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First Choice. Before a distressed or underperforming company reaches the point where a formal restructuring is needed for survival, retaining the services of an experienced turnaround expert can make a tremendous difference. Our turnaround services, for example, typically include renegotiation of debts and major contracts, streamlining operations and re-focusing company’s priorities on critical activities that will generate the highest revenue and cash flow in the short term. Provided there is sufficient runway, a managed turnaround is often the least costly, least disruptive option and has the added benefit of allowing company management to remain focused on running the business.

If a company is beyond the point of turnaround, there is a complex menu of legal options to choose from. In this article we pay special attention to three highly efficient, low-cost, fast-track restructuring tools: UCC Article 9, Assignment for the Benefit of Creditors and Subchapter V.

UCC Article 9 vs. Assignment for the Benefit of Creditors

• Legal Basis. A UCC Article 9 process is based on the Uniform Commercial Code (“UCC”), a set of laws governing commercial transactions in the United States. An Assignment for the Benefit of Creditors (“ABC”), on the other hand, is based on common law and is not specifically governed by any statute
• Parties involved. In a UCC Article 9 process, there are two primary parties involved: the Debtor and the Secured Creditor. The Debtor is the party that owes money or has assets that are being used as collateral, while the Secured Creditor is the party that has a security interest in those assets. In an ABC, there are three parties involved: the Debtor, the Assignee (the person or entity that takes control of the Debtor’s assets), and the Creditors.
• Scope. A UCC Article 9 process typically involves the sale or disposition of specific assets that are used as collateral for a loan or other debt to a Buyer who wants to continue the business (assuming the underlying business is viable as a stand-alone business or could become viable by combining with a Buyer’s existing business). In this scenario, a Buyer acquires only the assets necessary to continue the operations of the business, including, for example, equipment, inventory, customer lists and intellectual property, all unencumbered by debt (unless the Buyer wants to assume any of the Debtor’s contracts or leases, in which case it will need to obtain the consent of the relevant parties.)  When successful, this scenario typically results in the highest possible recovery of outstanding debt.  
• An ABC, on the other hand, involves the transfer of all a Debtor’s assets to an Assignee, who then liquidates the assets and distributes the proceeds to the Creditors.
• Timing. A UCC Article 9 process can be initiated by a Secured Creditor at any time as long as the Debtor is in default. An ABC, however, can only be initiated voluntarily by the Debtor, and typically only when the Debtor is insolvent or on the verge of insolvency.
• Control. In a UCC Article 9 process, the Secured Creditor retains control over the disposition of the assets, while with an ABC, the Assignee takes control of all the Debtor’s assets and manages the liquidation process.
• Costs. A UCC Article 9 process can be less expensive than an ABC, as it typically involves the sale or disposition of only specific assets, rather than the transfer of all of the Debtor’s assets. An ABC, on the other hand, can involve significant costs associated with the transfer and liquidation of all of the Debtor’s assets.

Chapter 7 Bankruptcy. Also known as “liquidation bankruptcy,” Chapter 7 involves the sale of a Debtor’s non-exempt assets to pay off creditors. Individuals, partnerships, and corporations can file for Chapter 7.

Chapter 11 Bankruptcy. Chapter 11 is primarily used for business reorganization. It allows a business to restructure its debts and operations while remaining in business. The Debtor retains control of its assets and operations and proposes a plan to reorganize and pay off its creditors.

Chapter 13 Bankruptcy. Chapter 13 allows individuals with regular income to create a plan to pay off their debts typically over a period of three to five years.

Subchapter V. Subchapter V is a relatively new chapter of the Bankruptcy Code that was created as part of the Small Business Reorganization Act of 2019. Designed for small businesses with no more than $7.5 million in secured and unsecured debt (Chapters 7 and 11 are available to individuals and businesses of any size), it provides for a streamlined reorganization process as an alternative to traditional Chapter 7 and Chapter 11. Here are some other key differences between Subchapter V, Chapter 7 and Chapter 11:

• Timeframe. Subchapter V is designed to be a faster and more streamlined process than traditional Chapter 11 bankruptcy. In Subchapter V, the Debtor must file a Plan of Reorganization within 90 days of filing for bankruptcy. The plan must be approved by the court but does not require the approval of all creditors and the case must be resolved within one year of the filing date (with the possibility of an extension). 
• In Chapter 11, the debtor must file a Plan of Reorganization and obtain the approval of all impaired creditor classes before the plan can be confirmed. Chapter 11 cases can last for years.
• In Chapter 7, there is no plan of reorganization and cases can be resolved more quickly.
• Discharge of Debts. In Subchapter V, the Debtor may be eligible for a discharge of debts upon completion of the Plan of Reorganization. In Chapter 7, eligible debts are discharged upon completion of the case. In Chapter 11, there is no automatic discharge of debts, and the debtor must satisfy certain requirements before obtaining a discharge.
• Trustee. In Subchapter V, a Trustee is appointed to oversee the case, but the Debtor retains control of its assets and operations. In Chapter 7, a Trustee is appointed to liquidate the debtor’s assets and distribute the proceeds to creditors. In Chapter 11, a Trustee may be appointed if there is evidence of fraud, dishonesty, incompetence, or gross mismanagement by the debtor.

Pre-Packaged Bankruptcy. A pre-packaged bankruptcy (also known as a “pre-pack”) is a type of bankruptcy in which a Debtor arranges a reorganization plan with its creditors before filing for bankruptcy. The plan is then approved by the court and implemented immediately upon filing for bankruptcy.

Section 365. Section 365 is a special provision of the U.S. Bankruptcy Code that governs the treatment of executory contracts and unexpired leases in bankruptcy. Under Section 365, the Debtor can choose to assume or reject executory contracts or unexpired leases, meaning that debtors can shed unwanted contracts and leases or renegotiate on more favorable terms. If the Debtor assumes the contract or lease, it agrees to fulfill all of its obligations under the contract or lease going forward. If the Debtor rejects the contract or lease, it is considered terminated as of the date of the bankruptcy filing. Section 365 is often an integral part of any type of bankruptcy that involves a restructuring of a Debtor as a going concern.

Debt Restructuring. Debt restructuring involves renegotiating the terms of a business’s debt with creditors to make it more manageable. This can include extending the repayment period, reducing the interest rate, or lowering the principal balance.  

Friendly (Out-of-Court) Restructuring. A friendly restructuring is a process by which a company negotiates with its creditors to modify its debts and restructure its operations outside of a formal bankruptcy proceeding. The goal of a friendly restructuring is to avoid the costs, delays, and stigma associated with bankruptcy, while still achieving a successful debt restructuring and allowing the company to continue operating.  

While considering the optimal type of restructuring, related questions often arise regarding personal guarantees and the homestead exemption.

Personal Guarantee. In a UCC Article 9 process, a Personal Guarantee (often referred to as a “PG”) may remain in effect even if the underlying debt is discharged or satisfied through the sale of the collateral. This means that the Secured Creditor may still be able to pursue the Guarantor for any remaining balance owed after the sale of the collateral. However, if the Personal Guarantee was secured by the same collateral that was sold in the UCC Article 9 process, then the Personal Guarantee may be extinguished along with the debt.

If the Personal Guarantee was secured by the same collateral that was sold in a UCC Article 9 process, the guarantee is not automatically extinguished. However, the Creditor’s ability to pursue the Guarantor for any remaining balance owed after the sale of the collateral may be affected.