An article in the March edition of the ABI Journal concludes that the continued decline of middle-market businesses bankruptcies is no longer a trend, but instead a permanent shift to the way insolvency situations are managed in the current and likely future market conditions. “Investors and creditors increasingly recognize that consensual out-of-court restructurings of debt accomplish the same task in or out of court,” writes Jim Fleet of Phoenix Management Services (Boston) in his article “Chapter 11 on Decline? Changes Are Here to Stay.” Where chapter 11 was seen only a few years ago as a significant opportunity for a distressed firm to negotiate relief of debt and establish reorganization and turnaround plan, Fleet explains how the environment has changed for middle-market businesses (revenues between $50 million and $500 million).

One of the biggest drivers of middle-market companies seeking out-of-court solutions, according to Fleet, is the advent of special purpose/hedge funds with collective pools of capital to buy distressed-debt offerings. “The readily available size of transactions that fall into the middle- or lower-middle-market situations has markedly increased, translating to an increase in the appetite for these funds to convert their debt to equity with greater frequency than prior credit cycles,” Fleet writes.

Fleet also targets the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) as an unintentional driver of the shift to out-of-court solutions for middle-market businesses. “BAPCPA has managed to add significant administrative and professional fees to all bankruptcies, making it difficult for a middle-market company to avoid administrative insolvency claims and significantly increasing the odds against confirming a reorganization plan,” according to Fleet. Additionally, BAPCPA’s shorter timeframes for a company to reorganize creates additional pressure on constituents and an unsustainable environment for most of the parties, Fleet said.

While the shift to out-of-court solutions will continue, Fleet writes that the need for skilled bankruptcy counsel will remain in alternative funding environments as the “big stick” of bankruptcy remains in the background. “The intricacies associated with insolvency require legal expertise and skilled logic, which are essential for determining whether there is a viable option for restructuring and a subsequent turnaround,” according to Fleet.

To obtain a copy of “Chapter 11 on Decline? Changes Are Here to Stay,” published in the March edition of the ABI Journal, please contact John Hartgen at 703-894-5935 or via email at jhartgen@abiworld.org.