When is it Time to Declare Bankruptcy?

Posted on April 1, 2002 by LCT Staff - Also by this author

In today?s economy, we are forced to accept the fact that companies, in a variety of industries, are going to have to file bankruptcy. In recent months we?ve seen one of the largest American retail corporations, Kmart, decide that it was time to declare bankruptcy.

According to the American Bankruptcy Institute, more than 1.5 million bankruptcies were filed in 2001. Also, according to the ABI, approximately 2 percent of the Fortune 500 companies filed for relief under the Bankruptcy Code.

To many operators, the thought of bankruptcy is unthinkable. In many peoples? minds, it is the ultimate expression of failure. However, in tough economic times it may be a company?s best option.

Bankruptcy does not necessarily mean the end of the world, and in some cases, it may even help to make a company stronger. Operators who are even considering bankruptcy as an option should have clear-cut goals of what they want to come out of it.

Why Declare Bankruptcy? ?Bankruptcy, if it is taken as a last resort, is exactly that,? says Jeff Fadley, a partner with Tatum CFO Partners, LLP, one of the largest CFO firms in the country with more than 25 offices. ?There has got to be a strategic reason for bankruptcy. A key thing to consider when you?re thinking about filing bankruptcy is what are you trying to accomplish.?

Operators should assess their situation and take an inventory of their assets and bills. From that they should decide what they would be achieving by declaring bankruptcy.

There are two major reasons to declare bankruptcy. One reason is for consolidation and an opportunity to restructure one?s company in order to make it profitable. This is Chapter 11 (see sidebar on Page 40 for complete explanation).

The second reason is a little more severe. It is declaring bankruptcy to liquidate one?s company, and get out entirely. This is Chapter 7.

Operators should establish what their desired end result is, consider their options when declaring bankruptcy, and seek advice from an attorney specializing in corporate bankruptcy.

Consider Rent When Declaring Bankruptcy As stated earlier, if you look at declaring bankruptcy when it?s your last resort, then it?s probably too late for restructuring. Bankruptcy, or even the threat of declaring bankruptcy, can provide much better results if you consider it prior to the last option.

For example, an operator with a small fleet and working from an office is considering bankruptcy. If he or she is planning on remaining in the office building, they are going to have to continue to pay rent.

However, before the operator decides to declare bankruptcy, her or she should look at what can be done beforehand. The operator may be able to renegotiate the terms of the rent, which is an avenue that?s available outside of bankruptcy.

?The operator can do this by essentially telling the landlord that if he doesn?t play ball the tenant will go away,? Fadley explains. ?Yeah, the landlord was going to get the deposit, but he would essentially be stuck with the empty building.?

Even though the tenant is negotiating from a position of weakness, Fadley says that if you do this you must make your position look as good as possible.

However, look at all your options before choosing a particular course of action. If you are going to be staying in the same building, bankruptcy may or may not accomplish what you are trying to do.

Vehicles Play an Important Role in Bankruptcy Bankruptcy may not be right for every situation. It really depends on your reasons for filing and your goals after you file. The size of the operation can help determine an operator?s success of coming out of bankruptcy.

?If you have only one car with a note to the bank or dealership, it?s very difficult to survive a bankruptcy, because there?s really nothing to be gained,? Fadley says. ?If you are going to stay with the same vehicle, if you only have a single asset, bankruptcy may or may not accomplish what you are trying to do.?

An operator with one or two cars has less room to work when considering bankruptcy.

?Let?s say you?re a single-car operator,? Fadley explains. ?Well, you really can?t cut beyond a single car. So, what does bankruptcy do? Well it might help with a 48-month loan and have it extended out to 60 months and defer it on the past-due charges. Then again, it may not, The question then becomes, is that enough? As a one- or two-car operator it?s a more difficult negotiation because it?s harder to cut back to profitability in that case. There?s a much smaller margin for error. Creditors are going to want to know what else you?ve cut back on (i.e., maintenance). The question then becomes smart cheap vs. dumb cheap.?

This scenario is different if an operator has more vehicles. These operators have more to work with in the eyes of creditors.

?Let?s say you have 15-20 cars, and you decide that under current market conditions only 10 of them are necessary and you need to drop back in terms of the number of cars that you?re running,? Fadley says. ?You can?t get any of the note holders to play ball with you. And turning them back in is not going to be feasible. Then bankruptcy may help you.?

Essentially, what happens is that an operator can have the ability within the bankruptcy court to reaffirm or disaffirm (reject) leases. However, there are limitations and it can cost an operator. But similar to the rental situation explained earlier, you might also be able to accomplish a positive result by threatening bankruptcy. The key question to keep in mind is, why will life get better after declaring bankruptcy as opposed to now?

?If you do go into bankruptcy, creditors are at least going to know how badly they?re going to get hosed,? Fadley says. ?You have to have a convincing plan that says this is why life is going to be better for me as the debtor and for you as the creditor. Remember that lenders have always heard this song and dance. So your argument has got to be convincing. It has to be based upon a reasonable approach to the market.?

For example, let?s say that you have 20 cars in your fleet, and you?re currently running about four cars a night. So, you knock your inventory down to six cars. You all of a sudden show that your utilization is up to two-thirds. However, creditors may not agree with that utilization because there are going to be cars in the shop and any number of reasons as to why you don?t have all the cars available. An operator?s argument has to be subject to scrutiny. Remember that lenders like Ford Motor Credit are going to be used to seeing things done in a certain way, and with a certain amount of documentation and by a certain amount of management credibility.

?If the creditor is going into a situation where essentially the owner has given him poems, prayers and promises for the last year and fallen short on every single one, the lender is going to say basically, ?Why should I believe you now??? Fadley explains. ?Management credibility is critical in being able to get any type of plan, whether in court or out of court, agreed to. I can guarantee that Ford Motor Credit knows more about bankruptcy than most of those operators who will be opposing them. It?s critical that they approach the debtor with a high degree of credibility. They need to have done their homework.?

Is it Just Denial? The issue of bankruptcy should not be, but often times it is a surprise. Usually it is a surprise because the owner is in denial. The warning signs are out there if one cares to look. However, there is a fear out there that turns into a lack of action. But then if, at the last minute, you have no other alternative but to declare bankruptcy, then you?ve gotten yourself to the point where there is no other viable option.

Leading up to bankruptcy, you do have other choices, and the point is that you can get past the denial in order to deal with those issues.

Remember the Costs One of the most important things to remember is that you need to have money if you file bankruptcy. It does not allow you to operate without any money. Whether it?s financing or a loan from a lender, you still need money to operate.

?If you don?t have any money and you?re completely out then you have a problem and might not be able to declare bankruptcy,? says Peter Tourtellot, managing partner at Anderson Bauman Tourtellot Vos & Co. in Greensboro, N.C. ?Even liquidation is going to cost you. Obviously not as much, but you still need money.?

Prior to filing bankruptcy, having some amount of cash gives a company more options and more breathing room.

?There?s an expression that ?Cash is king, but cash is also queen and it?s the court jester,?? Fadley says. ?The point is that when you have cash, you have more time to operate. You have more choices, and can do more things.?

So Now What to Do? Declaring bankruptcy is an option that no entrepreneur likes to think about. However, in today?s world ... for more on this topic, check out the April issue of LCT magazine.

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