Bankruptcy is bad medicine. (Viewpoint).

A RECENT ARTICLE IN CONTEMPORARY LONG TERM CARE (December 2001, page 63) suggested bankruptcy as a possible solution to cure the financial ills of some facilities within the industry. That article was entitled "Prescriptions for Bankruptcy." The prescription may prove to be a bitter pill for those who pursue that remedy without becoming educated on the subject.

The article casts a favorable light on the advantages of bankruptcy. Unfortunately, it contained some totally erroneous information and left out some important factors.

Chapter 11 reorganization must be regarded as an extreme remedy. When a Chapter 11 is filed, a very significant majority of those cases (80 percent) end up in failure and the eventual disappearance of the company is the result.

Certainly one item to be considered is the cost of a Chapter 11. Not only are there significant costs to the debtor entity for its counsel, but it is likely that the creditors will form an official unsecured creditors committee. That creditors committee will no doubt retain its own counsel, and that creditors committee will most likely retain its own accounting firm for assistance. All of these costs eventually will be passed on to the debtor entity. In addition, costs of frequent printing and mailings to all creditors may become burdensome as well as quarterly fees to the office of the United States Trustee.

In its simplest terms, the day a company files a Chapter 11 bankruptcy is the day that company belongs to the creditors and the plan of reorganization is essentially a plan to purchase the company back from those creditors. There can be no successful reorganization until the creditors committee is satisfied with the plan for reorganization that is filed. (There is something known as a "cram down" provision, which may override this, but it is used infrequently, is applicable in only certain circumstances, and should not be relied upon as a likelihood of forcing the plan upon creditors). The plan of reorganization generally is negotiated with the creditors committee and then must be ratified by a vote of the creditors. Failure to obtain the requisite number of votes based on a formula set forth in bankruptcy court generally will result in the liquidation of the corporation.

The previous article included erroneous statements about the cancellation of leases. While the bankruptcy code does specify that a debtor may cancel certain leases, note that should those rental locations stay vacant for a period of time, the landlords have the right to make a claim for future unpaid rents. In those cases where the principals of the entity have guaranteed a lease, it generally may be assumed that the landlords will look to those individuals under the terms of their guarantee.

In most instances, the Chapter 11 will not proceed very far without the consent of the secured creditors who generally have a security on all of the assets including accounts receivables. Those receivables, which are needed to operate on a day-to-day basis, will be available only if the secured creditors agree, or in the absence of an agreement with a secured creditor, if the Court is satisfied that the secured creditors can be granted adequate protection The success or failure of this issue can torpedo a Chapter 11 proceeding. Likewise, if the secured creditors lose confidence during the proceedings, they can seek to obtain "relief' and bring the proceedings to a final halt.

Each jurisdiction has a "U.S. Trustee," a federal employee whose job it is to monitor a Chapter 11 proceeding for compliance with the bankruptcy code, to ascertain that all withholding taxes are paid promptly, and to review monthly reports that must be delivered to the U.S. Trustee in a timely manner. The level of cooperation of the U.S. Trustee varies from jurisdiction to jurisdiction, but the Trustee is an additional key player in the bankruptcy drama who has the right (and sometimes the duty) to call into issue any deviations of the bankruptcy code or the foretelling of an inability to reorganize under a Chapter 11. That Trustee may then petition the Court for hearing, for motions to impose a liquidation of the assets, or a motion against the debtor for failing to observe certain requirements-such as paying withholding taxes.

A strong consideration before filing Chapter 11 is the level of guarantees by the individual owners of the facility. It can be expected that they are personal guarantors for bank loans. There may be personal guarantees with federal agencies such as HUD or SBA. Additionally, many owners fail to recognize that they have guaranteed credit with vendors, with certain lessors of equipment, and, as mentioned above, with landlords. The failure of a Chapter 11 will then trigger personal liability. Another consideration is that in the event of filing Chapter 11, there may be unpaid withholding taxes to state, federal, or local authorities. In the event that the Chapter 11 should not succeed, and in the further event that the assets are insufficient to satisfy the secured creditor, the liability for unpaid taxes will fall upon the "responsible parties."

While Chapter 11 should not be ignored as a remedy, it is best to regard it as a remedy of last resort. Often, intermediate remedies may be safer and far preferable.

A.C. Strip is a founder and principal in the law firm of Strip, Fargo, Hoppers & Leithart Co. in Columbus, Ohio. He can be reached at 614-228-6345.