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Alternatives to Bankruptcy: What Should Business Owners Know?

Bennet G. Young
Jeffer Mangels Butler & Mitchell LLP

The coronavirus pandemic has upended many sectors of the economy in unprecedented ways. Supply chains are disrupted. Businesses that rely on face to face interaction with their customers such as retailers and restaurants, are subject to financial distress. In turn, companies that supply products to businesses impacted by COVID-19 may also experience pressure as their customers delay or cancel purchases or are unable to pay their bills.

These stresses are likely to cause some owners of distressed businesses to explore their legal options. Bankruptcy is only one alternative for a struggling company Two other options are an assignment for the benefit of creditors (ABC) and a voluntary workout. These strategies are available to address a failing company; which can be faster and equally or more effective, at a lower cost, without the publicity of a bankruptcy filing. Business owners should be aware of these non-bankruptcy options and the circumstances in which they can be useful. 

Any discussion of bankruptcy alternatives must start with bankruptcy. Bankruptcy is the most widely known insolvency proceeding and, as the usual course taken by a failing company, forms the baseline. Any alternative should be compared to the likely outcome of a bankruptcy case. The business owner then can balance the bankruptcy and non-bankruptcy alternatives available to him or her to choose a strategy that is the best fit. 

One useful alternative to bankruptcy is an assignment for the benefit of creditors. This procedure, commonly known as an ABC, is a recognized state law procedure to sell the assets of a failing business while shielding the purchaser from liability for the old company’s debts. Usually, a distressed company is running out of cash and has limited runway to sell itself; an ABC provides a non-bankruptcy method to effectuate a prompt sale of the business. 

In an ABC, the company, called the assignor, transfers its assets to a third party, called the assignee, that typically is selected by the company. In legal terms an ABC is a trust in which the assignor transfers title to its assets to the assignee in trust for its creditors. The assignee is a fiduciary tasked with selling the assets and paying the proceeds pro rata to creditors. The assignee must give notice to creditors of the assignment and of the deadline to file claims and creditors can file claims with the assignee.

In California, no court filing is required to commence an ABC. This lowers the publicity dramatically. The proceeding is not secret or confidential, but it is not public in the way that filing a bankruptcy case is. Instead, an ABC is a matter of contract between the distressed company and the proposed assignee. The company’s board and shareholders must approve the ABC. 

The process is fast and flexible. Because the company picks the assignee, an ABC lends itself well to pre-packaging. A distressed company seeking a prompt sale, a potential buyer of the business, and the proposed assignee can negotiate a sale in advance of the ABC occurring on the understanding that the sale will be completed through the ABC. All parties know what to expect and the process can proceed on the parties’ schedule, with no delays imposed by court processes or availability. This enables a sale of a distressed business as a going concern to take place quickly with little uncertainty and minimal disruption to operations. 

Used in this manner, an ABC is a viable alternative to a sale of the business in a bankruptcy chapter 11 case. The speed and flexibility of the ABC process are its chief virtues. Since there is no court the process is usually less expensive than a chapter 11 bankruptcy case and the sale can often be completed more quickly than would occur in a chapter 11. The process provides an efficient method to sell a small to medium size failing company on a going concern basis. 

The ABC process is not without its downsides. A distressed business must weigh these downsides against the speed, flexibility and lower transaction costs of the ABC process. The most important is that the purchaser will not get a court order validating its purchase as it would in a bankruptcy. The purchaser must rely on the integrity of the process to shield it from the distressed company’s creditors. Furthermore, there is no automatic stay to restrain foreclosure as there would be in a bankruptcy case, so the cooperation of the assignor’s secured lenders is essential. Unlike in a bankruptcy case, there is no power to assign leases or contracts without consent. This can cause complications if the company’s contractual relationships are a major asset. Finally, by handing the company to the assignee, the business owner will lose control. This is not necessarily a negative, as it enables the business owner to move on to new opportunities. 

Another useful option is for the distressed company to attempt a voluntary workout with its creditors. This is not a formal process. Instead, a workout is a matter of negotiation between the distressed company and its creditors. The usual concept is to engage in a process that is substantially similar to what would occur in a chapter 11 bankruptcy case by agreement of the parties, without filing a bankruptcy case and without incurring the large legal fees or impact on the business that will result if a bankruptcy case is actually commenced. Chapter 11 thus forms the backdrop for the negotiations. 

Typically, in a voluntary workout the debtor will invite its creditors to a meeting. At the meeting, the debtor will make a presentation to the creditors in attendance regarding its financial condition, how it got there, and what the debtor intends to do to extricate itself from its predicament. The debtor will request that the creditors agree to a moratorium on collection action, similar to the automatic stay in a bankruptcy case, and that the creditors appoint a committee of creditors to negotiate a workout plan with the debtor. In return, the debtor will usually offer to be completely transparent with its creditors, to provide information regarding the business, and to refrain from engaging in any out of the ordinary course transactions. This creates a structure that mirrors what would occur in a chapter 11 case.

The goal of the process is for the debtor and the appointed committee to negotiate a repayment plan on behalf of all creditors. The plan can take whatever form the parties negotiate. Often the plan will consist of the debtor’s agreement to pay a percentage or even all of its profits or positive cash flow to its creditors over a period of time in exchange for the creditors agreeing to discount their debts in some amount. Another common structure is for the creditors to agree to a discount in return for an immediate cash payment funded by new capital contributed by a new investor. 

Once the debtor and committee have negotiated a plan, the plan is circulated to creditors to accept or reject it. Participation is voluntary. Only creditors that accept the plan are bound, so the debtor generally will insist that a high percentage of creditors accept the plan in order for it to go into effect. If a sufficient number of creditors accept the plan, it will go into effect. If the required majority do not accept, the debtor likely will end up in a chapter 11 case. The plan thus needs to provide a result that is at least as good, if not better, than the result would be in a chapter 11 case.

The voluntary workout thus can be a viable alternative to a chapter 11 case. The benefits of the process are its flexibility and reduced legal fees which can mean more funds available for creditors. A workout often is faster than a chapter 11 case, there is no public filing and therefore less publicity, and the business owner remains in control. On the other hand, a workout depends upon cooperation between the debtor and its creditors. If that cooperation is absent because creditors do not trust the debtor or for other reasons, a voluntary workout might not be possible. The process also depends upon creditors cooperating with one another and accepting equal treatment. There is no automatic stay, so creditors are free to pursue collection actions and to attempt to jump to the head of the line. If some creditors pursue collection actions and seek to improve their position relative to other creditors, the process can break down. Finally, creditor participation in a plan is voluntary. There is no way to bind creditors that reject the plan. Holdouts thus can create major hurdles.

The selection of the non-bankruptcy alternative depends upon the result the business owner desires to achieve. If the goal is to sell the business as a going concern, an ABC is a useful tool. Usually a distressed company is running out of cash and has limited runway to sell itself, and the ABC provides a non-bankruptcy method to effectuate a prompt sale. On the other hand, if the business owner’s objective is to retain his or her stake in the enterprise and to negotiate a payment plan with creditors globally, a voluntary workout can be a less costly way to achieve this goal.

Bankruptcy is not a one size fits all solution. There are other routes available to a distressed business which can be just as effective at a far lower cost. Owners of troubled companies should be aware of these options and should evaluate whether one of them might provide a better fit.

Bennett G. Young is a partner at the law firm of Jeffer Mangels Butler & Mitchell LLP. He represents parties in insolvency matters and has extensive experience in workouts, restructurings, bankruptcies, and assignments for the benefit of creditors. Ben is a member of the Bench-Bar Liaison Committee for the United States Bankruptcy Court for the Northern District of California and is a former Chair of the California State Bar’s Insolvency Law Committee, a past president of the Northern California Chapter of the Turnaround Management Association, and has been a member of the Board of Directors of the Bay Area Bankruptcy Forum. He is recognized by Best Lawyers in America® in the area of bankruptcy. Contact Ben Young at BYoung@jmbm.com

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You’ve Received an SBA Paycheck Protection Loan: Now What?

Written by Jeffrey Markarian, CPA: Dedekian, George, Small & Markarian

COVID-19 has had a devastating effect on the American economy, and agriculture has been especially hard hit.  To help provide economic relief, various federal legislation has been enacted, including the Coronavirus Aid, Relief and Economic Security (CARES) Act.  As part of the CARES Act, the Small Business Administration (SBA) received funding and authority to establish the “Paycheck Protection Program” (PPP).  The PPP is a forgivable loan program that was established as an incentive for small businesses to keep their workers on payroll during this financially difficult time.  As of June 5, 2020, the SBA had received total funding from Congress in the amount of $659 billion, and had approved 4,525,081 loans totaling approximately $511 billion.   

If you are one of the many small business owners in the agricultural industry that has received a forgivable PPP loan, you must apply for forgiveness of your PPP loan by submitting an SBA “Loan Forgiveness Application” to the lender servicing your PPP loan, as the loan is not automatically forgiven.  As a result, it is imperative that you plan now to maximize the forgiveness of your loan.  

The SBA has continued to provide additional guidance throughout the PPP in response to ongoing requests for assistance and clarity.  Also, on June 5, 2020, the Paycheck Protection Program Flexibility Act (PPPFA) was enacted, which provides PPP loan recipients with increased flexibility in utilizing PPP loan proceeds.  Most significantly, The PPPFA has extended the period to use funds from eight weeks after the date of receipt of loan proceeds to twenty-four weeks.  Borrowers receiving PPP loan proceeds prior to June 5, 2020, retain the option to use an eight-week covered period if desired.  Please note that all of the following information includes the changes resulting from the PPPFA.

The original intention of the PPP was to keep employees paid for the eight-week period beginning with the date loan proceeds are received.  As mentioned above, recent legislation has extended this to a twenty-four-week period.  Expenses to be paid with loan proceeds include payroll costs and specific non-payroll costs. 

Payroll costs include the following:

  • Salary, wages, commissions, or tips (limited to $15,384.62 per employee for the covered period)
  • Employee benefits (including payments for vacation, parental, family, medical, or sick leave; allowance for dismissal or severance pay; group health care benefits; payment of retirement benefits; and state and local taxes assessed on compensation)

Non-payroll costs include the following:

  • Interest on mortgage incurred before February 15, 2020
  • Rent on lease agreement in force before February 15, 2020
  • Utilities (including electricity, gas, water, transportation, telephone or internet) for which service began before February 15, 2020

To be eligible for full loan forgiveness, at least 60% of the loan must be used for payroll costs and not more than 40% for allowable non-payroll costs.  If less than 60% of the loan is used for payroll costs, the borrower is still eligible for partial loan forgiveness.  The first iteration of the PPP required 75% of the funds to be used for payroll or only part of the loan would be forgiven, but the PPPFA decreased the required percentage.  

What happens if your PPP loan is not forgiven?  Any portion of your PPP loan that is not forgiven will be required to be paid back over a 2-year period at 1% interest, with payments deferred for ten months from the date of the PPP loan disbursement.  However, for PPP loans approved by the SBA on or after June 5, 2020, the PPP loan maturity is increased to 5-years.

Dynamic Coatings Inc.
Industrial and Commercial Flooring Solutions

On May 15, the SBA released its long-awaited PPP forgiveness form and instructions for borrowers to apply for forgiveness (please note that a modified forgiveness form is pending as a result of the PPPFA).   The form also provides detailed information related to the documentation required to be provided with your loan forgiveness application. It is important to review the documentation requirements; as extensive documentation may be required to be submitted depending upon your eligible expenses submitted for forgiveness.  Although the release of the form by the SBA brought with it significant changes to the interpretation of some components of forgiveness that were not previously known, additional guidance and clarity is still needed on some of the components of forgiveness.  Changes were made to the following components of the program based on the release of the form:

Covered payroll periods – Under original guidance, the covered payroll period began immediately after loan disbursement and lasted eight weeks. The PPPFA has increased the covered payroll period to twenty-four weeks.  For those with payroll schedules that did not align with the disbursement and covered period, this generated many questions and concerns. However, this latest guidance indicates that the eight-week period may begin starting with the borrower’s first payroll following disbursement, not necessarily on the day of disbursement. This alternative period only covers payroll costs, not other allowable expenses, although adjustments do exist for other allowable expenses.

Incurred and/or paid expenses – The CARES Act originally indicated that, for costs to be covered under PPP, they would need to be incurred and paid during the eight-week period (increased to twenty-four weeks by the PPPFA). The latest guidance, however, forgives costs that are incurred, but not paid, as long as they are paid on or before regular billing date. This expansion applies to costs such as mortgage interest, rent, utilities, and payroll incurred during the loan period. Payroll costs incurred during the last payroll period but not paid during the covered or alternative periods (mentioned above) may be forgiven if those payroll costs are paid on or before the next regular payroll date. 

Full-time equivalent (FTE) employee counts and wages – The guidance also included several clarifications to the FTE employee count and wage calculations necessary for forgiveness including:

  • FTE calculation can be rounded to the nearest tenth – The formula to calculate an FTE is average number of hours paid per week per employee/40, rounded to nearest tenth (differs from Affordable Care Act calculation).
  • Wage reductions must be analyzed on a per employee annualized basis – Salary or hourly calculations should be done on an average annualized basis compared to period of Jan. 1, 2020, to March 31, 2020. If the average for the twenty-four week period is 25% less than first quarter of 2020, loan forgiveness will be reduced, unless the reduction is restored at equal to or greater levels by December 31, 2020, then forgiveness will not be reduced.
  • Safe harbor exists for borrowers who rehire lost employees by December 31, 2020, at the same level as of Feb. 15, 2020. Forgiveness will not be reduced. 
  • Safe harbor exists for borrowers who made good faith written offer to rehire employees who then refused. Forgiveness will not be reduced.
  • Safe harbor exists for borrowers who fired employees for cause, voluntarily resigned, or voluntarily requested and received reduction in hours. Forgiveness will not be reduced.

Here is a quick rundown of the changes made by the PPP Flexibility Act.

CriteriaPrior GuidanceCurrent Guidance
Covered Period*8 weeks from PPP loan disbursementThe earlier of 24 weeks from date of loan disbursement or Dec. 31, 2020
Usage of FundsMinimum of 75% of funds must be used for payroll to with a maximum of 25% for non-payroll costs to achieve forgivenessMinimum of 60% of funds must be used for payroll with a maximum of 40% used for non-payroll costs to achieve forgiveness. If 60% of loans are not used for payroll, forgiveness is calculated on a sliding scale.
Extension of Safe Harbor for Compensation & FTE ReductionsSalary or hourly wage reductions must be reinstated by June 30, 2020, to avoid reduced forgivenessSalary or hourly wage reductions have until Dec. 31, 2020, to be restored to avoid reduced forgiveness
Deferral of Loan Payments6 months from loan origination dateEarlier of 10 months after the last day of Covered Period or when SBA remits the loan forgiveness funds to lender
Loan Maturity2 yearsLoans originated after June 5, 20205 yearsLoans originated prior to June 5, 2020 – Borrowers and lenders may mutually agree to extend the maturity date of loans to 5 years
Safe Harbors Based on Employee Availability, Rehiring, New HiresNoneForgiveness would not be reduced if borrowers can document in good faith:-Inability to rehire individuals employed on Feb. 15, 2020-Inability to hire similarly qualified employees by Dec. 31, 2020
Safe Harbors Based on Employee Availability in Compliance with HHS, CDC, or OSHA guidelinesNoneForgiveness would not be reduced if borrowers can document in good faith the inability to return to same level of business activity as before Feb. 15, 2020, due to compliance with requirements issued by HHS, CDC, OSHA from the period of March 1, 2020, to Dec. 31, 2020

Also of note:

  • *Borrowers may elect to stick with the 8-week covered period for loans originating prior to June 5, 2020. However, it is not clear if the June 30, 2020, safe harbor deadline still applies.
  • The amount of any Economic Injury Disaster Loan (EIDL) refinanced will be factored in when determining the percentage of proceeds for payroll costs.
  • It is unclear whether compensation limits formerly prorated based on 8 weeks now prorated based on 24 weeks.
  • It is unclear if the covered period may end prior to 24 weeks if funds have been used.

Further rules and guidance are expected to be issued from the SBA, including a modified borrower application form, and a modified loan forgiveness application that will included the changes resulting from the recently enacted PPPFA; however, please do not hesitate to contact us for further assistance with your PPP loan questions and help maximizing your loan forgiveness.  

Dedekian, George, Small & Markarian Accountancy Corporation
8080 North Palm Avenue, Suite 201
Fresno, California 93711-5797
P: 559.431.5500 
Cpaplus.com

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