US chapter 11: businesses must change

David Cameron has highlighted the risk that the credit crunch will lead to a huge increase in business failures. He believes that aspects of the US Chapter 11 process may give good companies the chance to be rescued or restructured. But it is businesses ­ not the insolvency process ­ that must change.

Whether it is administration in the UK or Chapter 11 in the US, the process is quite similar. Directors can apply to the courts for protection from their creditors while seeking to restructure their business. This moratorium allows time to plan and implement restructuring proposals.

The principal difference between administration and the Chapter 11 process is that in the US the company remains under the control of its directors, not its creditors.

Given that, broadly speaking, the processes are similar, why do people often cite Chapter 11 as having particular advantages over our administration process? Perhaps poor managers are unwilling to face up to the real reasons for insolvency. Businesses go bust because they run out of cash.

Successful businessmen are those who recognise that cash is king and plan accordingly.
As the credit crunch bites, well-managed businesses will have considered the consequences already. They will be managing cash even harder. Where insolvency appears inevitable, they will have identified funding; mapped out proposals acceptable to secured lenders, other creditors and shareholders; and will see a restructured business emerge.

Poorly managed businesses will delay implementing key measures to save cash, and will make a last minute call on lenders for more funds at a time when lenders are least likely to be sympathetic. The poorly managed business will enter insolvency with no plan, no funding and with creditors at the end of their tether. The prospects for a successful restructuring will be limited.

The stigma of insolvency results in management delaying the inevitable, reducing the opportunities to keep businesses intact. Until businesses adopt a more rigorous approach to cash management and enter insolvency processes at a much earlier stage, there is little prospect of creditors accepting the idea of the directors of those businesses staying in the driving seat while their businesses are restructured.

James Money is a director at Smith & Williamson