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Turnaround Professionals Expand Options for Curing Credit Woes

Spring 1997

Our Financial and Business Restructuring Practice Group would be happy to assist you with any questions relating to this article.

Creditor’s rights lawyers who perform legal services for troubled companies have been called the "legal equivalent of cancer specialists." If there is any truth to this, it is that, like curing cancer, the key to a successful turnaround often is early detection and treatment. This is so, to a large extent, because early intervention increases the number of treatment options available. If competent turnaround professionals are consulted late in the process, unfortunately, often the only option remaining is radical surgery (liquidation). The purpose of this article is to explore some of the less intrusive "treatment options" that are available if there is early intervention.

Refinancing the "Fatigued" Lender

Often, what pushes a company onto the downward slope toward liquidation is a senior lender who has become disenchanted with the company as a borrower. The result of this loss of confidence is pressure to renegotiate the terms of the lending arrangement. The lender will demand an increased interest rate (to compensate for the increased risk) and an increased ratio of collateral to debt. Management of a troubled company, often without consulting legal counsel, may agree to such demands just to buy time. The result is reduced cash availability at the worst possible time. This will only hasten the decline, and could lead to a downward spiral from which the company will never recover.

Accommodating "lender fatigue" or "lender disenchantment" in this way is rarely a good strategy. Access to working capital will decline as the lender attempts to extricate itself from the relationship. The lender’s cure will only make the disease worse.

Usually, refinancing the senior debt is a far better prescription for both the company and the lender. The company retains its working capital and benefits from having a new lender who is willing to believe the company has a future. Refinancing benefits the "fatigued" lender because its "risky" loan is paid off altogether. Therefore, a financial "transplant" is the treatment of choice, if you can find a new lender.

Retention of experienced turnaround professionals can facilitate a successful refinancing for a number of reasons. First, they are familiar with potential financing sources. They can rapidly assess the company’s needs, and evaluate which lenders should be approached (bank, finance company, or asset-based lender). This can save time and money, precious commodities during a turnaround.

Next, the turnaround professional will help to present the company to the prospective lender so as to maximize the likelihood of a favorable result. Sometimes old lenders become disenchanted with the company because of a perceived weakness in management. The turnaround professional can bolster management, helping it to focus on, and eliminate, real and perceived shortcomings. By helping management to identify and address the problems that contributed to financial distress in the first place, the turnaround professional can foster the new lender’s confidence that the company will be a good customer.

Out-of-court Restructuring

Sometimes the problem is not only with the senior lender, but also with the company’s trade vendors. Unpaid vendors can be held off only so long. Soon, management’s time is consumed by working individual deals with the trade creditors and, staving off lawsuits. There was a time when the knee jerk reaction to this was Chapter 11. Conventional wisdom was that an out-of-court, or "informal" restructuring usually would not work because any three dissident creditors could throw the company into involuntary bankruptcy.

Recently, informal restructurings have been much more successful. Many credit managers who, in the past, might have forced a delinquent customer into bankruptcy have found that working with a troubled company can pay off. Chapter 11 reorganization, while still appropriate in some circumstances, often involves cumbersome procedures, time, and expense. An out-of-court restructuring (if successful) is generally cheaper and more flexible; does not pose as many risks; is less likely to result in loss of control; and does not damage the franchise value of the company as seriously.

The mechanics of an out-of-court restructuring are as follows. An informal creditors’ committee is formed and selects counsel. The company meets with the committee, discloses appropriate financial information, and negotiates a repayment plan based on that information. The key to this process is creditor cooperation. And the key to cooperation is creditor confidence that the restructuring is being handled in a straightforward, professional manner.

Again, turnaround counsel is essential to the success of an informal restructuring. He or she has done it before, often having worked with the very same trade groups and having won the trust of trade representatives and their counsel. Turnaround counsel can assist in formulating the repayment plan, coordinating it with the refinancing of senior debt, and preparing financial projections and analyses which are the basis for the plan’s credibility. It is surprising how vendor hostility can dissipate when an informal workout is managed with competence, integrity, and professionalism.

Preplanned Chapter 11

When an out-of-court restructuring proves to be impossible, either because creditor cooperation breaks down or because only the powerful debt restructuring tools provided by federal bankruptcy law will enable a company to implement its repayment plan, the solution may be a "preplanned Chapter 11." The preplanned Chapter 11 may be to a conventional Chapter 11, what arthroscopic surgery is to conventional surgery—less intrusive and less taxing to the system.

While a full scale Chapter 11 case can last a year or more, in a preplanned Chapter 11, the company may be in and out of bankruptcy court in a few months. As much is done prior to the Chapter 11 filing as possible. Typically, the company first finds a senior lender and negotiates future financing. As in an out-of-court restructuring, the company will negotiate a repayment plan with an informal creditors’ committee. In some preplanned cases, the creditors will be asked to vote on the repayment plan prior to the bankruptcy filing. In other instances, the plan and disclosure statement describing it may be filed in court at the beginning of the formal bankruptcy case, with creditors being given an early opportunity to vote for or against the plan following court review and approval of the disclosure statement. While this process is underway, the company may use federal bankruptcy law powers to resolve disputed debts, sell unneeded assets, reject burdensome contracts, or reverse certain payments or property seizures. If all goes well and the process is managed by experienced and efficient restructuring counsel, the company may be able to emerge from bankruptcy court in a matter of months.

These are just a few examples of treatment options for a financially sick business. The key point, however, is simple: early diagnosis and the assistance of competent turnaround professionals will maximize the opportunity for financial recovery.

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