In times of crisis or uncertainty, such as the pandemic, few creditors are eager to litigate. Many creditors will simply be silent and send invoices, while others will be proactive in determining what can be done and understand that your business continuing is in their best interest. Business owners or friends or family members of the business owners may be willing to contribute capital. The friendly secured creditor is one of the most underutilized tools when dealing with other creditors in either debt reduction discussions, reorganization or asset protection.
Identifying the Friendly Creditor
The most important factor is trust. This could be a family member, a business partner or a friend. You are putting them in an improved position regarding your assets, and you need to know this person is not simply going to chase the easiest dollar or give up on you.
In the event there is no one with a long history whom you trust and is able or willing to become a creditor of you or your business, find a company or person interested in your business continuing with minimal disruption. For many creditors, you may just be a line item, but certain creditors may rely on you as a critical customer. These creditors create the best business relationships and provide the greatest opportunity to be friendly creditors.
Creating the Friendly Creditor
Documentation at the time funds or services are advanced is the best practice, including interest rate, length of repayment and defining security. Ensuring liens are timely perfected also helps place your friendly creditor in the best position to protect themselves and assist your business.
The Benefit to the Business
In many instances, a friendly secured creditor must be paid before other unsecured creditors. As a result, unsecured creditors may be less inclined to bring lawsuits when they know they will still be behind other creditors when it comes to recovery.
Further, improving the position of a creditor from unsecured to secured permits the renegotiation of terms, including interest rate and payments over time.
In the event a Chapter 11 bankruptcy is needed, the friendly creditor creates an impaired consenting class that may be necessary to cramdown other creditors later.
To the extent key equipment must be replaced, having a creditor lend money subject to a purchase money security interest prevents any other creditor from taking a turnkey operation and creates more leverage for negotiations.
Risks
There are risks with securing friendly creditors. You must understand the preference statutes under the Bankruptcy Code, and the parties must understand the risk and timing. Timing is particularly important when creating a purchase money security interest when there is a creditor with a blanket lien or the purchase money security interest will simply become part of the blanket lien and lost.
Additionally, the parties should be aware of the risk of non-monetary defaults. If done incorrectly, other creditors could make an allegation of fraud. Additionally, the business must understand what control and leverage is given up so it can be appreciated within the framework of a restructure or asset protection strategy.
The business reorganization and asset protection attorneys at Mesch Clark Rothschild know how to use these tools created by the law to create leverage in uncertain times. Schedule an appointment at (520) 624-8886 to determine if this is appropriate for you or your business.
