In an out of court restructuring or a “workout”, a troubled company can work with its creditors to come up with a viable plan to balance the needs of the company in order to stay in business with the need for creditors to get paid. In order for this process to succeed, the company’s senior managers must have a very good command over the company’s finances so that they can effectively negotiate with creditors. At the outset, it is important to inform the creditors of the company’s financial situation. Doing so enables company management to get a sense of whether the creditors will work with the company to implement a plan and what that plan will look like.
There are several advantages to a workout. First, a workout is usually accomplished far quicker than a bankruptcy court restructuring. This is because the procedures and notification requirements outlined in the Federal Bankruptcy Rules take additional time.
While there are no hard and fast rules to a workout, the company must balance the idea that they must pay creditors something with the idea that it must retain enough liquidity to allow the company to operate going forward. Although a workout does not have the benefit of the automatic stay to protect a debtor from creditors’ attempts to collect from a debtor, it does have the unspoken threat of an imminent bankruptcy filing. Most savvy creditors know that a chapter 11 bankruptcy filing would take away much of a creditor’s leverage to negotiate a favorable resolution to their debt with the company.
Through many mechanisms in the bankruptcy code, a debtor can reduce the amount of claims (both secured and unsecured) and even extinguish certain interests in the debtor’s property. Most debtors make an effort to achieve an out of court restructuring early on. However, if they cannot make progress in negotiations, debtors can then file a chapter 11 bankruptcy petition. Sometimes the mere threat of that chapter 11 filing is enough to motivate creditors to negotiate in good faith with the debtor.