If a business is facing liquidation, it may opt instead for Chapter 11 bankruptcy—a type of bankruptcy that grants a debtor the space and legal protection to restructure their business and pay back creditors over time. In short, it provides a second chance. But the success of a Chapter 11 bankruptcy depends on how a business handles its critical restructuring period.
To restructure a business successfully, a debtor must make strategic, fundamental changes to the company and also have the resources to conduct major upheaval.
Historically, most successful restructures are carried out by large businesses, while small businesses have gone from bankruptcy to liquidation. However, a recently enacted federal law called the Small Business Reorganization Act (SBRA) aims to reduce restructuring costs for individuals and small firms.
Learn how business restructuring really works and how it could help get back your business back on its feet.
What Is Business Restructuring?
All businesses have an archetypal structure, developed as a way to establish how the organization functions to execute its goals. A company may be organized based on specialized function, with accountants in the finance department and marketers in the marketing department, for example. Or a company may be structured around business lines or divisions.
When a company goes through restructuring, it’s organizing the system in a new way to increase the effectiveness of the operation, often changing its original structure. A restructure will likely also include reconfigurations, or more surface-level changes such as adding, splitting, transferring, or dissolving business units that don’t necessarily impact the deeper structure.
In 1995, for example, IBM restructured its company into a back-to-front matrix, so that divisions such as technology would develop products that the front-end (marketing) team would then serve to customers. This represented a reverse of the company’s previous matrix, and the restructuring was viewed as a success.
Most restructuring under Chapter 11 includes relieving debt obligations that stifle growth, terminating unprofitable contracts, or selling unproductive assets. Delta successfully avoided Chapter 11 in 2007 in part by renegotiating its pilot contracts, for example, saving the company around $280 million annually.
Why Does a Business Restructure After Bankruptcy?
A Chapter 11 bankruptcy offers particular incentives to restructure. Per their restructuring plan, a debtor might be able to do things they couldn’t legally do during the normal course of business, such as pausing or amending debts or rejecting unprofitable contracts.
A company may decide to restructure without the threat of bankruptcy. This may occur to keep up with shifting markets, or when a company enacts other organizational changes, such as a merger with another business.
How Restructuring Works
After filing for Chapter 11 Bankruptcy, a debtor will draw up a written disclosure statement and a restructuring plan. The plan of reorganization aims to convince creditors and the court that, upon completion of the plan, the company will achieve financial solvency.
Under the SBRA, small businesses can significantly reduce their Chapter 11 Bankruptcy costs. For example, small businesses no longer have to pay for a creditors’ committee to oversee and vote on restructuring, a historically prohibitive cost for smaller firms.
To be considered a small business debtor, the total, noncontingent liquidated secured and unsecured debts of the organization must amount to $2,566,050 or less.
The plan approval process for a company filing Chapter 11 Bankruptcy includes the following:
- A debtor has a 120-day period to file an exclusive restructuring plan. The court may extend this exclusivity period up to 18 months. After that period, a creditor or case trustee may file competing plans to the court.
- The reorganization plan must demonstrate that a business will be capable of meeting all financial obligations going forward, including debts, federal income, and payroll taxes.
- The court appoints a U.S. trustee to oversee proceedings and make sure the plan stays on track.
- The debtor must report balance sheets, regular earnings and profitability reports, compliance reports, and more to the court throughout the restructuring process.
- An automatic stay temporarily protects debtors from “all judgments, collection activities, foreclosures, and repossessions of property.”
In addition to implementing functional organizational changes, a company will probably include debt management in its restructuring plan. There are many programs and incentives that allow for debt management under Chapter 11:
- Under certain conditions, a debtor can implement debtor-in-possession (DIP) financing, which means that a debtor can finance certain debt using funds that it may not have been able to previously. This debt repayment outweighs all other debt or equity.
- A restructuring can include preparing some or all company assets for sale. Buyers won’t have to contend with typical legal liabilities (such as potential fraud), making these assets highly desirable.
- A restructuring enables debtors to legally void certain contracts if they cannot meet the requirements. The contractor must renegotiate or shoulder the loss.
- A restructuring also allows for special exit financing, which helps the company emerge from bankruptcy. Exit financing could make a company more attractive to investors, since it denotes low liability and the company is actively trying to get out of debt.
Business Restructuring vs. Liquidation
If a business doesn’t comply with its Chapter 11 restructuring plan—such as a failure to obtain financing or a failure to file monthly reports—the court will dismiss the case. The trustee may also move to file a Chapter 7 bankruptcy if the debtor does not successfully reorganize and get a debt payment plan approved, thus liquidating the debtor’s assets.
Liquidation means a trustee will convert anything of value into cash, which is used to pay creditors.
Chapter 7 provides relief to companies, regardless of the amount of debt they owe or whether a debtor is solvent or insolvent. Unlike restructuring, much of the debtor’s property will no longer belong to them. It will be put into the hands of the trustees handling the liquidation.
- A business may avoid liquidation by restructuring its corporate framework and debt.
- Companies are granted leniency during Chapter 11 restructuring, such as the ability to cancel unprofitable contracts and suspend foreclosures.
- A restructuring plan is often a collaborative effort between debtors, creditors, an appointed U.S. trustee and the court.
- Chapter 11 Bankruptcies were previously unaffordable for small businesses, but the SBRA has reduced costs for these firms.