Much has changed in the past decade, but at least two things have stayed the same: First, Chapter 11 bankruptcy is still exceedingly expensive and reputationally taxing for middle market companies. Second, it is not the only way out of deep financial distress.
When I wrote about composition agreements a decade ago, mid-market companies could expect to pay around $500,000 to $1 million for professional services related to Chapter 11. That range has reached toward the millions. For companies already struggling financially, these costs can mean the difference between a potentially successful reorganization and liquidation.
Despite these often exorbitant costs, the composition agreement continues to be surprisingly underutilized as an out-of-court alternative to Chapter 11. As someone who has led over 160 turnaround engagements, managed 30-plus bankruptcies, and served on more than 20 boards, I’ve seen firsthand how this strategy can save companies millions while achieving the same restructuring goals.
With the majority of U.S. corporate debt falling below $10 million, and bankruptcy costs ticking ever upwards, the economics increasingly favor out-of-court solutions. Add in today’s market uncertainties, from tariff concerns to refinancing challenges, and the need for cost-effective restructuring tools becomes even more pronounced.
Let’s talk about how composition agreements work, when they work best, and why they’re effective.
Understanding Composition Agreements
A composition agreement is a negotiated settlement between a company and its creditors outside the bankruptcy court system. Unlike Chapter 11, where creditors must approve a plan by specific statutory thresholds, 51% in number and 67% in dollar value, a composition agreement allows the company to set its own approval requirements.
This flexibility might seem like a flaw, but it’s actually a strategic advantage. When I guide composition agreements, I typically seek 95% or even 100% creditor approval, not because I must, but because it creates leverage. The message to creditors is clear. Participate in this out-of-court process, or face the uncertainty and reduced recoveries of formal bankruptcy.
The beauty of this approach lies in its optionality. As I often tell clients that composition agreements should be the first step because they can always convert to a prepackaged Chapter 11 if needed. You’re not burning any bridges; you’re building them.
Today’s Restructuring Landscape
Though the two foundational truths I explained above have held constant, some things have changed in the last ten years. Most notably, Subchapter V emerged in 2020 as a fantastic option for smaller companies.
During COVID, Congress temporarily raised its debt limit to $7.5 million, creating a streamlined bankruptcy process that eliminated unsecured creditor committees and led to highly efficient 90-day exits. During this brief period, Subchapter V was an excellent option given its broad applicability. However, that expanded limit expired in June 2024, returning the threshold to $3,024,725. Bankruptcy judges and the American Bankruptcy Institute (ABI) are strongly advocating permanently setting the eligible debt limit at $7.5 million, indexed for inflation
This reversion reopened the door for composition agreements, particularly for companies with debt between $3 million and $50 million, too large for Subchapter V but small enough that $2 million in Chapter 11 fees would significantly hamper creditor recoveries.
The current market adds urgency to finding efficient solutions. Smaller retail and restaurant chains face particular challenges, with many unable to refinance or find buyers, pushing them toward liquidation unless creative alternatives emerge. In this environment, preserving capital through lower-cost restructuring becomes essential.
The Composition Agreement Process
Successfully executing a composition agreement requires careful planning and professional guidance, but the following can serve as a roadmap as you consider your options:
Building the Foundation
Before approaching creditors, companies need several elements in place:
- Analyze your creditor base. A concentrated group of payables makes communication and consensus-building more manageable. If your top 20% of creditors represent 80% of the debt, you have a workable situation.
- Ensure business viability. The company should demonstrate positive EBITDA once past debts are addressed. Creditors need confidence that this is a liquidity problem, not a fundamental business failure.
- Assemble your team. Retain both a financial advisor experienced in turnarounds and a bankruptcy attorney. While the attorney represents the company, owners often need separate counsel due to potential conflicts.
Initiating the Process
The formal process begins with a carefully crafted letter to all creditors. This communication should:
- Announce the freeze on pre-petition debt payments as of a specific date
- Commit to COD terms for future purchases
- Introduce the financial advisor
- Schedule a creditor meeting with adequate notice (typically 2–4 weeks)
The letter’s tone matters. Whether it comes from management or legal counsel depends on circumstances. If litigation is already pending, the attorney’s letterhead may carry more weight.
The Creditor Meeting
This meeting sets the stage for negotiations. The company’s history and current financial position need transparent discussion. Creditors deserve to understand how the situation developed. The financial advisor typically presents recent statements, cash flows, and a candid assessment of challenges faced.
Legal counsel then outlines three potential paths:
- Chapter 11 bankruptcy, where secured creditors get priority and unsecured creditors might receive minimal recovery
- Chapter 7 liquidation, where unsecured creditors typically receive nothing
- The proposed composition agreement, positioned as offering the highest recovery
After fielding questions, invite larger creditors to form an ad hoc committee. This group becomes the negotiating body, typically requesting 4–6 weeks to review proposals and present terms to the broader creditor group.
Structuring the Vote
The voting structure often determines success. Two key strategies enhance approval odds:
The Convenience Class: Small creditors can derail votes through sheer numbers. If 150 creditors hold claims under $5,000 totaling just $150,000 of $10 million in debt, paying them in full eliminates potential “no” votes while costing relatively little.
High Approval Thresholds: As previously mentioned, seeking 90–95% approval serves a practical purpose. With $10 million in debt, a 67% approval (Chapter 11’s threshold) leaves $3.3 million with dissenting creditors. Most mid-market companies lack the liquidity to manage litigation from holdouts of that magnitude.
Strategic Benefits
The advantages of choosing composition agreements extend beyond mere cost savings, but those are a great place to start. With overall Chapter 11 costs on the rise, every dollar saved on professional fees increases creditor recoveries. This creates a virtuous cycle where creditors see higher returns and become more cooperative.
Organizations also can save quite a bit of time by avoiding bankruptcy. While Chapter 11 cases can stretch for months or years, composition agreements often conclude in 8–12 weeks. This speed preserves business value and minimizes operational disruption.
Owners also benefit from maintaining control and equity stakes, avoiding the dilution common in formal bankruptcies. This incentivizes management to pursue the out-of-court option aggressively.
Finally, avoiding bankruptcy court preserves vendor relationships and customer confidence. The stigma attached to bankruptcy can damage a brand for years. By successfully navigating a composition agreement, that stigma can be avoided.
Navigating Challenges
Composition agreements aren’t without risks, of course. The absence of an automatic stay means creditors could theoretically file an involuntary bankruptcy during negotiations. However, companies retain the right to convert to voluntary Chapter 11, making this threat less potent than it appears.
Landlords present a particular challenge, especially for retail and restaurant organizations. They understand their rights in bankruptcy and often resist out-of-court modifications. This is why many retailers ultimately choose Chapter 11, to access lease rejection powers.
Additionally, success requires genuine creditor buy-in. Unlike bankruptcy’s cram-down provisions, composition agreements rely on voluntary participation. This makes the initial creditor relationships and the company’s reputation of paramount importance.
When Composition Agreements Excel
Through my experience, certain situations particularly favor this approach. For example, companies in close-knit industries where creditors know each other. These are more likely to benefit from peer pressure dynamics. When the ad hoc committee includes respected industry players, their endorsement carries weight.
Businesses facing temporary distress rather than fundamental model failures also make strong candidates. If the problem is a bad lease, a failed product launch, or temporary market conditions, creditors can see the path to recovery.
Finally, strong pre-existing vendor relationships create the trust necessary for voluntary agreements. Creditors who’ve profited from the relationship over years are more likely to work toward solutions.
The Path Forward
Somewhere right now, a viable company is about to spend $2 million on Chapter 11 fees that could have gone to creditors, employees, or rebuilding the business. Their lawyers, good lawyers, are preparing bankruptcy petitions because that’s the tool they know best.
But what if they asked a different question first? Not “how do we file?” but “how do we not file?”
Generally, the best bankruptcy is the one you never enter. The owner who keeps equity stays motivated. The vendor relationships that survive intact become tomorrow’s growth partners. The millions of dollars that stay in the company fund the turnaround instead of attorney fees.
So before your business, or your next client, files for bankruptcy protection, ask them this: would you rather control your restructuring or let a court control it? Would you rather pay creditors or lawyers?
For distressed middle market companies with viable business models, a composition agreement could be your springboard into a sustainable future.
