For the beleaguered car wash owner struggling for a profit and fighting valiantly through costs, claims, and creditors to keep the ship afloat, Chapter 11 bankruptcy can be a lifesaver — a proverbial “fresh start” from an otherwise seemingly impossible situation. And, given the uncertain nature of the current economy and the challenges that still confront many industries including the car wash industry, federal bankruptcy law is possibly a creative solution that can benefit car wash owners. This point — that filing for bankruptcy is a beginning, not an end — bears repeating, because car wash owners deserve the right to reorganize their affairs in the same way that major companies across the country have done for many years.

First, the Bankruptcy Code can be a company’s sole means of salvation. (It can be a city’s salvation too. Detroit is a recent example.) Famous companies like Hostess, The Los Angeles Dodgers, MGM, Blockbuster, and Trump Entertainment Resorts have all used bankruptcy as a way to regain balance and develop a blueprint for success. Bankruptcy can offer a precious commodity: time. For time gives the debtor the chance to reorganize its finances with a “breathing spell” from creditors.

Second, a bankruptcy filing gives a business flexibility. The business can design new financing for the bankruptcy court’s consideration and approval. The judge has wide discretion to create a new and practical relationship between borrower and lender.

Third, with depressed real estate and business values, a company can call on the bankruptcy court for a “strip down” of a lender’s secured claim. For example: if an owner buys a car wash for $1,000,000 and puts $300,000 down, the bank has a claim for $700,000 and is oversecured. When the value of the car wash falls to $600,000, the bank’s claim of $700,000 is split into two parts, the secured part equal to the value of the car wash or $600,000, and the unsecured part, $100,000, that attaches to no collateral value. The car wash can generally pay a very small distribution on the $100,000, and go forward with easier debt service on the lower secured claim of $600,000. In turn, the lender has devices and procedures for its protection.

In a nation of business owners calling banks for “modification” — a process in which the lender acts as a prosecutor and judge, and the lender is so overwhelmed that it may lack the human resources to handle the flood of calls — owners see delay and uncertainty, which makes bankruptcy more compelling.

CASE STUDY

The following case study illuminates how Chapter 11 bankruptcy can allow a car wash that is overburdened with debt to reorganize its affairs and re-emerge toward success.

In 2007, “John” fulfilled his dream of becoming a business owner. He purchased a full-service car wash, “Los Alamos,” located on a busy intersection in southern California. He borrowed $1,600,000 for the purchase.

At first, business was strong and John was happy with his purchase. Then, starting in 2009, economic conditions caused a drop in business. Los Alamos was still busy, but was not producing enough revenue to service the car wash’s debt. Over two years, John attempted to negotiate with his lenders for relief. John’s efforts failed. Los Alamos faced foreclosure.

Chapter 7 Bankruptcy

On the verge of losing his dream, John met with legal counsel to review his options. He asked about Chapter 7 bankruptcy. His counsel informed him that under Chapter 7, a company’s assets are simply liquidated. Upon filing a Chapter 7 petition, the company turns its keys over to a private trustee and walks out of business. The trustee is appointed by the Office of the U.S. Trustee (a part of the Justice Department that generally monitors bankruptcy proceedings). The filing of the Chapter 7 petition creates a “bankruptcy estate” that the trustee administers for the benefit of creditors. The trustee locates and liquidates everything of value that the debtor had. Chapter 7 was not the answer for John. He felt Los Alamos could be rehabilitated. He wanted to keep it alive.

John discussed other out-of-court workout options. But these options largely involved compromise by lenders. John had been negotiating with his lenders for the last two years, to no avail. He knew these other workout options stood a slim chance of succeeding in his circumstances. He wanted to grab the lenders’ attention and strongly push them toward compromise. Based on his counsel’s advice, John chose Chapter 11 as the tool.

Chapter 11 Bankruptcy

John recognized the requirements and costs of a Chapter 11 bankruptcy. The requirements include substantial initial filings, regular reporting to U.S. Trustee, answering to creditors, and developing a plan. The costs are mainly counsel fees, as “debtor’s” counsel must be active and assertive at every step. Nonetheless, John felt strongly that Los Alamos could reorganize with restructured debt. He felt that the future would be better than the past.

As mentioned above, bankruptcy provides a breathing spell from creditors. The technical name is the “automatic stay” (a freeze or stop sign against creditor action). The automatic stay operates as a temporary injunction or prohibition against creditor collection or enforcement action. No creditor may commence a new lawsuit, or continue an existing lawsuit, or take any foreclosure steps, or send a threatening letter, or make a collection phone call. Upon a company’s filing of the bankruptcy petition, creditor action must stop, as a matter of federal law. The company has shelter under the wing of the Bankruptcy Court, and an opportunity in a calm atmosphere to re-assess operations and make a “fresh start” toward profitability.

While a breathing spell is short-term relief, John’s objective was long-term relief. He wanted to restructure the secured claims against Los Alamos that came with his financing for the acquisition. Again, a Chapter 11 debtor may reduce, or “strip down,” secured claims to the value of the property securing them. Los Alamos and the land it sat on secured the lenders’ claims. Since economic conditions had caused business to slow and property values to drop, Los Alamos was “underwater” – its debt exceeded its value. John aimed to reduce this debt to the value of Los Alamos and thus reduce monthly debt service. With this change, he was confident that Los Alamos could be profitable again. He turned out to be correct.

OUTCOME

With assistance from legal counsel, John successfully reduced the secured claims against Los Alamos to the current value of Los Alamos. This restructuring allowed John to return to profitability. Specifically, Los Alamos obtained the following:

1. A Bankruptcy Court order reducing the secured claims against Los Alamos from over $1,800,000 to approximately $800,000 (the value of Los Alamos as determined by the Court)

2. Affordable payment terms for the new secured (and unsecured) claims

In sum, John used federal bankruptcy law to keep his dream alive despite setbacks largely beyond his control. Car wash owners in these and other circumstances may find opportunities in the Bankruptcy Code. To keep the ship afloat — to enable borrowers and lenders to reach an acceptable, if not ideal, destination — Congress and the courts have created a wide variety of rights and remedies. Many experienced Chapter 11 lawyers provide initial consultation without charge.

Jerome S. Cohen is certified in business bankruptcy by the American Board of Certification and practices bankruptcy law in Los Angeles. You can contact him by phone at (213) 267-1000, or by visiting his website at www.cohenbordeaux.com.

Scott P. Layfield is an attorney practicing in the area of business bankruptcy, restructuring, and associated transactions and litigation.