While many lenders are familiar with dealing with troubled loans once they are in bankruptcy, there are a variety of non-bankruptcy alternatives that a lender should be aware of as part of its loan enforcement toolbox. Depending upon the circumstances, bankruptcy alternatives can provide a lower-cost alternative to formal bankruptcy proceedings with greater control, flexibility and speed. This article highlights three common types of bankruptcy alternatives.

Forbearance and Composition Agreements

When faced with a loan default, one of the first options a lender should consider is a forbearance agreement. A forbearance agreement is an agreement between a lender and the borrower that delays loan enforcement, subject to certain conditions being satisfied. Common terms in forbearance agreements include ratification of the debt, release of claims, a collateral liquidation plan, payment schedules, performance benchmarks and tolling provisions. A well-drafted forbearance agreement establishes the new rules of the road for the relationship and provides both the borrower and lender some sense of certainty as they attempt to navigate a troubled loan. Forbearance agreements are going to be most common between borrowers and secured lenders, especially where the borrower needs the lender’s collateral to operate its business.

A composition agreement is similar to a forbearance agreement but generally involves an agreement between several of the borrower’s unsecured creditors. The borrower will make a proposal to its creditor body asking that, in exchange for accepting a one-time payment or a series of payments, the creditor will accept less than the total amount due to it. Such a proposal should be accompanied by financial disclosures such that the creditor can evaluate whether the proposal makes economic sense versus a more aggressive debt enforcement strategy such as receivership or involuntary bankruptcy. Composition agreements generally involve a borrower’s unsecured creditors and treat such creditors in a similar fashion.

Composition agreements work best when the borrower has a small and known creditor pool. The benefit of a composition agreement is that it may ultimately maximize the amount a creditor receives because the distribution pool will not be burdened with the same administrative overhead of a more formal insolvency proceeding. At the same time, the creditor will also not incur the same loan enforcement costs in terms of both money and time.

Receivership

A receivership is either a state or federal proceeding where a third-party neutral, i.e. a “receiver,” is appointed by a court to oversee the preservation, operation and/or liquidation of specific assets or an entire going concern operation. In 2016, Missouri enacted the Missouri Commercial Receivership Act (MCRA), which is a comprehensive statute related to commercial receiverships. MCRA covers a wide range of receivership topics including the qualifications of the receiver, the liquidation of property and the handling of claims.

The complexity of a receivership can vary in degree as can the specific powers and duties of a receiver. While most states, like Missouri, and the federal rules have some provision for receivership, the controlling document will generally be the receivership order. In a lender-sponsored receivership, the lender will want to make sure certain provisions are contained within the receivership order including consent and notice rights, reporting obligations, debt repayment and how the receiver and its professionals will be compensated.

A receivership can be an effective way for a lender to gain a measure of control over its collateral, especially when dealing with a troubled or fraudulent borrower. This is especially true for those lenders who cannot invoke the involuntary provisions of the Bankruptcy Code. As a caveat, however, the lender should recognize that a receiver acts as an arm of the appointing court and not as an agent of the lender. Thus, while in many cases, their interests will be aligned, a lender should recognize the receiver’s independence. Further, while in many cases the costs of the receivership can be paid for from receivership assets, the sponsoring lender should be prepared to back-stop any operating deficiencies, including fees and expenses, of the receivership.

Assignment for the Benefit of Creditors

An Assignment for the Benefit of Creditors (ABC) is a process where the borrower’s assets are transferred to a third-party neutral known as an “assignee.” The assignee then carries out the liquidation of the assets and administers a claims process. It is very similar to a Chapter 7 bankruptcy but without the same formal structure and oversight. An ABC is a creature of state law and the amount of court oversight and regulation varies from state to state. Missouri has both statutory and common law ABCs. Common law ABCs have little to no court oversight.

Whether statutory or common law, the operative document in an ABC is the assignment agreement. The assignment will often times specify the various duties of the assignee. Additionally, an ABC does not necessarily prevent litigation going forward against the assigning entity and can serve as a basis for an involuntary bankruptcy. To the extent collateral is involved, the assignee will often work with the lender, including getting the use of cash collateral. One of the primary benefits of an ABC is that it allows for a more flexible liquidation of assets that may not be possible in a bankruptcy or receivership liquidation.

Conclusion

While not all of the bankruptcy alternatives will be a good fit for a particular situation, the lender should consider its options and balance the various benefits and risks of each for a particular situation. Indeed, bankruptcy proceedings may still remain the best option. A lender, however, should not rule out a bankruptcy alternative as it may provide a speedier and less costly solution to a troubled situation.