is a single Bankruptcy Code that bankruptcy courts must apply throughout all 50 states, they can and do apply it differently. A bankruptcy judge in New York City is free, for example, to rule on an issue in a way that is diametrically opposed to the ruling on the same issue by a bankruptcy judge in Iowa. In fact, that same judge is also free to similarly ignore the bankruptcy judge who sits down the hall.|
|—||State law continues to govern state law issues, even when a party is in bankruptcy. And it is state law that generally governs property and contract rights.|
Where You Stand Depends on Where You Sit
|—||Does the company need a full-on operational restructuring, requiring significant changes to the way it runs its business and business relationships, or is the need for chapter 11 limited to a “balance sheet restructuring?” What industry is the company in? How large is it? What is the ownership structure (public or private? If private, is it owned by a single individual, a family, a family office, a private equity fund, angel investors, VC investors, etc.?) What are the nature of its debts?
This last question deserves amplification: some cases, virtually by definition, will not follow the path outlined in the next installment. These are cases involving companies that (1) do a pre-pack or pre-arranged chapter 11 to deal entirely with balance sheet issues, (2) own single asset real estate, and (3) file chapter 11 to deal with mass tort litigation.
These are a small sampling of the questions whose answers will drive how a particular company’s chapter 11 case will go.
No Two Patients are the Same. Ever.
|—||Even when two distressed companies appear to be the same on the surface (same industry, similar size, similar creditor bases), numerous factors about the debtor play a significant role in shaping the trajectory of a chapter 11 case, such that no two cases are ever the same. These include, for example, the debtor’s cash position at filing, relationships with creditors, importance to its customers, management team, its chapter 11 professionals, and where the case is filed.|
|—||The plot thickens. The Small Business Reorganization Act (“SBRA”), which took effect in February 2020, added a new subchapter V to chapter 11, which contains specialized rules governing small business cases (currently defined as a chapter 11 case where the debtor’s total outstanding liquidated debts are under $7,500,000).3 The SBRA modifies provisions of the Bankruptcy Code in small business cases, including what constitutes “property of the estate,” in a small business case, and appointment of a specialized “Subchapter V” trustee, among other changes to the Bankruptcy Code.|
With all of these chapter 11 caveats as preamble, we present to you, the “typical,” lifecycle of a “typical,” chapter 11 case, in our next installment of this series.
[Editor’s Note: To start from the beginning of this series, or to access previous articles from our table of contents, read “Dealing with Corporate Distress 01: Hello Darkness, Our Dear Friend.”
1. In an earlier article Friedland co-authored, he wrote:
Indeed, Chapter 11 is but one, albeit critical, part of a broader restructuring market that includes a vast array of out-of-court workouts because, as Professor Brubaker points out, it serves as a critical court-supervised market of last resort when a consensual deal is not (or economically cannot be) forthcoming. Its very presence (simply as the logical alternative to a private workout) normatively influences the markets because every market participant knows the price of failure to reach a consensual deal out-of-court—a Chapter 11 case. Miller ignores the vital importance of out-of-court workouts, and thereby gives short shrift to the broader restructuring milieu in which Chapter 11 operates. Indeed, Baird and Rasmussen are right when they observe that out-of-court workouts constitute an important segment of the restructuring markets. They go too far in concluding that private, out-of-court workouts can entirely supplant Chapter 11. Indeed, we believe that out-of-court workouts dominate the restructuring markets directly because Chapter 11 exists and performs a very necessary role. As Professor Ralph Brubaker put it when he debated Professor Kenneth Klee about the state of Chapter 11:
“[I]t’s appropriate, in judging the success of Chapter 11, to focus primarily not on what happens in Chapter 11, but what happens outside Chapter 11. The preferred means of responding to financial distress and default is a negotiated resolution, without resort to bankruptcy. And, at least half the time, those negotiations produce a successful, consensual, out-of-court deal with very low direct and indirect costs that deplete the value of the firm.”
James Sprayregen, Jonathan Friedland, Roger Higgins, Chapter 11: Not Perfect, But Better Than The Alternatives, JOURNAL OF BANKRUPTCY LAW AND PRACTICE, Vol. 14, No. 6 (2005) (internal citations omitted).
2. Food is often tastier and therefore easier to swallow with a grain of salt, so this idiom claims that if someone is telling you something that is probably not entirely true or correct, it is easier to swallow it with a grain of salt than to argue against it.
3. Under the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”), which took effect March 27, 2020, Congress has temporarily increased the eligibility threshold for debtors filing under subchapter V from $2,725,625 to $7,500,000. The increased eligibility threshold is scheduled to sunset after one year of the CARES Act’s enactment.
©All Rights Reserved. July, 2020. DailyDACTM, LLC
Jonathan Friedland is a senior partner in Sugar Felsenthal Grais & Helsinger LLP’s Chicago office. He is ranked AV® Preeminent™ by Martindale.com, has been repeatedly recognized as a “SuperLawyer”, by Leading Lawyers Magazine, is rated 10/10 by AVVO, and has received numerous other accolades. He has been profiled, interviewed, and/or quoted in publications such as Buyouts…
Jack O’Connor is an associate in Sugar Felsenthal Grais & Helsinger LLP’s Chicago office. He has been recognized repeatedly as a “Rising Star” by SuperLawyers Magazine in the area of Bankruptcy & Creditor/Debtor Rights and has been named an “Emerging Lawyer,” by Leading Lawyers Magazine.
Hajar is an associate with Sugar Felsenthal Grais & Helsinger LLP in both its Business Transactions Group and its Restructuring & Insolvency Group.
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