Available Cash: Crucial Element for Reorganizing a Family Business in Chapter 11

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By: Donald L Swanson

Cash in a business is like blood in a body: without it, you die!

A Huge Challenge

Cash availability is a huge challenge for family businesses in bankruptcy. Here’s why:

  • Running out of cash is a common symptom of financial stress that leads to bankruptcy; and
  • A bankruptcy filing will magnify that stress by making creditors, vendors and customers nervous.

And there are no easy solutions.

A Business Issue

Cash availability is a business issue. It’s not a legal issue:

  • A debtor’s attorney is responsible for legal matters, like seeking court authority for DIP financing and/or use of cash collateral; but
  • It is the debtor who must assure that cash is available.

A debtor’s cash needs during a Chapter 11 case are reduced: debtor gets a respite from pre-petition debt service.  But the cash needs are still significant: debtor still needs enough cash to keep the lights on and the business operating, and suppliers will often demand cash up front.

The Cash Problem

If and when the debtor runs out of cash, however, the reorganization effort is over: all that remains is liquidation.

A 1980s Example

An example of the cash problem is found in Chapter 11 farm cases of the 1980s.

Back in the 1970s, farming could produce a livelihood for small operators. So, there were lots of career farmers. And farming was a good life. Granted, farmers worked hard and lived at the mercy of the elements. And very few got rich: capital requirements were heavy and margins skinny.  But farmers were able to make ends meet, back then.

That all changed in the 1980s. Prices for farm products plunged to terrible lows, and values of farm land and equipment followed suit, while interest rates jumped to 18% per annum. Many farmers could not survive, and many of those turned to Chapter 11 for relief.

Unfortunately, Chapter 11 failed farmers: they could not confirm a plan allowing them to stay in business. Chapter 11’s absolute priority rule became the culprit—that’s why Congress enacted Chapter 12 for small farmers.

So . . . what happened to the vast majority of Chapter 11 farm cases, back then?  It’s this:

–debtors continued operating inside Chapter 11 until they ran out of cash—and then they had no choice but to liquidate.

A Hard-Knocks Rule

So, here’s a lesson learned the hard way from back in the 1980s:

—As long as debtor has enough cash to keep the lights on and the business running, hope for a reorganization exists. But once the cash runs out . . . all hope is gone.

Conclusion

Available cash is a most-crucial element for reorganizing in Chapter 11. For businesses facing the prospect of a Chapter 11 filing, this is a primary issue they must confront.

And it’s a business issue, not a legal one.

** If you find this article of value, please feel free to share. If you’d like to discuss, let me know.

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