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Business Reorganization

What Is Reorganization?

Reorganization is a process designed to revive a financially troubled or bankrupt firm. A reorganization involves the restatement of assets and liabilities, as well as holding talks with creditors to make arrangements for maintaining repayments. Reorganization is an attempt to extend the life of a company facing bankruptcy through special arrangements and restructuring to minimize the possibility of past situations reoccurring. Generally, a reorganization marks the change in a company’s tax structure.

Reorganization can also mean a change in the structure or ownership of a company through a merger or consolidation, spinoff acquisition, transfer, recapitalization, or change in identity or management structure. Such an endeavor is also known as “restructuring.”

Breaking Down Reorganization

The first type of reorganization is supervised by the court and focuses on restructuring a company’s finances after a bankruptcy. During this time, a company is protected from claims by creditors. Once the bankruptcy court approves a reorganization plan, the company will repay creditors to the best of its ability, as well as restructure its finances, operations, management and whatever else is deemed necessary to revive it.

U.S. bankruptcy law gives public companies an option for reorganizing rather than liquidating. Through Chapter 11 bankruptcy, firms can renegotiate their debt with their creditors to try to get better terms. The business continues operating and works toward repaying its debts. It is considered a drastic step, and the process is complex and expensive. Firms that have no hope of reorganization must go through Chapter 7 bankruptcy, also called “liquidation bankruptcy.”

Who Loses During Reorganization?

A reorganization is typically bad for shareholders and creditors, who may lose a significant part or all of their investment. If the company emerges successfully from the reorganization, it may issue new shares, which will wipe out the previous shareholders. If the reorganization is unsuccessful, the company will liquidate and sell off any remaining assets. Shareholders will be last in line to receive any proceeds and will usually receive nothing unless money is left over after paying creditors, senior lenders, bondholders, and preferred stock shareholders.

Structural Reorganization

The second type of reorganization is more likely to be good news for shareholders in that it is expected to improve the company’s performance. To be successful, the reorganization must improve a company’s decision-making capabilities and execution. This type of reorganization can take place after a company gets a new CEO.

In some cases, the second type of reorganization is a precursor to the first type. If the company’s attempt at reorganizing through something like a merger is unsuccessful, it might next try to reorganize through Chapter 11 bankruptcy.

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Three keys to a good business reorganization

The typical reorg evokes fear, stress and suspicion — and kills productivity. Here’s how to change that.

If you have been in business or at a business for more than six months you are probably familiar with the all too frequent business reorganization. Businesses reorg when they are growing, they reorg when they are shrinking. They reorg when things are good and when they are bad. With all this reorging out there you would think that there would be a tried-and-true process for it. But you would be wrong.

The many company reorgs I have been through have been handled poorly. All but one, that is.

What made the exception so successful was that the leadership of the organization followed three simple principles. Your next business reorganization can be a positive experience too, if you follow these three principles — but I am going to warn you.

They aren’t easy to follow. None of them.

The three keys to a successful reorganization are:

  1. Transparency
  2. Speed
  3. Participation

Transparency

I remember one company I worked for that traditionally had a reorg first quarter of every year. People didn’t know who their new boss would be, what the logic behind the reorganization was or where they were going to be in the organization. Projects stopped because people didn’t know if they would be on the project come March, so why work on it. Stress was high. Everyone at this company just assumed that January and February would be an unproductive time.

Gossip needs secrecy to survive.

The antidote to this paralysis? Share everything you know in a business reorganization. (I told you this wouldn’t be easy.)

Transparency is typically scary for leaders. They have to share their vulnerability. They have to say, “We know these things … and we don’t know these things.”

It may be hard, it may feel uncomfortable, it may go against just about everything you believe about management. Do it anyway.

Gossip needs secrecy to survive. When people don’t know something and everyone thinks someone else has some tidbit of information, they gossip. When all the information that is to be known is out in the open, there is nothing to gossip about. Stress is reduced and people can focus on other things. When you start a reorganization, it’s imperative to tell everyone. Not a few people … everyone. Tell them why you are reorganizing, tell them what you plan to focus the reorganization around and what you are not going to focus on.

Early in the game you won’t know who is going where or what managers are doing what or anything. Tell everyone you don’t know. They want to know. If you have done a lot of reorgs the cloak-and-dagger way, they likely won’t believe that you are telling them everything the first time you tell them. You will need to reinforce it and reinforce it and reinforce it.

Be ready for the questions. Get used to answering, “I don’t know.” You will soon discover that it is freeing when you can say that and not feel like you have to cover up or pretend like you know everything. Initially you may think it will hurt your credibility, but it will actually have the opposite effect. People will respect you more when you admit what you know and don’t know.

The next thing you need to do is move swiftly.

Speed

There are two people in an organization who are important to every employee: the CEO and the employee’s direct manager. Of the two, the employee’s manager is the most important in a business reorganization, because reorgs often represent a change at the managerial level.

If word gets out — and it will get out — that a reorg is happening, people begin to worry about who their new boss is going to be. If an organization tries to keep it secret, people will talk around the water cooler or on Facebook, or on the internal chat utility. Productivity will go down, and stress will go up. All of which is bad for getting any work done at the office.

Transparency mitigates some of the disruption in the flow of work, but people are distracted during a reorg, so be quick about it. The faster you can get through the reorg the faster you can get back to productivity.

Simple in theory but, again, hard in practice.

Most reorgs I have seen take months and months. They don’t have to. A reorg is a serious effort that affects the lives of a lot of people. Some may argue that we need to take it seriously and take the time necessary to make good decisions.

Well, yes, this is serious business, but do the decisions need to take a lot of time?

The answer to this problem is principle No. 3: participation.

Participation

One of the things that slows down a reorg is that the decisions are all made by a small number of high-level people. It is believed that this is the best and in fact the only way to handle such important decisions. There are many decisions in a business reorg that need to be made by high levels in the organization, to be sure. Things like:

  • Why are we doing this reorg?
  • What should the overall structure look like?
  • What are we optimizing for in this reorg?
  • What are we not optimizing for in this reorg?
  • What does success look like in this reorg?
  • How will we measure success?
  • What is this worth to us as an organization?
  • Who are the key high-level (close to the top) people in the new structure?

But there are a plethora of other decisions that do not need to be made by these people that often end up getting made by them, taking up important time and slowing down the process. Decisions like:

  • Who will report to those key high-level people?
  • Who will report to the people who report to the key high-level people?
  • What will their roles be, by name, by person?
  • How will we maintain technical integrity?
  • What new governing bodies do we need?
  • How will this affect governance?
  • How will budgeting be impacted?

And a million other things. I am not saying that the top leadership abdicates responsibility for these decisions completely. But mostly. Many of them should be given over to task forces, and in a cascading ladder of responsibility. Just as the top leaders decided who should report to them, the next level should work out who reports to them, and so forth. The rest of the work should be assigned to taskforces that are formed of volunteer teams.

Now you may be thinking that these volunteer teams will take time away from people’s work, but remember that these people are already thinking about the reorg. When you give them something productive to do on the reorg you accomplish three things. First, they are given something important to do related to what they are already thinking about, so you make good use of that time. Second, you take some of the workload off the high-level leadership who are already overworked. Finally, and possibly most important, you are moving the decisions closer to the level of the organization which has the information necessary to make good decisions.

Not only does participation help the process go faster, by giving people a vital active role in the reorg you give them a reason to believe in the reorg. They have a hand in the decision-making process so they have a vested interest in it going well. Participation is not just nice to have, it is critical to the perception of success of the reorg.

As business grow, shrink, merge, or realign strategy, they will need to reorganize. Reorgs always take your team’s attention off the work that they need to be doing so take advantage of that. Tell them everything you know and everything you don’t know, move quickly and get them involved to make it go faster and to create engagement. If your organization will keep these three simple principles in mind — transparencyspeed and participation — you will greatly increase your likelihood of having a positive reorg. The concepts are simple, but they are not easy.

When you are getting ready for your next reorg, see if you can do it this way and tell me how it goes: joseph@whitewaterprojects.com.

About the author:
Joseph Flahiff is an internationally recognized leadership and organizational agility expert at 
Whitewater Projects Inc. He has worked with Fortune 50 and Fortune 500 companies, government agencies, startups and publicly traded firms, where he has been recognized as an experienced, pragmatic and innovative adviser. He is the author of Being Agile in a Waterfall World: A practical guide for complex organizations. Learn more at www.whitewaterprojects.com.

Next Steps

Previous management tips from Joseph Flahiff:

Destroying your way to organizational agility

Fire your managers! Practice supportive leadership

Three characteristics of great senior leadership teams

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7 Types of Corporate Reorganization

Corporations reorganize and restructure for various reasons and in numerous ways. The bottom line usually is, well, the bottom line. Companies reorganize to increase profits and improve efficiency. The reorganization of a company typically addresses the efficiency component in an attempt to increase profits. It’s not unusual for a corporation to reorganize on the heels of changes at the top. A new CEO often sees reorganization as a cure for a company’s ills, and companies sometimes hire a new leader based specifically on his vision for reorganization.

Possible Reorganization Reasons

Corporate reorganization normally occurs following new acquisitions, buyouts, takeovers, other forms of new ownership or the threat or filing of bankruptcy, according to the Thinking Managers website. The VC Experts website reports that reorganizations involve major changes in a corporation’s equity base, such as converting outstanding shares to common stock or a reverse split – combining a company’s outstanding shares into fewer shares. Reorganizations often occur when companies already have attempted new venture financing but failed to increase company value.

Type A: Mergers and Consolidations

Section 368 of the IRS Revenue Code identifies seven types of corporate reorganizations. As reported by Tax Almanac, the first recognized reorganization type is a statutory merger or acquisition. Mergers and consolidations are both based on the acquisition of a corporation’s assets by another company, according to the firm Greenstein, Rogoff, Olsen & Co., LLP.

Type B: Acquisition – Target Corporation Subsidiary

A Type B reorganization is the acquisition of one company’s stock by another corporation, with the acquired company becoming a subsidiary of the acquiring corporation. The acquisition plan must be carried out in a short time period, such as 12 months, and the acquisition has to be only one in a series of moves comprising a larger plan to acquire control. The transaction also must be made solely for the purpose of acquiring voting stock.

Type C: Acquisition – Target Corporation Liquidation

Unless the IRS waives the requirement, a targeted corporation must liquidate as a condition of a Type C acquisition plan, and target-corporation shareholders become shareholders in the acquiring company. Reorganization provisions dictate tax consequences, not liquidation rules contained in Tax Code Sections 336 and 337.

Type D: Transfers, Spinoffs and Split-Offs

Type D transfers are classified as acquisitive D reorganizations or divisive D restructurings, which include spinoffs and split-offs. For example, if Corporation A contains the assets of former Corporation B and of Corporation A, Corporation B goes out of business, and former Corporation B shareholders control Corporation A.

Type E: Recapitalization and Reconfiguration

A recapitalization transaction involves the exchange of stocks and securities for new stocks, securities or both by a corporation’s shareholders. The move concerns just one company and the reconfiguration of the company’s capital structure. Possible scenarios include a stock-for-stock recapitalization plan, a bonds-for-bonds move and a stocks-for-bonds transaction.

Type F: Identity Change

A Type F reorganization plan is defined in the Internal Revenue Code as “a mere change in identity, form or place of organization of one corporation, however (a)ffected.” F reorganization rules generally apply to a corporation that changes its name, the state where it does business or if it makes changes in the company’s corporate charter, in which case a transfer is deemed to occur from the prior corporation to the new company.

Type G: Transfer of Assets

Type G reorganizations involve bankruptcy by permitting the transfer of all or some of a failing company’s assets to a new corporation. One caveat is that the stock and securities of the controlled corporation are distributed to the previous company’s shareholders under Type D – transfer reorganizations – rules for distribution.

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3 Types of Business Bankruptcy

Most new small businesses don’t survive and are faced with the decision concerning whether they should file for some form of business bankruptcy. About one-fifth of new small businesses from 2005 to 2017 survived only one year.

Bankruptcy is a process a business goes through in federal court. It is designed to help your business eliminate or repay its debt under the guidance and protection of the bankruptcy court. Business bankruptcies are usually described as either liquidations or reorganizations depending on the type of bankruptcy you take.

There are three types of bankruptcy that a business may file for depending on its structure. Sole proprietorships are legal extensions of the owner. The owner is responsible for all assets and liabilities of the firm. It is most common for a sole proprietorship to take bankruptcy by filing for Chapter 13, which is a reorganization bankruptcy.

Corporations and partnerships are legal business entities separate from their owners. They can file for bankruptcy protection under Chapter 7 or Chapter 11, which is a reorganization bankruptcy for businesses. The different types of bankruptcies are called “chapters” due to where they are in the U.S. Bankruptcy Code.

Chapter 13 – Adjustment of debts with individuals with regular income

Chapter 13 bankruptcy is a reorganization bankruptcy typically reserved for individuals. It can be used for sole proprietorships since sole proprietorships are indistinguishable from their owners. Chapter 13 is used for small business when a reorganization is the goal instead of liquidation. You file a repayment plan with the bankruptcy court detailing how you are going to repay your debts. Chapter 13 and Chapter 7 bankruptcies are very different for businesses.

Chapter 13 allows the proprietorship to stay in business and repay its debts and Chapter 7 does not.

The amount you must repay depends on how much you earn, how much you owe, and how much property you own. If your personal assets are involved with your business assets, as they are if you own a sole proprietorship, you can avoid problems such as losing your house if you file Chapter 13 instead of Chapter 7.

Chapter 7 – Liquidation

Chapter 7 business bankruptcy may be the best choice when the business has no viable future. It is usually referred to as a liquidation. Chapter 7 is typically used when the debts of the business are so overwhelming that restructuring them is not feasible. Chapter 7 bankruptcy can be used for sole proprietorships, partnerships, or corporations.

Chapter 7 is also appropriate when the business does not have any substantial assets. If a business is a sole proprietorship and an extension of an owner’s skills, it usually does not pay to reorganize it. and Chapter 7 becomes appropriate. Before a Chapter 7 bankruptcy is approved, the applicant is subject to a “means” test. If their income is over a certain level, their application is not approved. If a Chapter 7 bankruptcy is approved, the business is dissolved.

In Chapter 7 bankruptcy, a trustee is appointed by the bankruptcy court to take possession of the assets of the business and distribute them among the creditors. After the assets are distributed and the trustee is paid, a sole proprietor receives a “discharge” at the end of the case. A discharge means that the owner of the business is released from any obligation for the debts. Partnerships and corporations do not receive a discharge.

Chapter 11 – Business reorganization

Chapter 11 may be a better choice for businesses that may have a realistic chance to turn things around. Chapter 11 business bankruptcy is usually used for partnerships and corporations. it is also used by sole proprietorships whose income levels are too high to qualify for Chapter 13 bankruptcy.

Chapter 11 is a plan where a company reorganizes and continues in business under a court-appointed trustee. The company files a detailed plan of reorganization outlining how it will deal with its creditors. The company can terminate contracts and leases, recover assets, and repay a portion of its debts while discharging others to return to profitability. It presents the plan to its creditors will vote on the plan. If the court finds the plan is fair and equitable, it will approve the plan.

Reorganization plans provide for payments to creditors over some time. Chapter 11 bankruptcies are exceedingly complex and not all succeed. It usually takes over a year to confirm a plan.

Small Business Reorganization Act of 2019

Recently, the Small Business Reorganization Act of 2019 was passed by the U.S. Congress and signed by the President. It enacted a new subchapter V of Chapter 11. The Act will go into effect on February 20, 2020. This subchapter of Chapter 11 seems to favor the side of the applicant for business bankruptcy. It only applies if the applicant wants it to apply.

Subchapter V, for example, does not require that a committee of creditors is appointed or that creditors have to approve a court plan.

Sole proprietorships or incorporated entities should consult with a good business bankruptcy attorney before deciding on which type of bankruptcy you will file or whether you need to file bankruptcy at all. There may be other options that can be explored.

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What the Small Business Reorganization Act of 2019 Means for Creditors

Small Business Reorganization Act of 2019 “Reorganizes” Ch. 11 Bankruptcy Proceedings in Favor of Debtors

On August 23, 2019, the Small Business Reorganization Act of 2019 (SBRA) was signed into law, creating “Subchapter V” in Chapter 11 of the Bankruptcy Code as part of an effort to streamline the structuring process for small businesses (defined as those whose total noncontingent liquidated secured and unsecured debts do not exceed $2,725,625). The new law will go into effect February 19, 2020.

What does this mean for creditors?

Harder to contest Chapter 11 bankruptcy cases

The SBRA makes it more difficult for creditors to contest small business Chapter 11 cases. It favors small business debtors by eliminating the Absolute Priority Rule (APR), which previously required full payment to unsecured creditors for debtors to retain ownership of assets.

The APR will continue to apply for secured creditors.

While this new law only applies to businesses whose debts are less than $2,725,625, debtor businesses may qualify by paying down debts at negotiated discounts, since contingent and unliquidated debts are not calculated in the total.

What’s changed?

Before SBRA:

Previously, debtors would be unable to retain ownership of their business without paying creditors unless: 1) the class of creditors voted to accept the plan, or 2) the equity holder paid a “new value” to the debtor business in a substantial and essential amount.

Because debtors were not able to pay a large amount upfront in cash, they would often attempt to negotiate to buy back ownership, offering to provide new value in payments over several years. Thanks to the immediacy of the APR, these attempts would mostly be unsuccessful, with the result that over 90% of Chapter 11 cases would transfer to Chapter 7 liquidation proceedings instead.

After SBRA:

Without the APR in place, debtors can retain ownership of its assets without paying unsecured creditors in full, which means they are more likely to be successful in reorganizing and creditors are less likely to receive substantial payment.

The silver lining: fewer preference lawsuits

It’s not all bad news for creditors. The SBRA also makes changes to Preference Laws that favor creditors by increasing the threshold and due diligence requirements for preference lawsuits.

Under current law, trustees and debtors in possession can file lawsuits to recover preferential transfers made in the 90 days before the bankruptcy was filed, or one year, for insiders. If the amount was less than $13,650, then they would have to file a lawsuit to recover the transfer in the federal district where the defendant resides, rather than the bankruptcy case district.

Under SBRA, the threshold is raised from $13,650 to $25,000 for non-insider defendants, and the trustee or debtor in possession is required to exercise reasonable due diligence, taking into account “a party’s known or reasonably knowable affirmative defenses.”

Prohibitive costs and logistics generally prevent filing of preference suits outside of the bankruptcy case district, so raising the threshold effectively protects most transfers $25,000 and under from recovery. The new due diligence requirement will also help to reduce the number of preference lawsuits.

Actions creditors can take

In light of the new law, creditors and their attorneys, when settling lawsuits with businesses, should:

  • Insist on liens upon assets with equity, including during contract negotiations;
  • Insist upon entry of a judgment – or, at the very least, an admission of liability – exceeding $2,725,625 in order to disqualify the business from Subchapter V;
  • Obtain admissions of wrongdoing in the settlement agreement, since the same debts that are non-dischargeable under other chapters of the Bankruptcy Code remain so under Subchapter V;
  • Lean more towards larger transactions (exceeding $2,725,625) instead of smaller ones;
  • Focus on anything that may create a lien or property interest, such as a writ of attachment, lis pendens, or judgment lien, as these will increase the chance of a substantial payment.

In order to find more successful outcomes under the new Subchapter V, creditors should be more selective about extending credit, insist on obtaining liens wherever possible and monitor the assets that secure the liens on a regular basis.

Make More Informed Decisions with Cedar Financial

Business Credit Reporting

Cedar Financial offers Global Business Credit Reporting, Skip Tracing and Investigative Services to help you make more informed decisions about your business transactions.

In light of SBRA, knowing your customers is more important than ever to reduce potential credit risks. You don’t want to be left in the dust if your trusted business companion decides to file for bankruptcy.

Get the financial knowledge you need to put your best foot forward and maximize your profits. Ask us for a sample credit investigation report today.

The Best Legal Representation, Anywhere

When you place your claims with Cedar Financial, we do everything we can to resolve your accounts amicably, without litigation. But in the event, it comes to that, you’re in good hands – no need to hire a separate commercial debt collection lawyer.

Our clients receive access to full legal support through our in-house counsel and vetted creditor’s rights attorney network for the most trusted legal representation around the globe.

We can evaluate your accounts, review collectible assets and recommend the best course of action for potential legal proceedings. Every case receives the same close monitoring, management and follow-up as our in-house collections accounts, so you don’t have to deal with anyone else.

For more information about our services, contact our representatives at 800-804-3353.

*The information provided on this website does not, and is not intended to, constitute legal advice; instead, all information, content, and materials available on this site are for general informational purposes only. Information on this website may not constitute the most up-to-date legal or other information.

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