For Small Businesses in financial distress, Merger is a better alternative to filing for Chapter 11

Right now, there are many very nervous small business government contractors, that provide a primarily services footprint, who don’t know which particular programs are going to be cut within the federal agencies they currently contract, due to budget cuts and the potential sequestration, and thus can’t do much in terms of proactive decision making.

At the same time, due to the highly variable cost structures and declining task-order availability, many firms are considering the prospects of what used to be a viable means of restructuring, Chapter 11 bankruptcy. However, this may not be the viable option that it once was. The rules have changed significantly over the years. Today, if your firm goes into Chapter 11, the odds of you keeping the business are much lower.

The Supreme Court’s 1999 LaSalle decision has given unsecured creditors a huge advantage, and the result is the cost of bankruptcy has gotten so high that the ability to continue your firm under current ownership has reached almost zero. The key issue is the expansion of the ‘363 sale’. As many of you may be aware, the 363 sale was originally designed to allow companies to sell off spoilable product, like fruit. If you were in the grocery business and you filed bankruptcy, it allowed you to sell off assets. The Lionel case expanded that so you could sell major assets, virtually including the whole company. Thus, giving unsecured creditors a very logical reason to avoid a plan of reorganization.

These, and many other changes, say to the world that the chance of your small business surviving bankruptcy is much lower. And if it’s much lower, the banks aren’t going to give debtor-in-possession financing, and rightfully so. The D.I.P. financer gets a priority lien; last in, first out, but the contingency is that your business survives to have the money to pay that super-priority lien. In addition, in Chapter 11, you are required to pay for the attorneys, accountants and consultants of the creditors’ committee; including any investment bankers that may be involved. Essentially, you are paying your creditors to oppose you. In short, Chapter 11 is tilted to the unsecured creditor side of the equation.

Given these facts, Chapter 11 should be an absolute last-resort strategy. A better approach may be to merge your firm with another small business to create one survivable company.


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