Magazine article Business Credit

Alternatives to Bankruptcy: What Credit Professionals Should Know about Liquidation and Restructuring outside of Court

Magazine article Business Credit

Alternatives to Bankruptcy: What Credit Professionals Should Know about Liquidation and Restructuring outside of Court

Article excerpt

In an era virtually no liquidity in the capital markets and many lending institutions asking borrowers to leave, more and more companies are seeking avenues to liquidate their assets or possibly restructure outside the view of bankruptcy court. While bankruptcy provides tools for restructuring, such as the ability to sell assets free and clear of liens, claims and encumbrances and the ability to shed above-market or burdensome leases and contracts, many companies don't need or cannot afford the use of these tools. Thus, many are resorting to tools available outside the bankruptcy courts to liquidate some or all of their assets, arrange workout agreements with their creditors, or cleanse their assets of claims through common law or state court remedies. This article is intended to provide a brief overview of several available options open to companies caught in the current economic downturn. It also addresses questions that creditors should ask when faced with these alternatives.

Extension and Composition Agreements

Extension and composition agreements provide payment to creditors on account of debt owed by a debtor. Each agreement is entered after negotiations with either a group or committee representing a body of creditors. In an extension agreement, a debtor provides full payment of its debts over an extended time period which is negotiated with the creditor body. After the debtor provides adequate analysis and projections to the creditors demonstrating that it will produce adequate cash to make payments on account of the past due debt, the creditors and the debtor will agree to a payment schedule. The schedule may require payment of the greater of either a minimum guaranteed amount or a percentage of income or profits. The payments may also bear interest if it is negotiated by the creditors. If the creditors and debtor agree to the payments, failure to provide them under the terms of the contract would be considered a breach.

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A composition agreement is appropriate where a debtor's business can be reorganized only by a reduction of total debt and where the creditor body is unified or small enough that an agreement can be ironed out in a short amount of time. For example, for a debtor whose creditors are all members of a National Association of Credit Management (NACM) industry group and can be easily met with, a composition agreement might work. It may also work where the significant creditors are bondholders who are willing to compromise and agree to a payment plan, while other smaller creditors are to be paid in full. It presents a good alternative to bankruptcy as the costs of administration are far below those of a Chapter 11 bankruptcy proceeding. Through a composition agreement, the value of the business can be preserved while providing for payment of claims held by the creditor body.

A composition agreement must be in writing and fully state the terms under which the debtor and creditors will be bound. The agreement will be a contract which is enforceable by the parties, and provide payment terms and remedies to the creditors if the debtor defaults under the agreement. The dividend may be paid in cash at the time the agreement is entered, over a period of time, or after an event to be determined in the future.

Creditors being asked to agree to a composition or extension agreement are entitled to due diligence to provide sufficient information to determine whether the proposed agreement is in their best interest. Some of the areas to be explored by individual creditors or by a committee negotiating on behalf of the creditors include the following:

* Liquidation value of the assets

* Costs of administration in a Chapter 11 versus the proposed composition/extension agreement

* Percentage which would be expected in a Chapter 11 proceeding

* Compensation of management

* Payments made during the last 90 days to other creditors (Are there certain creditors that have been preferred? …

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