Chapter 11 is the business reorganization section of the Bankruptcy Code.  Sometimes Chapter 11 must be applied to an ailing business so that it can continue operations while reorganizing.  Other times, alternatives to Chapter 11 may be applied that are less expensive and yet just as effective to reorganize a business.

Since last year, the housing bubble burst. The Dow fell over 6,500 points. The commercial credit markets rendered borrowing almost impossible. Lenders, who once competed over loans, are now declining everyone except for the most creditworthy borrowers. Consumers are starting to save, just when the government needs them to spend. As cash becomes scarce and loans become due, businesses need to assess their options.

Chapter 11 is still the first option that most decision-makers think of when grappling with an insolvency situation in their business. Still, that is appropriate. Bankruptcy offers features that are unavailable anywhere else. Under Chapter 11, debtors are afforded the automatic stay, the ability to reject burdensome contracts, and the power to impose a plan that most constituents agree upon and bind holdouts to the deal. These are powerful tools and bankruptcy is often the best, if not the only viable, option for some companies. But bankruptcy should not be the only option that businesses consider. The market for debtor in possession (“DIP”) financing has become scarce. Even when DIP financing is available, its pricing has increased and the usual term of the loan has been shortened.

If a company does not need the tools tafforded under the bankruptcy laws, there may be faster, less expensive, ways to reorganize or liquidate. This is especially true for smaller businesses.

For businesses that need to reorganize while continuing their operations, a composition may be attractive. A composition is simply an agreement between a company and its creditors to restructure the company’s debt. If it can be achieved, it can be quick, quiet, and less expensive than Chapter 11. The main obstacle to a composition’s success is the holdout. If one or more creditors refuse to compromise their claims, a composition does not offer a way to compel them to accept it. Everyone else takes a haircut, while the holdout keeps its full claim and reaps the benefit of an improved balance sheet for its borrower. Of course, that doesn’t sound fair. Well, compositions work only in situations where few creditors hold the majority of the company’s debt.

Shareholders and/or management who need to liquidate a company and provide a cost effective way for creditors to get the proceeds of liquidation have at least two non-bankruptcy options. First, the company’s management can oversee the company’s own liquidation subject to relevant state corporations law and “Going out of Business” statutes, if relevant. Second, they can use an assignment for the benefit of creditors (“ABC”), if the company is located in a state that offers an acceptable ABC process.

Under an ABC, the company chooses an assignee and conveys its assets to the person or entity to conduct that liquidation. Indiana boasts a favorable ABC statute but, interestingly, it is little used by insolvency lawyers. It’s one of Indiana’s best kept secrets!

Once the assignment is perfected, the assignee, not the company or its officers, directors, or shareholders, is responsible for the unpleasant tasks that accompany liquidation, like telling creditors that they will not be paid in full. It does allow, however, the company to choose its liquidator.

In contrast, in bankruptcy court, a trustee or a creditors’ committee is often perceived as always looking for someone to sue, to place blame for a corporate failure. And, while an assignee also has a duty to investigate potential causes of action, assignees are less likely to bring speculative suits viewed more as shakedowns than anything else.

Creditors of a company that undertakes an ABC are often satisfied that a third party is overseeing the liquidation. Moreover, the creditors will enjoy a larger recovery than would be otherwise available in a bankruptcy because of an ABC’s significantly reduced costs, including reduced professional fees.

ABC laws vary from state to state, and in some states an ABC is not a viable option. Many practitioners are unfamiliar with the process. I’ve served many times both as an assignee in an ABC and as bankruptcy trustee so this firm has ample experience in both of these types of proceedings. Where they fit, ABC’s offer significant advantages over bankruptcy.

While many situations, especially those involving companies with public securities, large numbers of executory contracts or unexpired leases, assets in multiple states, or union, pension, or mass tort liabilities require the supervision of a bankruptcy judge under Chapter 11, many other situations do not. You should understand all available alternatives before choosing the right one for your company’s situation.