Many otherwise economically viable Virginia small- and medium-sized businesses (SMBs) will experience a period of “financial distress” due to the Covid-19 pandemic. For Virginia SMBs with no more than $7.5 million in debt, possible responses include: (i) an “Out-of-Court Restructuring” negotiated directly with creditors; and (ii) a proceeding pursuant to the recently enacted Chapter 11, Subchapter V of the Bankruptcy Code.
The Bottom Line: In circumstances where the exercise by creditors of their rights does not appear to be imminent, an “Out-of-Court Restructuring” should be considered prior to initiating a proceeding pursuant to Chapter 11, Subchapter V of the Bankruptcy Code. In circumstances where the exercise by creditors of their rights appears to be imminent, a proceeding pursuant to Chapter 11, Subchapter V of the Bankruptcy Code should be initiated.
An “Out-of-Court Restructuring” involving loan workouts, the recapitalization of debt and equity securities and the amendment of leases and other contracts negotiated directly between an SMB and its creditors offers many advantages in dealing with “financial distress” including:
· Speed. The process can move quickly without regard to statutory waiting periods. The period from initial negotiation to closing can be measured in days or weeks rather than months.
· Flexibility. The parties have complete flexibility regarding the terms of the restructuring.
· Confidentiality. The fact that a restructuring is taking place and the final terms thereof may be kept private and confidential. No publicly accessible court filings need be made.
· Cost Effectiveness. In most cases, the shorter period from initial negotiation to closing results in lower fees for lawyers, accountants, appraisers and related professionals.
A noteworthy disadvantage of an “Out-of-Court Restructuring” is that creditors retain all of their enforcement rights (foreclosure, appointment of a receiver, etc.) during the process.
Historically, Chapter 11 of the Bankruptcy Code has been of limited usefulness to SMBs experiencing “financial distress” due to the cost, complexity and extended duration of Chapter 11 proceedings. This changed with the addition of Subchapter V to Chapter 11 of the Bankruptcy Code this past February (as further modified by the Cares Act in March) which was intended to create a cost effective, streamlined and accelerated process for certain “small businesses.” Features of a proceeding pursuant to Chapter 11, Subchapter V of the Bankruptcy Code include:
· Eligibility. Debtors with no more than $7.5 million in debt (excluding debt owed to affiliates and insiders) are eligible.
· Streamlined Process. The process is simplified and streamlined in a number of ways, including: no appointment of an official “creditors’ committee;” no ability for creditors to submit a plan of reorganization as an alternative to the plan of reorganization submitted by the debtor; and the debtor not being required to prepare a disclosure statement.
· Accelerated Timeline. The bankruptcy court must hold a status hearing within 60 days of the filing of the bankruptcy petition. The debtor must submit its plan of reorganization within 90 days of the filing of the bankruptcy petition.
· No “Absolute Priority Rule.” The “Absolute Priority Rule” is a principle of bankruptcy law requiring that the claims of each dissenting class of creditors be paid in full prior to the satisfaction of the claims of claimholders junior to the dissenting class of creditors. The result of the “Absolute Priority Rule” is that equity holders, who are junior in priority to all creditors, must either relinquish their equity or invest new money to retain their ownership stake. The “Absolute Priority Rule” does not apply to a proceeding pursuant to Chapter 11, Subchapter V of the Bankruptcy Code with the result that equity holders can retain their equity interests even if the plan of reorganization does not provide for the payment in full of all senior creditor claims.
· Plan of Reorganization Confirmation. The requirement that at least one class of impaired creditors votes in favor of a plan of reorganization as a prerequisite for confirmation by a bankruptcy court does not apply to a proceeding pursuant to Chapter 11, Subchapter V of the Bankruptcy Code. Instead, a plan of reorganization may be confirmed by a bankruptcy court so long as it “does not discriminate unfairly” and is “fair and equitable” to each class of impaired creditors.
Provisions of the Bankruptcy Code not varied by Subchapter V continue to be operative in a proceeding pursuant to Chapter 11, Subchapter V of the Bankruptcy Code including the “automatic stay” that prohibits all enforcement actions by creditors against a debtor upon the filing of a bankruptcy petition.
All of the foregoing having been said, how should a Virginia SMB experiencing “financial distress” proceed? In circumstances where the exercise by creditors of their rights does not appear to be imminent, an “Out-of-Court Restructuring” should be considered to take advantage of the speed, flexibility, confidentiality and cost effectiveness typically associated with such an approach.
The fact that there is no “Absolute Priority Rule” in a proceeding pursuant to Chapter 11, Subchapter V of the Bankruptcy Code and that a plan of reorganization may be confirmed without the approval of any class of impaired creditors raises the possibility of equity holders retaining their equity interests while the rights of creditors are adversely affected. The prospect of this scenario provides the Virginia SMB experiencing “financial distress” significant leverage in negotiating an “Out-of-Court Restructuring.”
In the event that the terms of an “Out-of-Court Restructuring” cannot be agreed, the Virginia SMB experiencing “financial distress” can then initiate a proceeding pursuant to Chapter 11, Subchapter V of the Bankruptcy Code.
In circumstances where the exercise by creditors of their rights appears to be imminent, the Virginia SMB experiencing “financial distress” should consider initiating a proceeding pursuant to Chapter 11, Subchapter V of the Bankruptcy Code which will trigger an “automatic stay” prohibiting all enforcement actions by creditors and will preserve the debtor-friendly aspects of Chapter 11, Subchapter V of the Bankruptcy Code.
Should you have any questions regarding the contents of this Client Note, please contact Steven G. Thompson by e-mail at sthompson@sgthompsonlaw.com or by telephone at (757) 253-5711 (Office) or (917) 817-2720 (Mobile).
