Chapter 11 of the United States Bankruptcy Code allows for the reorganization of a corporation or partnership. A debtor may present a plan to keep their business alive and pay back creditors over time. This allows companies to shed their debt and get a fresh start. Creditors can gradually recover most of what they are owed, as the company turns itself around and starts generating profit.
Yet tens of thousands of businesses go into liquidation each year, renouncing the second chance at the success which the law encourages. These liquidations lead to huge losses for creditors, reaching billions of dollars each year. This topic has been researched by Harvard Professor Samuel B. Antill, who has studied three decades of court filings.
In his research article Do The Right Firms Survive Bankruptcy? Antill says that; “Chapter 11 allows for reorganization, which sounds like such a great thing. People get to keep their jobs, the creditors get paid equity, and the customers don’t lose this business that they loved”.
During these times of the Covid pandemic, many businesses have been hit hard and may be considering going into liquidation. Antill’s research could help business leaders to make important decisions, avoid liquidation, and choose a beneficial path forward.
Antill studied 503 companies, each carrying debt of more than $50 million dollars when they defaulted. This data was collected from Bankruptcydata.com, Bloomberg Law, Moody’s Investors Service, and the Federal Reserve Bank of St. Louis. Each case study included the name of the judge who made the ruling, allowing Antill to see patterns in their rulings.
Prior to analyzing this data, Antill expected bankruptcy judges to generally rule in favor of reorganization of a company over going into liquidation. He was surprised to find that, actually, it’s the other way around. According to Antill, there is “…excessive liquidation in the US bankruptcy system”.
Why is the general trend for businesses to go into liquidation, rather than to restructure? Many creditors hire external managers that will help to guide a company through chapter 11 of the Bankruptcy Code. However, instead of reorganizing, these managers often persuade judges to approve a quick sale of assets. They basically prioritize a quick resolution over long-term benefits. These managers often end up steering companies into liquidation. This can harm creditors, employees, and customers, as well as the economy at large.
Section 363 of the US Bankruptcy Code states that judges may grant liquidation without creditor approval. This is reliant on showing that there is a “business justification” for the liquidation. Managers simply have to show falling values in the market, which are affecting the business, to be granted liquidation.
Antill says that; “There are some instances where you have a melting ice cube and assets in bankruptcy that are losing value really quickly. It’s ‘if we don’t do the sale right now, there’s not going to be any value left in this firm. .[Managers] just need the judge to believe there’s some business justification, and then they can make this wholesale happen in, like, 30 days.”
Rushing through this process may be short-sighted. It could end up costing both creditors and companies a lot more in the long term. The retail company Sears has had one of the most well known bankruptcies in recent history. Antill uses this as an example of how much value a company can lose through rushed asset sales.
According to his analysis, creditors would gain a potential 52 cents on each dollar when a company is restructured, rather than liquidated. 60% of the liquidations he studied cost creditors more than a structured reorganization would have. Creditors lost more money acquiring some bankrupt companies than they would have with a structured reorganization. Over time, these missed opportunities really add up. Antill finds that company liquidations and acquisitions cost creditors more than $2 billion per year.
This research has big implications for large and small companies. If they don’t have an absolutely crippling debt load, companies coming out of bankruptcy may perform well with some restructuring. This is a potential boon for companies, creditors, and the economy.
Antill says that; “If you could just get all the creditors to agree to lower that debt load, to accept a write-down, then the equity in that company becomes really valuable. Because, for some of these firms, really, their only problem was that debt”.
Creditors could actually benefit from this, as they could then negotiate equity stakes in the company as a way of receiving any outstanding debt. This becomes an asset with huge growth potential if the reorganization of the company is done in the right way.
Antill says that; “They become partial owners of this firm, and their equity stake can be very valuable—more valuable than what the liquidation proceeds would have been if the firm is healthy”.
Antill’s research may have important ramifications for small business owners who have been hit hard by the pandemic. Small businesses, if they are suffering financial stress and hardship, can struggle to afford to file for Chapter 11 of the US Bankruptcy Code. Instead, small businesses facing bankruptcy often file for Chapter 7 instead. Under these guidelines, they have less control.
The Small Business Reorganization Act of 2019 makes it easier for small businesses to reorganize under Chapter 11 guidelines. Antill thinks this is something small businesses should seriously consider. He advises that any company heading to court and considering bankruptcy should meet with their key creditors to try and gain their support.
He says; “Get them to sign some sort of restructuring support agreement, maybe even a prepackaged bankruptcy plan before filing. It allows the managers and creditors that signed the agreement to take advantage of one of the coolest features of bankruptcy: You can tell some creditors, ‘I’m only paying you half of what I owe.’”
Creditors can potentially help companies, and themselves, by being more open to working with companies to come up with a reorganization plan before going to court. This is especially relevant at this time, considering that many businesses are only suffering temporary setbacks due to the pandemic.
As businesses bounce back they can regain financial liquidity and start turning profits again. They can employ more people with the help of technology, expand their ventures, start to invest, and help the economy to bounce back during the pandemic. Any small business owners looking to invest may want to consider the best investment newsletter to sign up for.
Antill says that; “It’s important to help creditors understand that this might be an unusual circumstance and that if they could just be patient, accept some equity in this firm instead of liquidating the assets, that equity could be really valuable post-pandemic”.
Antill’s research provides an entirely different model of how both companies and creditors can respond to bankruptcy. It can benefit all parties involved and provide a welcome boost to the economy during these difficult times. Bankruptcy doesn’t have to mean the end!