Wielding the Bankruptcy Code: When and How to Renegotiate Debt with Your Demanding Creditors
BY: Joseph Wenzel
The Bankruptcy Code provides numerous protections for debtors facing ravenous creditors who seek to take their bite of the estate. A court “stays” (or pauses) the creditor’s abilities to seek repayment or exercise their liens on the debtor. The court can “cramdown” creditors under certain conditions, forcing them to take unfavorable repayment terms. However, bankruptcy can be an extraordinary expensive process for large debtors, racking up thousands in both legal and court fees. Additionally, a commercial debtor must give up some of their rights to freely run their business.
So how can an ailing debtor get the protections of the Bankruptcy Code while avoiding the associated expenses? This is the magic of the flexible, pre-bankruptcy “Workout Agreement.” Both the debtor and creditors share the aim of avoiding bankruptcy, often creating a substantial negotiating range where parties can cooperate to restructure the debt.
Ultimately, the creditor has a huge amount of leverage in that the debtor is contractually obligated to pay their debt according to the original terms until they strike a deal. However, the debtor has a variety of incentives to improve their bargaining power. The debtor can offer to waive the automatic stay in the case of bankruptcy, enter into restrictive covenants, or negotiate alternative financing options like debt for equity or convertible notes.
If a debtor wishes to negotiate more offensively, they can threaten to file bankruptcy. This will be especially dangerous for creditors who have recently received payments from the debtor, as they will risk being unwound, or “avoided” as preferences. Thus, there may exist a specific window for debtors to renegotiate their debt after paying their creditors. Loss aversion bias could exacerbate this effect, as creditors may fear losing money they already have in their possession, especially if they’ve made purchases or subsequent loans in reliance on that money.
Alternatively, a debtor can likely immunize payments to their preferred creditors from avoidance actions. Payments can easily be structured to intentionally fit in to one of the many exceptions to preference actions. Thus, even if an independent trustee is appointed to manage the debtor’s bankruptcy, they would be unlikely to reclaim those funds that would have otherwise been apportioned to other creditors based on priority. This is an enticing tool for debtors to use to curry favor with creditors they would like to maintain a long-term relationship with. A creditor may be willing to offer to renegotiate the debt in order to secure their recent payments from potential avoidance in bankruptcy.
Sources & Further Reading:
11 USC 362
11 USC 1129(7)(A)
11 USC 549
Mark Henricks & Mitch Strohm, Chapter 11 Bankruptcy: What You Need To Know, Forbes (Feb. 18, 2022, 7:00am), https://www.forbes.com/advisor/debt-relief/chapter-11-bankruptcy/
AccountingTools, Workout Arrangemetn Definition, (Sep. 21, 2023), https://www.accountingtools.com/articles/workout-arrangement
In re Darrell Creek Assocs., L.P., 187 B.R. 908, 910 (Bankr. D.S.C. 1995)
Kathleen P. March & Janet A. Shapiro, Prebankruptcy Creditor Actions and Strategies, Cal. Prac. Guide Bankruptcy Ch. 3-A 1
David A. Skeel, Jr., The Empty Idea of “Equality of Creditors”, 166 U. Pa. L. Rev. 699 (2018)