Home » MBJ FEATURE » Many take exit to Ch. 7; others try ‘363 Sale’

Many take exit to Ch. 7; others try ‘363 Sale’

The high cost of staying afloat while reorganizing under a Chapter 11 bankruptcy filing is forcing more businesses to accept unconditional surrender under Chapter 7 liquidation. But others are exiting their enterprises by attracting buyers who use a provision of the Chapter 11 code to pick up a debtor’s assets free of liens and other encumbrances.

“Chapter 11 filings in general tend to be down in Mississippi and across the nation,” said Kristina Johnson, chair of the bankruptcy and creditors’ rights practice group at Watkins Ludlam Winter & Stennis in Jackson. “There just aren’t that many,” she said. “Business simply can’t afford to reorganize.”

Of the 14,326 commercial bankruptcies in Mississippi last year, Chapter 11 business filings accounted for 74. Of those, 27 occurred in the state’s Northern District and 47 in the Southern District. Nationwide, Chapter 11 filings totaled 14,291, Johnson said. “That’s not many cases. What we have tended to see is that businesses are opting for 7.”

Total business bankruptcy filings in Mississippi fell 7.6 in the Northern District, from 7,048 in 2009 to 6,509 in 2010, the Administrative Office of the U.S. Courts reports. Total filings rose 2.2 percent in the Southern District, climbing to 7,820 last year from 7,653 in 2009, the courts office says.

Tighter lending has made surviving in Chapter 11 a risky play. First, you must pay the federal bankruptcy court quarterly trustee fees and the handful of professional service providers such as accountants and debt specialists who get involved in the case.  “If there is no asset to pay these people because the income stream is gone, there is no Chapter 11,” Johnson said.

Time is a factor, as well, she noted.

Johnson

Johnson

“Your average Chapter 11 (under a reorganization plan) can last five years or more.”

It’s much quicker to liquidate, Johnson added. “A liquidating 11 is typically done in two years, and that assumes you have a buyer when you go in.”

And even if you can stay afloat in Chapter 11 to that point, “you’ve got to have some post-bankruptcy funding in place,” Johnson added.

“It’s one of the ironies of life that you have to have money to do anything in bankruptcy,” said Steve Rosenblatt, bankruptcy attorney and financial services group leader at Ridgeland-based Butler Snow.

Finding options

“You have a lot of options available to you in Chapter 11,” Doug Noble, bankruptcy attorney with McCraney, Montagnet & Quin in Jackson.

Above all, Chapter 11 gives you time, a breathing spell during which you can analyze your options, Noble said.

“You have a reprieve from paying your creditors and you can continue to operate your business.”

The sooner you settle on a strategy the more time you will have to weigh the rest of your options, Noble noted.

“Just be mindful that when there is no credit out there you don’t get as many decisions to make to avoid bankruptcy. You make one wrong decision and you’ve given up all of your options,” he said.

“You’ve got to play out a worst-case scenario with every move you make.”

Rosenblatt said delays in acting leave the debt-ridden business owner with too much ground to make up. “The biggest difficulty we have is folks coming to see us too late,” he said. “You’ve just got limited options under that scenario.”

Securing financing to initiate an exit is an option, but you may have to seek alternative lending that will be expensive and demanding on the collateral side, Johnson said.

“They are a unique sector of lenders and turnaround companies that work with companies that need to reorganize their debt so they can continue to operate. In post-bankruptcy filings those lenders are going to try to get everything they can as collateral,” she added.

“It comes clearly at a price, but at least the business is saved and the jobs are saved and people can continue to enjoy the products and services provided by these companies.”

Looking for the exit

In many instances, the squeeze on lending has made a true restructuring and reorganization through Chapter 11 an unrealistic option, according to Noble of McCraney, Montagnet & Quin.

Rosenblatt

Rosenblatt

As a consequence, more and more debtors are entering a Chapter 11 with the plan to sell all or part of their assets and operations under the protective cover of the Chapter 11 umbrella, he said. Such a strategy is often referred to as a “363 Sale,” named for Section 363 of the Bankruptcy Code that governs a debtor’s ability to use and sell its assets in bankruptcy, Noble wrote in an article on 363 Sales for the Mississippi’s Bar’s electronic newsletter.

Buyers are eager to acquire the assets. And why not — they come free of encumbrances of creditors and flawed contract provisions agreed to by the seller before bankruptcy. “In a 363 Sale, the Bankruptcy Court can transfer all assets free and clear,” Noble said in an interview. “That is a better title than you can get outside of bankruptcy.”

Essentially, it turns the assets of the debtor into cash, he said.  “While 363 is not a liquidation it is a mode of liquidation.”

Rosenblatt said the 363 Sale reflects a trend to use Chapter 11 as a sales mechanism. “Instead of restructuring, they (the businesses) are sold as going concerns,” he said. “They are cleaned up so the buyer can come in and buy a company that is functioning. Jobs are preserved. It’s a win-win.”

And, on occasion, if the buyer is an investor and needs a specific type of management expertise, the debtor lands a role helping to run the rebuilt entity. In some instances, the former-owner-turned-manager may regain an equity stake in the business.

Buyers often find opportunities through 363 Sales to acquire difficult-to-obtain assets and to go into certain businesses that otherwise would have been difficult to enter, Rosenblatt said.

“By and large, this is the route most of the 11s seem to be going these days.”

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