Resolving business failures cheaply and rapidly has never been more important, with Covid-19 and the recession about to push record numbers of companies under. But consider what a small-business owner faces: Your company is on the brink, you can’t pay your employees or suppliers, and now you’re expected to master the complex vocabulary of federal bankruptcy law. There’s Chapter 11, Chapter 7, Chapter 13, Subchapter V, Section 363, and on and on. The process looks expensive and time-consuming, and the chance of emerging with a going concern seems slim.
The Uniform Commercial Code, which traces its origins to 1892, just might be the answer. It’s a set of state laws that have been enacted in identical form by all the states and cover commercial transactions. The relevant section if your company is failing is Article 9, which covers what happens when you owe money and your creditor is secured—that is, has a claim on some of your assets.
If you use Article 9, there’s no trustee to handle the case, as there is in bankruptcy court. Instead, the senior, secured creditor itself, typically a bank, takes charge of the resolution process. It finds a buyer for the collateral, through either an auction or a private sale. The process is quicker and cheaper than bankruptcy. It’s also faster than an assignment for the benefit of creditors, a resolution method available in some states that requires the appointment of a neutral third party, the assignee, to run the process.
True, if you’re the owner of the failing company, you’ll lose your entire investment in an Article 9 sale, just as you would in a Chapter 7 liquidation in bankruptcy court. But if the company is sold as a going concern you may be hired by it as a consultant or executive. Which is better than nothing.
Lawmakers have been trying to make the traditional bankruptcy process faster for small businesses. Last year, Congress created Subchapter V of Chapter 11 to allow very small companies to get their plans confirmed without the approval of creditors. This year, after the pandemic hit, it made more companies eligible, raising the ceiling for debts to $7.5 million from $2.7 million. Those are valuable measures, but probably not enough to keep the bankruptcy courts’ dockets from getting clogged.
Article 9 is often “the quickest, cheapest, and easiest” way to resolve a company whose assets are worth far less than its debts, says Jonathan Friedland, founder and publisher of DailyDAC LLC in Highland Park, Ill., and a partner in the Chicago law firm Sugar Felsenthal Grais & Helsinger.
Second Wind Consultants of Northampton, Mass., specializes in helping companies with Article 9 cases, particularly ones in which the assets are sold privately rather than by auction. One advantage of a private sale is that it happens quickly and quietly, so customers and suppliers of the business don’t have a chance to get alarmed and back away, says Second Wind Chief Executive Officer Adam Duso. The trick with a private sale is assuring other creditors that it raised as much money as an auction would have.
Using Article 9, a company can be resolved in as little as 30 to 90 days, Duso says. “Small businesses can’t operate in distress for 12 or 13 months,” he says. “They don’t have access to capital. They lose customers, clients. Over time the business value erodes. That’s why Chapter 11 is so inefficient.”
Among the companies Second Wind has led through Article 9 are an Arkansas manufacturer of staves for wine barrels, a Connecticut maker of truck tires that foundered after diversifying into retreading, and a Florida precision metal fabricator that sold to firearms and aerospace companies, according to Second Wind President Aaron Todrin.
Onyx Asset Advisors of San Francisco used Article 9 to liquidate a health and beauty company quickly, thus preserving the value of its brand name, says Kevin Otus, the company’s founder, and managing partner. He declined to name the brand but said it’s sold at Target and Walmart. If a company stumbles and stops production, “it’s hard to get back on store shelves,” Otus says.
While Article 9 has been used for years to resolve companies, in the past “it was always for the benefit of the lender” and ended in piecemeal liquidation, says Harvey Gross, executive director of the New York Institute of Credit, a nonprofit educational group. “Too many times,” says Gross, “and I hate to say it because I was a lender, but many lenders are control freaks, and they don’t think what’s best for the borrower. They think what’s best for them.”
Second Wind’s approach is to make Article 9 less adversarial and, where possible, to keep the operation going under new owners. That’s obviously better for the workers. It can also benefit the lender if it gets a higher price for the assets—and is in a position to make fresh loans to the new company. Says Duso: “The same way there are prepackaged Chapter 11 filings in bankruptcy court, we’re doing prepack Article 9s.”
Originally featured on Bloomberg.com, by Peter Coy