In this short article, learn about business debt relief under UCC Article 9, and how it works to preserve small and medium sized businesses as an alternative to bankruptcy.
Article 9, of the Uniform Commercial Code (UCC), offers relief to US businesses – to eliminate unsupportable debt, to preserve operations and jobs, and to avoid bankruptcy when it is unlikely to save the business.
Traditionally, distressed businesses have turned to the bankruptcy system when unable to meet creditor obligations. If the goal is to give a business a second chance to emerge and continue, this typically takes the form of a Chapter 11 reorganization. Under Chapter 11, a business submits a plan which must demonstrate its ability to repay debts in full, over a 5 year period. The widely understood problem is that bankruptcy is better suited to large enterprises with the financial ability to withstand the considerable expenses and time involved. For small and medium-sized businesses, the prospects are daunting, demonstrated by the failure of almost 90% of those businesses to complete a successful plan.
While large companies, such as major airlines or retailers often succeed through Chapter 11 plans, the vast majority of smaller companies end up converted to Chapter 7 liquidations; ending the business and leaving owners with more financial burden than they began with. This is because smaller businesses are not well positioned to operate in financial distress over a lengthy period of time or to absorb the significant costs and associated legal challenges that inevitably arise amongst the parties.
Given the failure rate of bankruptcy to offer a second chance in the form of debt relief to small and medium-sized businesses (SMBs), “out of court” solutions have been a key topic among turnaround professionals and consultants in recent years.
In this context, Article 9 business debt relief emerged to fill the void and to achieve the goal of business preservation. Recently, there has been growing awareness of Article 9 among business owners after it was recently featured by Bloomberg Businessweek in August of 2020.
The Uniform Commercial Code (UCC) consists of a standardized set of business laws that regulate commercial business transactions and financial contracts, adopted by all 50 states. Article 9 of the UCC offers a streamlined, out-of-court option for a business in distress – to fully resolve all liabilities, to preserve the business, and to completely avoid the courtroom and legal entanglements.
Under Article 9, an insolvent business, along with its senior lender (bank), can cooperate in a strategic reorganization of the business. What does that mean? It means that together, the business owner and the bank can cooperate in the transfer of the assets and business operation into a new legal business entity with a clean balance sheet while leaving all debt behind in the original, insolvent entity.
The reason this makes sense for the bank and all secured creditors must be understood in light of the alternatives.
If a business fails under the weight of unsupportable debt, liquidation is generally what follows. When a bank liquidates a business, it recovers pennies on the dollar for used business equipment at auction. Beyond that, it needs to incur legal fees and auctioneering expenses to do so. And, with very few exceptions, there is nothing left over for junior creditors who are left with personal guaranties, which have very little value if their guarantor is insolvent personally.
In that context, removing debt from the business benefits not only the owner and the business, but creditors as well. By giving the business a second chance in the form of debt relief and allowing it to return to profitability, the previously distressed owner can continue to earn and grow the business. This means they can afford to reasonably settle personal guaranties on loans removed from the business – in excess of the pennies creditors would have received otherwise.
For a struggling business, a true second chance benefits all parties, including creditors. This was the very reason for the development of the bankruptcy code. However, given bankruptcy’s failure rate for all but the largest companies, a better option for small and medium-sized businesses was required that could avoid the pitfalls and risks of the legal arena.
Ultimately, UCC Article 9 offers an expedient, out-of-court and cooperative solution, that gives a business a clean balance sheet and the debt relief they truly need. Because failure and liquidation benefit no one.