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Dispelling 10 Myths About Bankruptcy
Corporate bankruptcy is an area that is often feared and misunderstood by those who believe that bankruptcy will be the end of their business. In reality, most businesses operate with limited difficulty in Chapter 11. Moreover, a well-planned corporate bankruptcy can solve a number of problems for companies or their subsidiaries facing distress, and is preferable to an uncontrolled liquidity or other business crisis. Labor issues, landlord/tenant disputes and vendor relationship questions can all be satisfactorily addressed within the context of a Chapter 11 filing. Bankruptcy can also be used as an effective tool by companies seeking to acquire businesses. This article dispels various misconceptions about corporate bankruptcy that can impact a company's rights and interests during a bankruptcy proceeding.
Myth 1. A Company in Bankruptcy Can No Longer Obtain Credit and Will Be Placed On COD By All of Its Suppliers
In Chapter 11, a debtor is authorized to operate its business and is permitted to obtain unsecured credit and incur unsecured debt in the ordinary course of business without the need to obtain court approval. In turn, suppliers and other vendors often extend credit to corporate debtors and do not necessarily require debtors to pay cash on delivery.
Suppliers and vendors are often willing to provide credit to a company in a Chapter 11 because credit extended by a supplier or vendor to a debtor for post-petition goods or services entitles the supplier or vendor to an “administrative expense” priority for repayment of that new credit, which is senior to general unsecured claims and is required to be paid in full as part of any Chapter 11 plan. Creditors that continue to supply necessary post-petition goods and services to debtors will typically receive payment on an ongoing basis and in a timely manner. In addition, suppliers with existing contracts cannot refuse to supply goods to the debtor as a result of the bankruptcy filing.
Myth 2. In Bankruptcy, a Secured Creditor Can Automatically Enforce Its
Security Interest and Can Successfully Demand the 'Keys to the Company'
The automatic stay imposed under Section 362 of the Bankruptcy Code precludes any enforcement action by a creditor against a debtor without first obtaining relief from the bankruptcy court. The stay applies to all creditors, including secured creditors.
Although in certain circumstances, a secured creditor may indeed obtain the “keys to the company” through the bankruptcy process, the Bankruptcy Code provides a debtor with tools to prevent a secured creditor from seizing control of the company. Two tools that can be employed by a debtor seeking to confirm a Chapter 11 plan without the consent of its secured creditors are “cramdown” and “reinstatement.”
Cramdown: If a secured creditor does not support a debtor's proposed Chapter 11 plan, the debtor may seek nevertheless to confirm the plan by “cramdown” in accordance with Section 1129(b)(2)(A) of the Bankruptcy Code. Under Section 1129, a dissenting class of secured claims can be forced to accept a Chapter 11 plan that is “fair and equitable” with respect to that class. In practical terms, this means that secured and unsecured debt must be paid before equity. Payment in full, however, does not require senior classes to be paid in full on exit.
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