ABA Family Legal Guide

Forming and Operating a Small Business

Business Problems

Bankruptcy

Is bankruptcy my only option if I can't pay my debts when they fall due?

No. Frequently, it is possible for the business to work out accommodations with its creditors on a voluntary basis that will enable the business to survive through a rough period. Banks and mortgage companies, for example, are often willing to refinance indebtedness, especially if they can be convinced that the business's financial difficulties are temporary. Trade creditors are also amenable to stretching out payments for the same reason. After all, the last thing a creditor wants is to foreclose on property securing a debt or reduce a debt to judgment. Everyone loses in that situation.

A slightly more formal option is an out-of-court restructuring, or workout, in which the financially distressed business and its major creditors, such as lenders or suppliers, agree to adjust the business's obligations. That means that your creditors will cancel some of the debt you owe them. This can be a slow process. Creditors will want to bring in accountants and lawyers--at your expense--to understand and negotiate the restructuring. While you may believe that your initial restructuring plan is the fairest to your creditors, the creditors will most likely consider it your "first offer" and begin negotiating from that point.

A workout may be draining, but it is usually faster than a Chapter 11 restructuring. In addition, it is almost always a better deal for your business than bankruptcy. An out-of-court restructuring doesn't carry the stigma associated with bankruptcy. Third parties may decide that if the business's creditors are willing to do a workout, the creditors must feel the business can regain sound financial footing. Thus, other parties will have more confidence in doing business with you when you're in a workout than when you're in bankruptcy. Unlike Chapter 11, a workout allows the business to choose those creditors it believes are necessary to the restructuring. The business gets to decide how to approach those creditors, and has more flexibility in negotiating the plan.

Another advantage of workouts is that they are less obtrusive. In a Chapter 11 bankruptcy, the financially strapped company's executives are required to appear at a meeting of the company's creditors. At this meeting, the creditors get to question the executives, who are under oath. The creditors also can get court orders to make the executives available for questioning at other times, and to force the company to hand over copies of documents that deal with the company's business affairs.

A workout, on the other hand, gives the company more control. A workout allows the company to limit the release of its financial records to those creditors the company considers essential. The company also can require that this information be kept confidential.

The biggest problem is getting the creditors to agree to the plan. Each creditor will have to decide whether a workout is more beneficial than the outcome of a bankruptcy. Creditors may distrust the business's management. They may not have confidence in the restructuring plan. They may believe they would be better off if the company went through a Chapter 11 reorganization or was liquidated. Creditors will have less say, however, if the business goes into bankruptcy court. Thus, the threat of bankruptcy may convince creditors to agree to the plan.