Bankruptcy. A word that provokes more fear, loathing and foreboding failure than “world premiere” does to certain silver-haired symphony subscribers hoping to snooze again to Brahms. And no wonder when even venerable performing arts companies from the Philadelphia Orchestra to New York City Opera have gone through the reorganization wringer – and not always successfully.
But if you’re a financially troubled arts organization, one way to keep the wolves at bay may be bankruptcy — or at least playing poker with your creditors over possibly filing. To help me explain the potential benefits of pre-bankruptcy negotiations, I had my brother, New York bankruptcy Super Lawyer, Alec P. Ostrow, change from his cape and tights to a suit and tie and run his red pencil through my draft discourse on red ink.
Let’s say you’re the CEO of Washegon Opera and your company is nearly washed up and gone because attendance, fundraising and grant revenues are way down. And let’s say you think you can turn things around but you’re bleeding red ink and the sharks are circling. The time to talk about bankruptcy is well before Snidely Whiplash comes to padlock the door and cart away your costumes. But a Classic Comics digression into the bankruptcy process, with its own federal code and courts, is needed to understand why the “B” word bluff may be a helpful negotiating tactic.
Washegon Opera’s pre-bankruptcy tango will revolve around the prospect of filing for reorganization under Chapter 11 of the Bankruptcy Code (as opposed to a Chapter 7 liquidation case where everything is sold off and the business is shuttered). Reorganization is premised on an entity, whether a for-profit or not-for-profit business, having at least a chance of being viable once the bankruptcy case is closed.
And post-bankruptcy viability is tested throughout the bankruptcy process, from the filing of the case and continuing after the approval of a plan of reorganization. This plan is essentially a very detailed post-bankruptcy business plan that once submitted, is then negotiated with (and sometimes challenged by) the creditors and is ultimately approved by the court.
If the bankruptcy debtor successfully emerges from this process like a phoenix from the ashes of its pre-bankruptcy pyre, the bankruptcy judge will give his blessing to the now-reorganized red inkster by granting a discharge of its debts in accordance with the reorganization plan. A typical plan is one where creditors get pennies on the dollar for their pre-bankruptcy claims – and sometimes nothing at all. Moreover, claims are often paid over a much longer period time and at a lower interest rate than had been previously agreed to. This is pretty powerful stuff for a creditor to swallow.
But there’s more. In order for all similarly situated creditors (e.g., secured creditors like lenders as one group, and trade creditors like vendors of costumes and office supplies as another) to get a fair deal from a clean deck, there are provisions in the Bankruptcy Code that are designed to give the reorganizing debtor breathing room to deal with them evenhandedly. Other Code sections prevent some creditors from having an unfair advantage over others. Let’s look at a few.
Bankruptcy Benefits – Four Examples
First, let’s assume you commence Washegon Opera’s case by filing a Chapter 11 petition in the local bankruptcy court. As soon the petition is filed, an automatic stay kicks in. Think of it as the big, clear dome from the TV series, Under the Dome dropping down on your business and preventing any creditors from clawing at you. This means that absent the court’s permission, a lender can’t foreclose on a loan, a landlord can’t commence or proceed with an eviction and trade creditors can’t repossess equipment or pursue a lawsuit or a lien against you. But, like the denizens of the dome, a bankruptcy debtor is under glass: it pays a price for the stay’s protection as its actions are closely scrutinized by the court and creditors – and sometimes subject to their approval – through intrusive mandatory disclosures and other provisions of the Bankruptcy Code.
Second, the Bankruptcy Code allows a debtor to reject a burdensome executory contract which is an agreement where there are continuing obligations by both parties. Some examples are rent under a lease, payments under office equipment leases and salaries under an employment contract – even if it’s a collective bargaining agreement. Where an executory contract is rejected by the debtor, the rejected party is relegated to a pre-bankruptcy claim for damages. This means that the creditor under a rejected contract will probably be paid peanuts for what it’s owed, just like the others.
Of course, Washegon Opera can’t continue to reap the benefits of any contract it rejects. For example, if these contracts were rejected, Snidely Whiplash could padlock the door, you’d have to scratch the diva’s guest performance and the copiers and computers could be carted away under a canceled contract. For any agreements that are “assumed” and not rejected, Washegon would not only pony up past-due obligations but also pay these creditors full freight on a going-forward basis.
Moreover, most executory contracts are assignable, even those that have anti-assignment clauses, which are generally unenforceable. (Boilerplate provisions in contracts voiding the agreement or imposing other nasty consequences if you file for bankruptcy are also unenforceable). Contracts that aren’t assignable typically include personal services contracts and copyright licenses, both of which would require consent of the affected assignee.
Third, the Bankruptcy Code provides the debtor with the ability to prosecute “clawback” actions against certain pre-bankruptcy payments or other transfer of assets to creditors. There are two main types. A preference action is a lawsuit in the bankruptcy court where the debtor had paid some creditors prior to bankruptcy, but not others who are similarly situated. The ones who got paid, the “preferred” creditors, are required to give back the payments so that all similarly situated creditors get their proportionate share of the pot.
A fraudulent transfer is one where a financially strapped debtor makes a deal to transfer property with the intention of keeping those assets from creditors’ clutches. Regardless of intent, the debtor can reclaim these transferred assets (or the cash value of them) where the presumably insolvent debtor didn’t receive equivalent value in the exchange (e.g., a sweetheart deal like selling your Steinway to your sister for sixty bucks).
Fourth, a Chapter 11 debtor is often able to have better access to credit by offering lenders a statutory “superpriority” which means that the lender would be repaid first from estate assets that aren’t already collateral for secured loans. Moreover, they may also be able under certain circumstances to offer a lender a first priority or “priming” lien on collateral, thereby demoting the priority of an existing secured creditor’s lien. So, it’s possible that Washegon Opera may have better luck getting a loan against anticipated ticket sales to finance that new production of Aida after filing for bankruptcy.
This all sounds good for a debtor but there are many safeguards in the Bankruptcy Code to protect creditors and prevent abuse. For example, a company’s management can be kicked out and a bankruptcy trustee can be installed to manage the company in the best interests of the creditors.
And bankruptcy, like any legal proceedings, especially ones that may include side litigations like preference and fraudulent transfer actions, can be lengthy and expensive. Larger creditors will obtain their own counsel and various creditors may participate in unsecured creditors’ committees as part of the process. And the debtor’s lawyers and any court-appointed trustee get paid prior to the creditors.
All the Fun without the Fuss
Because of the extensive protections a bankruptcy proceeding provides debtors, hiring a bankruptcy lawyer to work out deals with creditors can be an expedient and cost-effective way to get the breathing room needed to survive. You could wind up with better terms with lenders, vendors, contractors, employees and other creditors. From their viewpoint, why go through the aggravation of a lengthy and costly reorganization where you’ll only wind up in the same place – or worse – than through a pre-bankruptcy settlement?
And these principles are applicable to any individual or entity, including arts-related ones like labels, recording artists and songwriters as well as dancers, painters, poets and photographers. But this post only scratches the surface. For example, the interplay between bankruptcy and the status of various copyright and other IP assignments, royalty streams and licenses can get pretty thorny. And my Super Lawyer sibling reminds me that some of the bankruptcy principles were simplified for illustrative purposes.
Bankruptcy counseling, like a symphonic world premiere, may be new and unfamiliar but need not be feared. But a pre-bankruptcy workout isn’t for everyone. If there’s no realistic prospect of a viable business or your idea of fundraising is a bake sale, it likely makes more sense just to fold your cards and walk away from the table. To paraphrase Jackie Mason, you probably can’t afford to go bankrupt. Or your creditors may call your bluff and force you into bankruptcy proceedings. But your attorney should be able to tell if potentially playing the bankruptcy card is for you.