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June 26, 2017
Categories: ABC » Article 9 Sales » Non-BKY Proceedings » Receiverships »

by Laura Davis Jones

Parties’ Desire for Efficiency and Effectiveness

In larger Chapter 11 cases, there has been an increased use of sales under Bankruptcy Code section 363, either as a sale of the going concern business or as a more orderly liquidation mechanism. Prepackaged and pre-negotiated Chapter 11 plan cases also appear to be increasingly used in larger bankruptcy cases — suggesting debtors, lenders, and other parties in interest (not surprisingly, and increasingly) desire expeditious speed, efficiency and cost-effectiveness in resolving a debtor’s affairs. However, depending on the circumstances and the parties’ specific objectives, non-bankruptcy alternatives, including out-of-court workouts, may offer the best route in some cases. This article will discuss various types of non-bankruptcy alternatives including creditor compositions, assignments for the benefit of creditors, receiverships, Article 9 sales and out-of-court workouts.


Creditor Composition

A creditor composition (which may also be viewed as a special type of workout) is at times referred to as an out-of-court Chapter 11 process. It is a binding contract between a debtor and its numerous creditors to restructure the subject debts. One common scenario might involve a debtor sending a proposal to its creditors, requesting that they each accept only partial payment or provide better repayment terms, setting an acceptance deadline, and explaining that the agreement will become effective only if a requisite percentage of creditors accept the proposal. Frequently, the debtor includes a disclosure of the debtor’s financial condition, so that creditors can assess how they would do if the company had to, instead, file for bankruptcy protection. Generally, the creditors who agree to the terms of such contract do so in exchange for partial payment, in full and final satisfaction of their claims. Some creditors, especially those who do not view the debtor as a critical customer, vendor or another business partner (as applicable), may hold out, possibly making the creditor composition process much more difficult for the debtor. For this non-bankruptcy alternative to succeed, a large percentage of the debtor’s creditors must accept the plan (perhaps 90% or more in some cases). Thus, the larger the creditor body, the greater the risk that a creditor composition may not be possible.


Assignment for the Benefit of Creditors (ABC)

Often referred to as an out-of-court Chapter 7 process, a general assignment for the benefit of creditors is a state statutory or common law alternative to bankruptcy. Basically, the debtor assigns all of its assets to an independent fiduciary (an “assignee”) for the benefit of creditors. The assignee, chosen by the debtor, marshals and sells all of the assets and distributes the proceeds to creditors, who must typically submit claims to the assignee. The assignee makes distributions pursuant to the priority scheme under applicable state law, which usually is similar to the priorities set forth in the Bankruptcy Code. In many cases, there is little or no court supervision. There may be less transparency in this process, and unsecured creditors usually have little recourse if they do not participate in the process. Further, the assignee is appointed by the debtor –a selection process that may be unduly swayed by the debtor’s secured creditor– which may raise questions as to whether the assignee is truly independent and disinterested.



A receivership is a remedy for creditors imposed on the debtor by court order. A court-appointed fiduciary takes possession of the debtor’s assets (often, real property) to protect creditors’ interests therein. A common receivership scenario is where a receiver is sought by a secured creditor, to preserve and protect collateral interests during the administration of a lawsuit that seeks to foreclose upon security interests. The disadvantages of a receivership include the fact that creditors, in effect, pay for the cost of the receiver and its professionals, and the receiver often reports to the secured lender (who is often the party who sought the receiver) and may unduly weight the lender’s desires. Commonly, the role of a receiver is more limited than the assignee in an ABC proceeding. Generally, actions that should be taken by affected creditors include demanding transparency of the receivership proceedings, and if appropriate, joining efforts with other creditors (including possibly forming an ad hoc committee). Creditors should be proactive in protecting and asserting their interests, including checking for any court order preventing creditor collection activities, and checking for a claims bar date and the method for asserting a claim (whether pursuant to court order and/or statute).


Article 9 Sales & Other Out-of-Court Sales

The Article 9 sale process results in a sale of the debtor’s assets to the debtor’s secured lender through a friendly foreclosure under Article 9 of the U.C.C. In such a sale, notice is generally required to be provided to the debtor, junior lien holders, and other secured creditors, but not to trade creditors. The various aspects of the sale must be commercially reasonable. Commonly though, there is no recovery for general unsecured creditors. In lieu of an Article 9 sale, a debtor may sell its assets to the secured lender outside of a foreclosure, or to a third party with the lender’s consent. This alternative is a relatively quick and inexpensive way to liquidate the debtor’s business, and the value of the company’s assets could be maximized through a going concern sale. One disadvantage is that the secured creditor may push for a quick sale that will be just enough to pay them off only, leaving nothing for other creditors.


Out-of-Court Workouts

Generally, a workout agreement will restructure the debt of a particular creditor. For example, a lender or other creditor may agree to defer required payments, extend the time for repayment, reduce the total amount of debt, or a combination of the foregoing. In exchange for this, the debtor may be required by the creditor to sell certain assets, give additional collateral, procure guarantees, meet certain operational benchmarks, be subject to heightened financial and other reporting requirements, and make other valuable concessions. This alternative is often easier to implement because the debtor is dealing with one creditor or a few key creditors at a time. Through cooperative efforts, a workout can avoid the risks, costs, strictures, delays, and stigma in a bankruptcy case, as well as some of the other non-bankruptcy alternatives noted above. The workout can be tailored to apply to specific issues, rather than calling all transactions and business relationships into question or under scrutiny. Further, a significant advantage of out-of-court workouts is the parties’ ability to keep the “bad news” between the debtor and workout creditor and avoid negative publicity among the public, customers, suppliers, and other vendors. Obviously though, the subject creditor must be willing to make some concessions regarding its claims.

Workout and related agreements may be especially appropriate where the debtor runs into difficulty through the occurrence of a non-repeating event, or where the interests of all parties including creditors are otherwise best served by the debtor continuing a generally viable business. Express or implicit, an important part of a workout negotiation process (in most cases) is a shared understanding among the debtor and creditors that the debtor’s business is salvageable (i.e., viable enough to be able to pay off its restructured debt).

To have a successful workout, the debtor and creditor must establish open communications with each other. Indeed, unreturned calls and emails, and delay in sending business or financial information, as well as an unexplained change in payment practices, are common warning signs for creditors. A common mistake (in many cases) made by a debtor is to turn its focus inward, shutting down or delaying communication with creditors. By having open and direct communications with creditors, the debtor will likely have more flexibility and time to solve or mitigate its problems.

Another point to consider is that the possibility of bankruptcy and other more supervised non-bankruptcy alternatives may be used to leverage a workout – that is, a debtor may go to the table and work out a deal because of the potential for bankruptcy (or other supervised alternative) as a last resort. On the other hand, some creditors may prefer a bankruptcy, especially in situations where they do not trust the debtor or are concerned that other creditors may cut a faster and better deal (generally speaking the Bankruptcy Code provides for equality of distribution among similarly situated creditors). From both the creditor and debtor perspective, various creditors (to the extent involved in the workout process) may engage in posturing (e.g., threatening a lawsuit or involuntary bankruptcy case) and positioning among other key creditors. Understanding each key party’s objectives and posturing can help the affected creditor in asserting and preserving its rights in the workout process.

Additionally, often, the advice and services of lawyers and turnaround specialists may turn out to be invaluable, including with respect to possibly calming down any crisis atmosphere, giving some assurances both to the debtor and the disgruntled creditors, and facilitating negotiations. At times, a debtor’s board and management may wait too long to enlist outside expertise.


In addition to the foregoing considerations, the following factors may also facilitate the out-of-court workout:

  1. the debtor has sufficient cash or access to financing to cover critical operating expenses, one-time payments (such as payments to settle certain trade claims) and professional fees;
  2. the debtor has good vendor relationships;
  3. the debtor has a small number of large or major creditors;
  4. the required debt reduction is not extreme;
  5. the debtor has a relatively simple capital structure;
  6. the debtor’s key creditors are sophisticated and/or represented by financial or legal advisors;
  7. credible financial projections forecast an improvement in financial health and return to profitability within a reasonable time frame;
  8. major cash outflows by the debtor are not necessary for the short term (or they can be postponed);
  9. debtor’s management has credibility;
  10. there are encouraging debtor fundamentals like a good product or service, prospects for growth, competitive or strategic advantages, and the like; and
  11. the debtor is operating within a healthy industry.

In many cases, as discussed above, a consensual workout between the debtor and creditor may be the most direct, straightforward, and efficient alternative under the circumstances. However, as the foregoing discussion illustrates, there is no panacea for all cases. Creditors and debtors alike must take into account various potential problems and risks, as well as their specific goals, when becoming involved with a particular non-bankruptcy alternative.

Laura Davis Jones

Laura Davis Jones is a named and managing partner of Pachulski Stang Ziehl & Jones LLP, a national law firm specializing in restructurings. Laura began her career as a law clerk in the Bankruptcy Court (D. Del.), and has been very active representing debtors, creditors’ committees, noteholder groups, purchasers, and other substantial parties in national and regional bankruptcies and out-of-court workouts.