With the sudden changes prompted by the COVID-19 pandemic creating financial pressures for many companies, business leaders might be asking themselves: When is it time to file for bankruptcy?
Milwaukee-area manufacturers Briggs & Stratton, Jason Industries, Techniplas LLC and Arandell Holdings have been among the more than 4,250 Chapter 11 cases filed nationwide this year. Each company’s reason was slightly different. They involve looming debt maturities, a lack of available cash, transactions spoiled by COVID-19 and industry challenges exacerbated by the pandemic.
As for when to consider bankruptcy, experts have two main pieces of advice: engage attorneys and financial advisors early and exhaust every other option before filing for bankruptcy.
“Once you file bankruptcy your whole business is bared to the world,” said Matt Lee, a partner at Foley & Lardner LLP.
“Everything you do has to be approved by the court,” he added. “It’s not fun, it’s very expensive, it’s very time consuming and in addition to trying to run your company, basically your entire upper management and a decent part of your middle management is going to have a second job complying with requests and information needs and disclosure requirements brought about by the bankruptcy code and the bankruptcy rules.”
Engaging an attorney early, however, can make it easier with banks, landlords, contract counterparties and other creditors.
“Right now, there is some level of sympathy in the creditor community,” said Michael Richman, an attorney focused on Chapter 11 debtors and creditors’ committees at Steinhilber Swanson LLP in Madison. He noted he has been representing a dry cleaning chain with more than 20 commercial leases that has stayed out of bankruptcy court by negotiating with landlords.
Claire Richman, a partner in the bankruptcy and insolvency group at Steinhilber Swanson, noted she’s represented a client for three years without them having to file for bankruptcy.
“We get more excited about and are more proud of keeping companies out,” Michael Richman said.
Seth Dizard, an attorney heading the banking, receivership and creditors’ rights practice at O’Neil Cannon Hollman DeJong & Laing s.c., said all professionals would prefer clients come to them sooner, but added it is a deeply personal decision to file for bankruptcy.
“Making that decision, however, a few days before payroll is due when there’s no viable way to fund it is pretty unwise,” he said.
In some cases, a bankruptcy filing may ultimately be necessary. For Arandel, which Michael Richman is representing, the company’s bank wasn’t willing to refinance existing debt, but would provide financing for a bankruptcy proceeding.
Claire Richman noted that companies should rely on their attorneys for the exact timing of when and how to file. A café or other small business with an aging owner might be better positioned for a Chapter 7 liquidation while a company run by an entrepreneur with decades to go before retirement might need a Chapter 11 reorganization.
“When the owners of that company are near retirement age, it’s a very different discussion,” she said.
Lee said it is important to identify an end goal, which could be to reorganize, sell the business as a going concern, liquidate assets in an orderly fashion or simply stop everything right now.
Beyond Chapter 7, which is an immediate liquidation, and Chapter 11, which allows a company to continue operating, Wisconsin businesses also have the option of a Chapter 128 receivership case. There’s also a new subchapter of Chapter 11 designed for businesses with around $2.7 million in debt, although the threshold was raised to $7.5 million under the CARES Act.
“It depends upon what an owner’s preferred outcome is, to the extent she or he can control it,” Dizard said. “Often times, if one waits too long, the decision will be made for you by your creditors.”
If a company is facing financial challenges, there are two main areas of preparation for a potential bankruptcy case.
The first is ahead of the engagement of professionals like lawyers and financial advisors. Claire Richman said it is important for a company to have a clear understanding of its financials so professionals who are new to the business can asses its current state.
This includes an accurate listing of assets and liabilities, a solid cash flow analysis, an idea of what assets could be sold and for how much, and an understanding of how certain debts and liabilities are secured or guaranteed.
She said that one of the biggest mistakes businesses make is letting that kind of accounting work slip as the stress of financial pressure begins to mount.
Some businesses may also be inclined to provide inaccurate or more optimistic information than reality to creditors and others involved in the process, Claire Richman added.
“You can be silent, but don’t say or write something that isn’t accurate,” she said.
Lee said it is easy and more comfortable for companies to continue operating as they have in the past, but they need to prepare to be creative and think outside the box.
“You have to be willing to have uncomfortable conversations with your existing relationships,” he said, noting banks, landlords and creditors expect to be paid. “If you’re in this position, obviously something isn’t working.”
The second area of preparation comes ahead of an actual filing. Lee said it is important to have a consistent, honest and hopeful messaging campaign for employees to understand where the company is headed.
“Without your people, you’re never going to recover,” he said.
Michael Richman said a business should want employees to understand what’s happening, but also noted it’s not good to have rumors circulating amongst employees or creditors before a filing.
“It’s important not to talk too much about all of these things before you file,” he said, noting that creditors can force a company into bankruptcy before it’s ready in some cases.
Eric Waters, an assistant professor of communication studies at Marquette University, said when it comes to major changes with a business, many companies opt for either a “spray and pray” or “withhold and uphold” strategy. In the former, a company provides a massive amount of information and leaves employees to sort out the details. In the latter, the company withholds as much information as long as possible.
“Neither of these strategies are effective,” Waters said.
He suggests using an “underscore and explore” strategy with an employee’s direct supervisor – not a senior manager or C-suite officer. Use face-to-face or video conferences to focus on the fundamental issues of the change “while allowing employees to creatively explore the implications and possibilities,” he said.
“This includes listening to employees to clarify misunderstandings and recognize the root causes of resistance,” Waters said. “Employees usually have established, trusting relationships with their direct supervisors, thus decreasing the chances of misunderstanding and/or resistance.”