8 Rules for Running a Company in Chapter 11

by Robert J. Gonzales


Effectively running a business in Chapter 11 is not easy. It requires special management skills, constant contact with both business professionals and bankruptcy counsel, and a healthy dose of patience and optimism.


In most Chapter 11 cases, the company will remain in possession of its property and run its own day-to-day affairs. Because the company stays in possession of its property, it is called a "debtor-in-possession" or "DIP." Chapter 11 gives management time to make operating decisions, accumulate cash and formulate a reorganization plan.


There is no single recipe for success in Chapter 11. Each case involves unique facts, issues, goals, and personalities that impact whether the company can confirm a reorganization plan and emerge as a stronger enterprise. But staying conscious of a few simple rules can help management in any Chapter 11 case maximize the chances for a successful reorganization.


1. Business as Usual

The most important rule for running a company in Chapter 11 is to run the company as profitably as possible. This may seem obvious, but it can also be difficult with the swirl of distractions a Chapter 11 case creates. Maximizing profits during the case is critical to the success of a reorganization. The company is required to stay current with its ordinary operating expenses (excluding debt service) during the Chapter 11 case and it will likely need to stockpile cash during the case to fund its reorganization plan. Moreover, if the goal of the Chapter 11 case is to reorganize and continue the business, it is vital to stay sharp and avoid losing market share.


2. Understand "Ordinary Course of Business"

During a Chapter 11 case, the DIP's management does not have to seek Bankruptcy Court approval to operate its business in the customary manner, which is known as the "ordinary course of business." Court approval is only required for activities that are "outside" the ordinary course of business. Some examples of actions that usually fall outside the ordinary course of business are: (i) settling any substantial claim or litigation; (ii) obtaining new credit; (iii) purchasing or selling equipment, old inventory and product lines; (iv) changes in senior management; and (v) leasing property or terminating leases.


Management is given latitude to decide how the business will be run, but actions that fall outside the ordinary course of business require Bankruptcy Court approval. Typically, the Court will approve such requests if the company is exercising reasonable business judgment.


3. Learn the Ropes

Chapter 11 is a complicated process. Along with the powers granted to the DIP by the Bankruptcy Code come many responsibilities. The more educated management is about the process, the more likely it is that good results will be achieved – including the company’s return to prosperity. The most successful cases are those where management takes an active role in learning the timeline of the case, likely significant events, the major players and how it all fits with the company’s goals for the case.


4. Embrace the Process

It is hard to deny there is some stigma associated with bankruptcy, and many companies will want to take measures to conceal their Chapter 11 filing. This is usually unrealistic since Chapter 11 is by its nature a public event and all creditors will receive written notice of the filing. Therefore, the best course of action is to embrace the reorganization and put a positive face on it. Employees and customers are much more likely to be supportive of the company's efforts if they are made to understand from the beginning that Chapter 11 is the vehicle by which the company's operations will be strengthened and profitability improved. To that end, it's almost always good strategy to issue a press release at the beginning of the case to let creditors and other interested parties know what is happening straight from the horse's mouth.


5. Communicate

Communication is critical in a Chapter 11 case. The key constituencies will generally be more supportive of the company’s efforts if made to feel that they are part of the reorganization process. Communication with employees, creditors, vendors, and the company’s other valuable contacts will also help ensure continued success after the Chapter 11 case concludes.

The most important communication during a Chapter 11 case is between management and the company’s restructuring professionals, including lawyers, accountants, and financial advisors. This communication goes both ways – management needs to understand the Chapter 11 process, and the professionals need to understand the business and management’s goals. Management and its professionals can function as an effective team only if there is good communication.


6. Respect Reporting Requirements

A company in Chapter 11 has numerous reporting and disclosure requirements. These include filing its schedules and statement of financial affairs near the beginning of the case, filing an operating report each month of the Chapter 11 case, attending the initial debtor conference and meeting of creditors, and perhaps giving one or more Rule 2004 examinations.

The U.S. Trustee monitors compliance with the reporting and disclosure requirements. Filing complete reports on time is important. Not only is it a requirement of the process, but it will facilitate trust and cooperation with the U.S. Trustee, the creditors and the Court.


7. Take the High Road

In the vast majority of cases, management is honest, hardworking, and focused on rehabilitating the company so it can stay in business and pay its creditors. Occasionally, however, management may be tempted to play fast and loose with rules, reporting requirements or information it disseminates. This is a terrible idea and can lead to serious consequences. Credibility and trust are among management’s most important assets – not only for success in the Chapter 11 case, but for the company’s continued success afterwards. More seriously, there can be criminal and civil penalties for supplying knowingly false information to the Court.


8. Keep a Sense of Humor

There is nothing fun about being in Chapter 11 and no business would choose it as a first resort. That said, it makes all the difference if management maintains a positive outlook – in the same way that a patient recovering from surgery benefits from a positive attitude. Additionally, employees, creditors, vendors, customers, and the Court will be influenced by management’s optimism.


Conclusion

Chapter 11 can be a difficult process. But by following these rules, management can take full advantage of Chapter 11 and increase the odds of a successful reorganization.

Robert Gonzales represents debtors, creditors, committees, and other parties in workouts and business bankruptcy cases. He is a 1994 graduate of Vanderbilt Law School.

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