Taking the Road Less Traveled: Three Alternatives to Chapter 11 for Suppliers in the Post-COVID Era

The onset of the COVID-19 pandemic has disrupted every level of the supply chain for suppliers and manufacturers. However, despite the added stress of a strained supply chain, labor shortages and the rising costs of raw materials, suppliers have largely avoided the chapter 11 process. In lieu of filing a bankruptcy petition, manufacturers and suppliers have sought out nonbankruptcy remedies, including out-of-court workouts, state law assignments for the benefit of creditors, and Article 9 of the Uniform Commercial Code (UCC) enforcement rights.

The utilization of out-of-court remedies has been particularly popular in the automotive industry. Given the complexity of the decision to file chapter 11, it is important for manufacturers, suppliers and lenders to understand the associated benefits, risks and available alternatives to filing for bankruptcy.

Filing for Bankruptcy: Pros and Cons

Chapter 11 undoubtedly offers significant benefits to organizations in distress and their creditors, but sometimes the expense, obligations and oversight that accompanies a bankruptcy filing outweigh the relief afforded by the Bankruptcy Code. When a company files for chapter 11 relief to effectuate a § 363 sale, liquidation or a restructuring, the company must consider significant professional and filing fees, which can make bankruptcy too expensive for some companies (and reduce funds available for distribution to creditors).

Congress attempted to streamline the chapter 11 process to make it a more viable option for smaller businesses with the passage the Small Business Reorganization Act of 2019, which created subchapter V of chapter 11. [1] Under subchapter V, businesses with less than $7.5 million [2] in debt are able to bypass some of the more onerous aspects of chapter 11, including, among other things, elimination of the obligation to submit a disclosure statement and elimination of the absolute priority rule. [3] Despite the increased flexibility afforded by subchapter V, suppliers and other companies are still choosing to forego bankruptcy and utilize an out-of-court process. To better understand the options available to companies in distress, three of the most often utilized bankruptcy alternatives are outlined below. It is important to note that these are high-level overviews of each form of relief, and companies in distress must evaluate their fact-specific needs with insolvency professionals before choosing a path.

Bankruptcy Alternatives

Out-of-Court Workouts or Wind-Downs

A workout typically involves a debtor negotiating with creditors to develop a payment plan following a default. An out-of-court workout offers suppliers and manufacturers more flexibility and a quicker overall process than a bankruptcy filing. Similarly, an out-of-court wind-down allows a company to liquidate its assets outside of the formal bankruptcy process, yielding cost savings and subsequently a greater distribution to creditors. However, these alternatives to bankruptcy do not come with the associated protections afforded by the Bankruptcy Code, such as the absence of the automatic stay, no discharge for the debtor, and potentially more difficulties obtaining financing.

Out-of-Court vs. Chapter 11

State Law Assignment for the Benefit of Creditors

An assignment for the benefit of creditors offers another alternative to bankruptcy for those secured parties seeking relief following a default. An assignment for the benefit of creditors is a remedy under state law that involves assigning “a debtor’s property to another person in trust so as to consolidate and liquidate the debtor’s assets for payment to creditors.” [4] It may be particularly beneficial for suppliers to utilize an assignment for the benefit of creditors where either (1) the company can no longer operate and is unable to find a buyer, or (2) there is a purchaser for the failing company, but the chapter 11 process is cost-prohibitive. [5] While this remedy does offer a viable alternative to bankruptcy for distressed suppliers, it does not provide the automatic stay or a discharge of debt that the Code affords.

Assignment for the Benefit of Creditors vs. Chapter 11

Article 9 Sales Under the Uniform Commercial Code

Section 363 of the Bankruptcy Code offers companies the ability to sell assets free and clear of claims, liens or encumbrances, the proceeds of which are then distributed to creditors. In contrast, Article 9 of the Uniform Commercial Code provides secured lenders with certain self-help remedies in the event of a default, with potential cost-saving advantages through its foreclosure process, which, in certain circumstances, can be completed within 45 days. Under Article 9, a secured lender may initiate a foreclosure, retain the collateral in full or partial satisfaction of the underlying debt, or collect payments from third parties where the collateral includes a right to payment. [6]

However, it is important to keep in mind that each of these remedies requires cooperation between the secured party and the debtor in order to avoid the need for judicial intervention. If there is a likelihood of noncooperation, the protections afforded by the Bankruptcy Code may be worth the additional time and up-front cost.

UCC Article 9 Sale vs. Chapter 11 Sale

Conclusion

The chapter 11 process might not be the best option for distressed entities, and it is imperative that all those involved understand the bankruptcy alternatives available. Out-of-court workouts and wind-downs, assignments for the benefit of creditors, and Article 9 of the UCC all offer companies in distress remedies with potentially faster and more cost-effective results when compared to the chapter 11 process. As always, it is important for distressed companies contemplating the alternative relief discussed herein to consult a restructuring professional.