The high cost of Chapter 11 restructurings — long the favored type of bankruptcy for many corporations because it allows firms to maintain more control — is pushing some bigger businesses to file Chapter 7 bankruptcies instead, according to Christopher A. Ward, president-elect of the American Bankruptcy Institute.
Among the bigger names that have recently gone the Chapter 7 route are Lake Forest, Illinois-based drug-maker Akorn Pharmaceuticals, which filed for Chapter 7 bankruptcy protection and put itself on the auction block in February, and the Carlsbad, California-based weight loss brand Jenny Craig, which began winding down its operations after filing for Chapter 7 bankruptcy in May.
Companies filing for Chapter 11 bankruptcy protection are allowed to liquidate their assets just as they can do in Chapter 7, Ward said. The main difference between the two types of bankruptcies is that companies in Chapter 7 “lose complete control” of the liquidation, as a trustee is appointed by the court to run the process. In Chapter 11, the company remains in control as a debtor in possession and remains in charge of the liquidation, he said.
“Historically you would not see a very large company file for Chapter 7 because they lose control of the process and a secured lender would much rather control the Chapter 11 process and maximize the value of the assets,” he said in a recent interview. “But given the cost of Chapter 11, some lenders don’t want to pay for that and would rather hand it over the process to a trustee, which is how the Chapter 7 process works.”
Most restructuring professionals agree that a “controlled liquidation” in Chapter 11 managed by people from the company that filed for bankruptcy who are familiar with its assets will realize the highest and best liquidation value, he said. But some companies don’t have enough liquidity to afford the “burn rate” to pay for the staff and experts needed to run a Chapter 11 bankruptcy. In those cases a Chapter 7 is one of several alternatives, Ward said.
Professional fees in a bankruptcy case are dependent on many factors and are hard to estimate, Ward said. But cases like Union, N.J.-based home-goods retailer Bed, Bath, & Beyond will incur millions of dollars in fees for restructuring professionals and, for the biggest mega-cases, such fees can rise into to the tens of millions, he said.
As for small and mid market Chapter 11 cases, they can rack up professional fees ranging from a few hundred thousand dollars to a million dollars, he said. “Bankruptcy requires significant reporting requirements and court approval for just about everything, which leads to a substantial commitment from the legal and financial advisors. Chapter 7 costs are much lower because there is no operating business to deal with; it is a pure liquidation of assets that can be done more cost efficiently,” Ward said.
Pulling off ‘orderly’ bankruptcies
CFOs are an integral part of the pre- and post-bankruptcy process because they are so familiar with the company’s finances, Ward said. He advises finance executives managing businesses on the financial brink to take action early to address liquidity crises.
While being proactive and timely about addressing a cash crunch is key, many CEOs and CFOs don’t reach out for restructuring help until it’s too late to fix the problems, said Ward, who is also a restructuring chair at the Polsinelli law firm. Even six weeks can be enough time to make a difference, he said.
During that period “there’s a lot of things that can be done to protect liquidity and to either prepare for an orderly Chapter 11 or to negotiate with your lenders and your creditors so that you can have a runway to try and recover,” Ward said. “If you wait until you’re two weeks out from missing payroll and decide that’s when you’re going to try and fix your liquidity issues, there’s not much you can do.”
Business bankruptcies are picking up again this year, after abating in 2022, as pandemic assistance programs and lender forbearance agreements have dried up as inflationary pressures and debt loads are growing.
The total number of U.S. commercial bankruptcy filings rose 18% to 12,107 in the first half of 2023 compared to the year-earlier period, with one of the biggest jumps seen in Chapter 11 filings that soared 68% in the period to 2,973, according to Epiq Bankruptcy.