Is Bankruptcy a Cure for the Coronavirus Economic Fallout?

March 12, 2020

We are all aware of the human impact of the coronavirus outbreak and the priority for every business is to keep their employees as healthy and safe as possible. With no vaccine to stop the virus, businesses have taken measures to limit exposure and the potential spread of the virus, like travel restrictions, temporary closures and quarantines. The economic impact of the coronavirus is also starting to become a reality for businesses. In recent days, borrowing costs have risen and financial conditions have tightened for numerous industries, including airline, hospitality, oil and gas, and retail. Oil prices have fallen dramatically in recent weeks and are about 30 percent below their levels at the start of the year. While the true economic impact is not clear, there is little question that the coronavirus outbreak has adversely impacted the economy in recent weeks.

The long-term effect that such economic impact may have on businesses is basically a supply and demand problem. Fear of the coronavirus and the heightened uncertainty result in less spending, less travel and less investment. Worsening economic conditions lead businesses to expect lower demand, minimize investment and consider layoffs. As the virus spreads, more workers are told to stay home, and the ability to provide necessary services is reduced. Together, these disruptions in business contribute to higher costs, lower productivity and reduced revenue stream.

While there may be no cure on the horizon for the coronavirus, there is an option for businesses — bankruptcy. Yes, bankruptcy. Despite the negative stigma associated with a bankruptcy filing, numerous businesses have successfully reorganized in difficult economic conditions. In the five-year period from 2015-19, 208 oil and gas producers filed for bankruptcy, most of which were chapter 11 reorganizations. These producers were able to restructure their balance sheets by reducing the debt load on their financial statements, obtaining financing and shedding burdensome liabilities. Bankruptcy saved the company and preserved jobs.

Experts agree that effectively containing the coronavirus requires preparation, and bankruptcy professionals also agree that preparation is key to a successful reorganization. Businesses must be mindful of market conditions and the consequences on cash flow at an early stage. In bankruptcy, businesses request court approval to use cash collateral and must demonstrate in a 13-week budget that projected cash needs, including restructuring costs, will be met. Of course, cash shortfalls are common in bankruptcy, and obtaining debtor-in-possession financing may be necessary. Such financing needs are often attractive to lenders who are granted superpriority status, replacement liens on collateral and the ability to set specific deadlines and budget targets. Just as important is having a team of professionals that can advise businesses on cost areas to focus on to streamline cash flow needs.

Businesses must also keep all key stakeholders in the loop. The filing of a bankruptcy petition requires the business to obtain approval of the board and shareholders based upon the terms of the company’s by-laws and operating agreement. Specific resolutions approving the bankruptcy filing, any financing obtained in bankruptcy, the retention of professionals, and authorizing an officer (or retention of a restructuring officer) to act in bankruptcy must be prepared, executed and filed with the petition. Further, many bankruptcies are initiated by agreement between all stakeholders (including the senior secured lender) and memorialized in a restructuring support agreement. The restructuring support agreement includes a term sheet that outlines the anticipated components of a plan of reorganization that is acceptable to a majority of the stakeholders. Additionally, preparing a discussion of the events leading to bankruptcy, the goals of bankruptcy and the impact upon customers, vendors and employees is essential to obtain support, as well as inform the public of the needs and benefits of the filing.

While there are many moving parts to a bankruptcy, being prepared reduces restructuring costs, creates consensus and minimizes lengthy disputes. Settlement of disputes and resolution of creditor concerns happen every day in a bankruptcy case. The goal is for the debtor to obtain a fresh start, while also maintaining key relationships with vendors and customers alike. Just as there are tools available to the debtor to protect its interests, there are also tools available to creditors that are presented with many uncertain questions when a bankruptcy is filed. For example:

Can a vendor continue to send invoices once the bankruptcy is filed? The answer is yes; creditors should continue to send invoices. Creditors should not take any action to collect on the debt, other than file a proof of claim.

What does it mean when the debtor tells me I’ll continue to be paid in the ordinary course of business? In many instances, the debtor proposes to pay trade creditors in full in order to maintain vendors that are key to the business and also to continue to obtain services post-bankruptcy filing. Vendors that provide these services should expect payment within normal payment terms.

What is a critical vendor and how do I get on the list? In some cases, trade creditors are not paid in the ordinary course of business, instead, the debtor proposes to pay certain “critical vendors” all pre-petition amounts owed as an incentive for the vendor to continue providing services. Obviously, all vendors want to be on the list but being a critical vendor, means exactly that, the services provided by the vendor are critical to the debtor’s business and alternative sources are not available.

Bankruptcy is a specialized field of law and the lingo and paperwork can be overwhelming. Just as a debtor should be properly prepared to file, a creditor should be prepared for what’s to come.

Phelps recently expanded its Bankruptcy group by hiring Rick Shelby in New Orleans. Rick has represented chapter 11 debtors in numerous industries, including oil and gas, gaming, construction, retail and restaurant, handled complex chapter 11 bankruptcy cases, and answered many of the questions presented in this article. Rick, along with Danielle Mashburn-Myrick in the Mobile office, leads a regional bankruptcy practice ready to assist and answer any questions a business may have regarding the benefits and impacts of bankruptcy. Phelps is a full-service law firm with a team to support the bankruptcy group by offering expertise in key areas of law, including transactional, business organizations, commercial litigation, tax and employment.