The Fundamental Difference
When borrowers and creditors reach a standstill in default payment remedies, borrowers may have the option to seek protection in the Bankruptcy Courts for resolution to their financial situation. The Bankruptcy Code can provide effective remedies to businesses that are in financially distressed situations. On the other hand, receiverships are a viable solution for creditors looking to maximize value that can be cheaper and more expedient than a bankruptcy proceeding. Both options play an important part in distressed businesses. However, it is important to understand the nuances of both Chapter 11 and receivership laws to better address a company’s situation. This article will focus on the restructuring and turnaround process of these two solutions.
The approach in which a business contemplates their path to debt resolution depends on many factors including, size of the corporation, debts, assets, operations, and timeline. In a Chapter 11 restructuring, the proceedings can take several months to a span of multiple years. That said, asset values may diminish during a potentially long and costly process. Moreover, rates for restructuring professionals can become expensive over the course of the case. Even the simplest case requires extensive administration because of the required filings, meetings, and court hearings. In addition, bankruptcy courts are courts of equity. The U.S. Bankruptcy courts will apply the principle of equity, to secure the rights of creditors to receive payment for what they are owed.
Receiverships have limited parties to an action making the process potentially more effective and efficient. Receiverships are administered by the receiver and their attorneys and are generally faster, avoiding complications where asset values can diminish. In the simplest of terms, a receivership benefits the creditors, but not necessarily the debtor, who seek to protect their collateral and preserve goodwill of the company. Receiverships, moreover, are a state law remedy (federal receiverships are not as often utilized) as opposed to a Chapter 11 restructuring which is governed by federal law. The State Court, typically at the request of the creditor, appoints a receiver who in turn, acts as an officer of the Court with a fiduciary duty to the Court and all constituents, usually creditors. One potential advantage of a receivership vs. Chapter 11, is that the creditor has the ability to nominate the fiduciary. The ability to select the receiver is one of the greatest aspects of receiverships. Creditors should choose a receiver that has an understanding and know-how of dealing with complex situations, which is most important in cases where going concern value must be preserved. Under the right circumstances, a receivership can be a more effective process for investors or creditors of a troubled asset.
Receiverships are governed by the Order of Appointment. The order sets forth the custodial responsibility of the receiver over the receivership estate. The order is flexible, specific to the case, and broad enough to allow the receiver special or unusual powers that the receiver may require in a given situation. The judge who issues the order can define virtually any procedures, rules, mechanisms, etc. that the court deem appropriate under the circumstances. This allows the receivership to be tailored to the circumstances of the case to a much finer degree than a bankruptcy.
Chapter 11 is given structure by the Bankruptcy Code and the Rules of Bankruptcy Procedure. The bankruptcy proceeding is a defined and intentional process. It is a very formal legal procedure set forth for dealing with financial and other issues that allows for a resolution based on an equitable outcome. In a receivership, the resolution can be a disproportionate outcome brought on by the receiver for the benefit of the receivership estate, whereas the outcome in a bankruptcy filing is impartial and is a function of the bankruptcy plan.
Chapter 11 proceedings are administered by the Federal Bankruptcy Code. The advantages are that the Code has broad protections built in that allows for the company and related professionals to accomplish the goal of reorganizing the entity thereby allowing it to continue to operate. Unlike a receivership, there can be a myriad of professionals and committees all with specific duties and responsibilities during the pendency of the case.
In financial situations where the business or operational problem lies in management, a receiver may be a more effective approach for creditors and investors. In a receivership, the receiver can immediately replace management, assume control over the operations and finances of a company within the confines of the court order. The receiver can exercise all the powers of the business in place of the board of directors, executive committee, or officers. The receiver, as reasonably necessary, can carry on the ordinary business of the corporation and manage its affairs in the best interest of the shareholders and creditors.
In financial situations where money is the business problem, bankruptcy may be a good course of action. On the other hand, a Chapter 11 proceeding typically allows existing management to maintain control of operating the company. Upon filing for Chapter 11, the company becomes the “debtor-in-possession” which typically means management remains in control of the business. In extenuating circumstances, the court may appoint a Chapter 11 Trustee to either replace or supplement existing management and operate the business during the pendency of the case.
Below are additional scenarios to consider when determining the appropriate course of action for debt solution.
Continued Business OperationsReceivership – Has the advantage to facilitate the continued operation of a business or the rehabilitation of an enterprise before sale to a third party. Chapter 11 – The prime consideration is to reorganize the company to allow for continued operations.
Receivership – Has unilateral control and can make managerial decisions, however big or small, for the receivership estate within the authority granted by the receivership order.
Chapter 11 – Management typically remains in control of the company with a stated goal of restructuring the company, both financially and operationally.
Assume or Reject Existing Contracts
Receivership – Has the power to enter into, terminate, and negotiate contracts and service agreements for the benefit of the estate.
Chapter 11 – Allows for the acceptance or rejection (and potential renegotiation of contracts) subject to certain conditions being met.
Infusion of Capital
Receivership – Additional capital can be invested with confidence that it will be applied for the sole purpose that it was requested without influence.
Chapter 11 – Debtor-in-possession financing allows the enterprise to have access to additional capital to address operational needs.
Receivership – The receiver has the authority to issue demands and institute, continue, or otherwise address all legal actions on behalf of the estate to preserve and recover all amounts that may be due.
Chapter 11 – All pending litigation is stayed during the proceedings allowing the company to focus on reorganizing the business.
What makes most sense for a business in a financially distressed situation – a Chapter 11 filing or a receivership? The short answer is that it all depends on the situation. In a Chapter 11 filing, the goal is to restructure the business while simultaneously attempting to satisfy the needs of parties that have an economic interest in the estate. In a receivership, the goal is to maximize returns of the assets typically to one or more creditors. Though the circumstance that prompt these two options may be similar, the approach can be materially different. The outcome, on the other hand, can be one of many things; reorganization, turnaround, sale of entity, or liquidation. A Chapter 11 and a receivership are solutions that are extremely important to a company in financial distress. It is important to understand each solution to better steer the enterprise in the right direction for debt solution.