In this blog, we examine receiverships and involuntary bankruptcy proceedings side by side to learn more about how they work and differ from one another. Before getting into the details, it is important to understand that while we know they are not the same they are also not mutually exclusive. A receiver can be in place during bankruptcy proceedings, and a receiver can be appointed without a company being bankrupt. With that said, involuntary bankruptcy and receiverships generally attempt to achieve the same goal: allow creditors to protect and regain value from a company they believe is not paying debts as they come due or refuses to enter bankruptcy when insolvent.

At its most basic, a receivership is a tool that protects a company’s value. Involuntary bankruptcy on the other hand is a tool for creditors to claim that they will not be paid back if a business does not file for bankruptcy. With this in mind, we will start by looking at how each process gets started.

Getting started

The process for instigating a receivership or involuntary bankruptcy is central to their differences.

A receivership is instigated by the court but is not a legal action. It is an interim solution. A creditor can petition the court to appoint a receiver in order to protect their asset (the business). This is done during a pending action such as bankruptcy, foreclosure, shareholder/partner disagreements. A receivership is a protective measure that shelters the business while some other problem is tackled. The court hands over certain portions or the entire business to the receiver and authorizes their actions. While helpful when debts or disagreements are being settled, the receiver specifically does not settle the issue at hand (although they often help with these specific issues).

Involuntary bankruptcy is instigated by a creditor submitting a petition for involuntary bankruptcy against a debtor (the business) because of a significant amount of unmet debt. This is a legal action. Now the creditor must prove that the debtor is not paying debts as they come due. If the debtor has fewer than twelve qualifying creditors, a petition can be filed by a single qualifying creditor, but if they have more, three creditors must file a petition together. Once the petition is filed, the debtor has 21 days to respond or the court places them in bankruptcy. The debtor can file an objection to the forced bankruptcy. This is where the process can become incredibly lengthy and legal/paper-intensive.

How it gets from A to B

Both processes intend to help creditors secure some control over an asset and regain some or all value.

The bankruptcy portion of involuntary bankruptcy is straight forward if awarded to the creditors. If the creditors are successful in convincing the court to force the business into bankruptcy, bankruptcy begins. For the creditor, reaching this point is a success. The petition for involuntary bankruptcy can only be filed under chapter 7 or 11. While the bankruptcy chapters could each have their own lengthy blog, here is a brief summary of their functions:

Chapter 7 - a bankruptcy trustee is appointed to liquidate nonexempt assets to pay creditors; after the proceeds are exhausted, the remaining debt is discharged.

Chapter 11 - During a Chapter 11 proceeding, the court will help a business restructure its debts and obligations. In most cases, the firm remains open and operating. The debtor may propose a reorganization plan; if not, the creditors will. This chapter is incredibly time-consuming and expensive.

Through bankruptcy, a business must restructure its debts or pay back as much as possible to the creditors. It is important to remember—the goal is to restore value to creditors. Reaching this stage is the ideal outcome for the creditor that chooses to force involuntary bankruptcy.

Comparatively, a receivership holds a much higher chance of being put in place for the creditor. That is what makes it so appealing. A receivership is a sort of protective umbrella that is often the first step for creditors who are dissatisfied with how a debtor is operating their business. It is an opportunity for someone to step in and prioritize returning the company to profitability and thus debt payments. It presents an opportunity for an experienced executive to temporarily run the business and set them on the right path.

Moving forward

As each process wraps up, where do receiverships and involuntary bankruptcy leave creditors and debtors?
If the creditors were successful in forcing involuntary bankruptcy, then bankruptcy proceedings occurred and the maximum possible debts were repaid. So where does this leave creditors and debtors? While bankruptcy has its role to keep businesses afloat, it surely has its consequences. Creditors may attempt to recover a debt after discharge, even though they have no right to it (so it’s important to retain bankruptcy documents, as duplicates can be costly). The instance of bankruptcy will appear on credit reports for 10 years from the filing date, seriously damaging the debtor’s ability to get loans. Also, a person cannot file and receive a subsequent Chapter 7 discharge within eight years of a previous Chapter 7 discharge. Chapter 11 allows debtors to have a fresh start, but the process is incredibly complex leading to serious costs in money and time. The creditor has likely regained some or all of their original lending amount.

A receivership offers smoother transitions and often leaves businesses in a better position than their pre-receivership status (if they were turned around and not closed). Firstly, if not part of bankruptcy proceedings, the receivership was likely far less expensive. The process also does not punish the business’s credit score like bankruptcy automatically does. Receivers often bring a fresh perspective to businesses and clean up operations. This leaves businesses in a position to continue to improve.

Conclusion

So what does this mean for you? While creditors have their own priorities, generally the goal is to maximize their profitability. They want their debtors to maximize the value of loans and repay debts in full and on time. Involuntary bankruptcy is a last-ditch effort to try to regain some value from their loan. Conversely, receiverships are accessible and more reliable. A creditor can get a petition through the court in about ten days and avoid the massive time and financial costs of bankruptcy proceedings. Additionally, receivers often help businesses find improvements and increase the value of businesses. Careful consideration of pros and cons as well as an assessment of goals and risk is important before making any decisions pertaining to involuntary bankruptcy or receiverships.

From receiverships to leadership development, running a business can be complicated. Here at NMBL Strategies, we pride ourselves on empowering businesses with our insights and experience. If you are looking for more information and tools, check our other blogs, social media, or start a conversation anytime by emailing us.

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