When to File Chapter 11

How do you know if you should file Chapter 11?

Chapter 11 can be filed by individuals but is most commonly used where a business is in trouble. Below are some of the most common tools I use to diagnose whether a business is a good candidate for Chapter 11 and to determine whether I can get it back on solid footing:

What are the root causes of the distress?

The causes of the distress often govern whether a business can be saved. The most frequent causes are bad management, economic downturn, unanticipated competition, excessive or unexpected debt, infighting, or poor marketing. If management is incompetent or the principals are at war, Chapter 11 will often be an inadequate solution, because no amount of number crunching or court edicts are going to turn around a business when its problem is the people involved.

What do the numbers tell me?

Chapter 11 works best when the problem is a numbers game…where bandages over the bleeding can be applied to give the business time to heal. To determine that, I employ the “magical” art of the spreadsheet. I create projections that take into account the historical expenses and income of the business. I remove from the ledger all secured debt payments, and all past accounts payable. I hypothetically deploy the tools that allow me to restructure loans and plug those back in. If there is then some net income left that can be applied to provide some payment for the unsecured creditors, I have the analytical framework for a successful Chapter 11.

Are the prime players “all in”?

My clients come to us already having a difficult time running their business. Now I add a whole new full-time job to their daily grind. That is effectively what Chapter 11 requires. The investment of time and energy that management must devote to the process is substantial. The lawyer is the guide or conductor–the real work is in the trenches and must be done by the insiders. If I do not perceive that my clients are willing to contribute some serious overtime to the effort, it will diminish the chances that I can be effective to them. If your heart and head are not into the game, no amount of superb lawyering will be enough to pull you through.

The two most important words: Exit. Strategy.

Too often Chapter 11 cases fail, and a primary cause of failure is inadequate preparation; a failure to do the homework, and to roadmap an exit strategy upfront. A pre-filing analysis is, in my opinion, the secret to successful outcomes in Chapter 11. Benchmarks and waypoints along the way should be plotted, and the expectations monitored to compare with projections as the case unfolds. The lawyer who is first pondering the reorganization plan as the case unwinds will rarely be steering their client into a safe harbor.

How do you find the right lawyer?

Experience, credentials, and track record are keys. The prospective Chapter 11 client should ask how many cases the lawyer has filed and what percentage of cases have been successfully confirmed. They should talk to other clients of the lawyer who have gone through the process. Most importantly, they should find out if their lawyer is board certified in business bankruptcy. You can find a list of nationally certified Business bankruptcy lawyers at www.abiworld.org.