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Chapter 11 debtor’s financial information
What is the best way to present an Chapter 11 debtor’s financial information be presented to bankruptcy courts to give the best impression? In order to provide the court with an accurate representation of the effects of operations in Chapter 11 and to ensure that the debtor has enough time to meet his objectives?
The pandemic has led to severe revenue reductions for many companies. The returning to normal has begun however, in many industries the business environment has not reached pre-pandemic levels.
For certain companies this was the tipping point which is why filing bankruptcy guide on Chapter 11 may now be needed to facilitate an orderly liquidation process of the assets of the debtor. For other companies with solid foundations, the debtor might require Chapter 11 relief. Why? Even though they’re run well or producing products that continue to be sought-after or investing enough in their business (or the three) certain companies do not have the capital to stand up. Long to the storm.
In the end, when rates of interest increase for over-leveraged businesses especially those that have survived solely by relying on Paycheck Protection Program funds, will have to think about the possibility of restructuring debt, whether in or out of the courtroom.
Bankruptcy cases
In the beginning of bankruptcy proceedings everyone involved particularly the bankruptcy judge to know the reason for this bankruptcy case. Did the debtor submit his petition because he produces a defunct product such as Polaroid cameras and his business has been declining steadily? Did the debtor file for bankruptcy after he was hit with an unfavorable ruling? Was the bank’s deposit a result of excessive leverage that was incurred in an earlier acquisition? Perhaps it is because the business is operating in an industry which has grown to be too big?
The responses to these questions will affect the judge’s initial impressions of the matter and maybe, as follows: (1) whether he or she approves urgent assistance requests (such as the sale in bulk of debtor’s assets) (2) the length of time the debtor is required to issue an reorganization plan, and (3) whether or not the judge allows a secured lender to exercise the authority to take possession of collateral.
In some instances Rome may appear to be in flames unless you dig deeper. Judges don’t want to delay liquidation of a debtor and cause job loss when they believe that the odds are in favor of the reorganization to be successful. However when the reorganization seems difficult and the debtor has a substantial cash loss that the judge will not want to delay liquidation.
Cash flows
In the case that fall under Chapter 11, this is generally cash flow. The cash flows must be reported every month in accordance with the United States Trustee, the administrator of bankruptcy within the Department of Justice. In general, an income statement will not be required (but as explained below, the best option is to file a 3 column income statement regardless). The lenders are more concerned with whether the borrower is burning funds. If they’re burning money the lenders are worried that they might need to pump more capital, something they prefer not to do. A depletion of liquidity can also be an indication that the borrower’s main business has not stabilized.
Although the court might need the submission of a monthly cash flow report it is best to provide to the judge a cash flow report that includes and does not include (1) those items that are related to Chapter 11 (such as professional fees and one-off financing expenses) which would not be incurred in any other context than Chapter 11 and (2) non-recurring items that aren’t related in ongoing activities (such like lease payment getting rejected or the severance payment that is included in the reduction of personnel). This is due to Chapter 11 expenses and non-recurring items may either overestimate negative cash flows or limit positive cash flows.
Chapter 11 case
In the beginning of the Chapter 11 case, the major question is whether current financial performance of the debtor can be an accurate reflection of how the debtor is likely to conduct themselves when they enter Chapter 11. Everyone wants to sort out their finances and reduce their expenses, and negotiate with creditors, and show that it’s a viable option. It is unfortunate that very only a few people file bankruptcy and immediately see the pendulum shift towards profit.
They often recognize what must be done, but they need time to put in place the solutions. It will take time before the solutions are visible in the financial statements of the debtor. The debtor might require some more time “burn off” the cost of certain expenses that aren’t recurring, but can result in a negative effect on financial results. In the end, the debtor requires time for a shaky market to resume normal in certain situations.
The financial report to the court should be presented in three columns. The financial results on their own could present a false image before an bankruptcy judge. Instead the judge should be presented with three columns of information. The first column is a representation of real results. The second column contains the list of adjustments that are required to restore actual financial results in order to remove the impact of unusual items. The third column contains the financial results after being restated which show what the actual results would have been without the extraneous items.
Every item in column 2 should be explained to allow the court to decide if it is appropriate to change the part of column 3. This process must also be used for the cash flow statements as well as the statement of income (although the income statement is typically not a part of the US trustee’s reporting obligations for the month of each month). The goal is to allow the court to determine how the principal business of the debtor is operating in the absence of the issues that led him to bankruptcy.
Failure to allow the bankruptcy judge the opportunity to examine (1) the debtor’s conduct in ongoing transactions prior to the bankruptcy would have been in absence of any extraordinary events, as well as (2) what the “normalized” results of the bankruptcy. The bankruptcy process can decrease the likelihood that you will have Chapter 11 success. It is essential that the financial advisor of the debtor clearly explains the fundamentals of the adjustments. Without these the court will see an inaccurate image.
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