I N S I D E T H E M I N D S Best Practices for Corporate Restructuring: Leading Lawyers on Communicating with Creditors, Analyzing Debt, and Filing for Bankruptcy
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Best Practices for Corporate Restructuring: Leading Lawyers on Communicating with Creditors, Analyzing Debt, and Filing for Bankruptcy CONTRIBUTORS Bonnie Glantz Fatell GUIDING CLIENTS DOWN A WINDING ROAD Thomas J. Salerno AN OVERVIEW OF THE RESTRUCTURING PROCESS Lynn P. Harrison III A CRITIQUE ON BEST PRACTICES IN INTERNATIONAL INSOLVENCY CASES Myron Trepper A SOUND APPROACH TO THE PROCESS OF RESTRUCTURING Hugh Ray REACHING A SATISFACTORY RESOLUTION AS QUICKLY AS POSSIBLE
Alan Gover SEEKING OUT THE TRUE BOTTOM LINE Gerald C. Bender HELPING THE CLIENT ACHIEVE THEIR GOALS Robin Phelan JUGGLING, PSYCHIATRY, RELIGION, DIPLOMACY, CLAIRVOYANCE, ACTING, AND OTHER USEFUL DISCIPLINES ENDEMIC TO RESTRUCTURINGS Richard L. Wasserman A STEP-BY-STEP LOOK AT CHAPTER 11
Guiding Clients Down a Winding Road Bonnie Glantz Fatell Chair, Business Restructuring and Bankruptcy Group Blank Rome LLP
Inside the Minds The Role of the Attorney and Other Financial Advisors Companies that experience financial challenges that impede their ability to operate profitably often turn to restructuring experts for advice. These experts may include attorneys, financial advisors, turnaround specialists, and investment bankers. The role of the attorney specializing in corporate reorganization is to act as the quarterback bringing legal talent and expertise to the game and drawing upon the knowledge and skills of the company s management as well as its outside advisors. The attorney will work closely with the client to identify the factors causing the financial distress and then develop a strategy through which these issues may be addressed. The strategy may include a sale of assets or a corporate restructuring both operationally and financially to achieve financial stability and reposition the business to become profitable once again. When initially meeting with clients, the attorney must first identify and analyze the critical issues the company is facing, whether due to forces outside the company s control (such as a change in the industry or marketplace, domestic or foreign competition, or rising costs for commodities or raw materials) or internal drivers (such as too much debt, an increase in labor and health care costs, operational inefficiencies, or mismanagement). The attorney must then determine what specific causation may be linked to the factors that are forcing the company into financial distress by looking specifically at the capital structure of the company, the operations and business plan, and even the qualifications and performance of management at all levels. Working with the client, the attorney will develop a strategy for addressing the problems as they have been identified. At this point, it may be possible to restructure the company s debts through negotiating with the major lenders, implementing operational changes, selling some aspects of the business, or, if no viable reorganization plan is likely to succeed, it may be necessary to sell the entire company. This may be accomplished in an outof-court workout or through a Chapter 11 reorganization proceeding. In any case, the process remains the same: The attorney works with the client
Guiding Clients Down a Winding Road and its financial advisors to determine the origin of the company s financial difficulties and then develops and implements a strategy for addressing these issues. A critical aspect of this process is selecting the best professionals to aid in the restructuring. Often, management may be resistant to bringing in experts and ceding control over any aspect of the business. One of the challenges counsel may face at the early stage is persuading the client that it should hire and then head the advice of turnaround specialists, whether they are financial advisors, attorneys, or investment bankers. Certainly, hiring experts will add another layer of expense at a time when the company feels stretched. While outside professionals will be costly, if the right people are selected, it will be money well spent. Management needs to appreciate that while they may understand the industry and the operation of the business, they are not trained or experienced at restructuring or rehabilitating a business. Too often, a company will resist hiring restructuring professionals or accepting their advice until its decline is so far gone that its equity is eroded, its business is in a downward spiral, and its options for recovery become limited. The key to a successful restructuring is to identify issues and challenges before they become insurmountable problems. A company should appreciate that bringing in outside advisors early in the process will enable the company to develop and implement strategies in an orderly fashion, thereby creating opportunities for the company to consider various options in its reorganization. By avoiding the inevitable, companies often find themselves looking down the barrel of a gun and are then forced to file for bankruptcy without sufficient time for pre-bankruptcy planning. More often than not, those cases result in an asset sale rather than a restructuring. How the Need for Reorganization Arises There are any number of reasons a company finds itself in financial distress. For example, a company may expand too rapidly and fail to properly plan in advance to manage the expansion in such a way as to ensure long-term success. Consider a retail company that grows from fifty to 500 stores in a short period of time. It may find itself unable to control costs and maintain
Inside the Minds quality on such a large scale, resulting in a decline in revenues and unexpected increased expenses and overhead. In other instances, a company may acquire another business without first establishing a protocol for integrating the two companies or may find it is impeded in its integration efforts by variables it failed to consider. The result is a redundancy in the types and numbers of employees found at different levels of each company, unnecessary and duplicative expenses, and operational inefficiencies. An additional factor commonly leading to the need to reorganize is the inability of a company to change as technology or the marketplace demands. In today s competitive global market, a company must be attentive to change and be able to move quickly to accommodate new trends as the customer demands. Ultimately, it is imperative that a company be willing to build on its most profitable areas and phase out those businesses or product lines that have proven unsuccessful over time. Recognizing the need for change and implementing it at the right time are key. Getting to Know the Client: The Importance of the Initial Interview The attorney s goals for the initial meeting should be to develop a rapport with the client and start to build a foundation of mutual trust and respect, gather factual information and an understanding of the business, and most importantly, listen to the client to what is said and, as importantly, to what is not said. Advising on the Responsibilities of Management The officers and directors should be advised in the early stages of the representation of the changing fiduciary duties as a result of the company s financial problems. Specifically, when a company is in financial distress and unable to pay its debts on a timely basis, the company may be in what is commonly referred to as the zone of insolvency. As a result, the fiduciary duty of the officers and directors may shift from a duty solely to protect the interest of the shareholders to a duty also to consider what is in the best
Guiding Clients Down a Winding Road interest of its creditors. This is an emerging area of the law, and officers and directors should be mindful that when in the zone of insolvency, a company cannot recklessly incur debt and increase credit from its trade if it appears there is no ability to pay these debts as they come due without risking that the officers and directors may be found to have breached their fiduciary duty. During this time, the company should make it a point of adhering to its policies and procedures and avoiding showing special favor to insiders. Should the company ultimately file for Chapter 11, the creditors committee, or perhaps a trustee if one is appointed, will look very closely at the insider transactions during the period prior to the Chapter 11 proceeding. Assessing the Factors Leading to the Need for Restructuring In the initial meetings, the attorney should have the client articulate its goals reduce debt, restructure around the core business, asset sale, orderly liquidation, or address some other problems. If the company wants to restructure its core business, an analysis must be undertaken to identify the drivers that are impeding the success of the company. For example: Overleveraged: Can the debt be modified or refinanced on more favorable terms, converted to equity, or reduced through asset sales or infusion of new capital? Diversification into other businesses that have become a drain on the company s resources and are not profitable: Consider selling divisions, orderly liquidation, or consolidation into core business. Changing market: Undertake market study and reposition company through discontinuing unprofitable lines, a new approach to sales and marketing, or the introduction of new, higher-margin products. Operational inefficiencies: Examine costs of labor, raw materials, overhead; consider cost-saving measures, outsourcing, new sources of inventory; identify above-market contracts; evaluate ability to renegotiate supply contracts or costly leases. Poor or unmotivated management: A hard look must be taken at the officers, senior executives, and board members. The company must undertake a self-evaluation and arm itself with the best talent
Inside the Minds in all aspects of the business. Often, a fresh approach may take the company in a new direction. Having examined these and other factors, the company, with its advisors, must determine if its goals are attainable bearing in mind that restructuring is a fluid process and goals may change as the process evolves. Informing the Client and Managing Expectations in a Restructuring Providing the client with an overview of a corporate restructuring process, in or out of bankruptcy, is an important agenda item for the initial meeting. The company should understand how the process works, the various players that may be involved, the role of the court, the timeline, and the likely costs. If Chapter 11 is the best option, the company must be advised in advance as to its role as a debtor in possession. While in some respects the company will conduct its business as it had previously, there are many aspects that will change. Anything not in the ordinary course of business will need court approval. This may include selling assets, incurring substantial capital expenses, settling litigation, entering into new material contracts, awarding bonuses to employees, and obtaining financing. In addition, it is critical that the company is advised not to pay debts that are due and owing as of the date the company files for Chapter 11. These obligations may be paid only pursuant to the Chapter 11 plan of reorganization or, in limited circumstances, if authorized by a bankruptcy court order. To ensure compliance with the bankruptcy laws, it is important that someone at the company (often general counsel) serve as the point person to work with bankruptcy counsel to establish procedures to ensure that the company operates within the parameters of the Chapter 11 process. Finally, it is important at the initial meeting that the attorney and the client discuss any critical deadlines the company faces in the upcoming months that will have an impact on the business restructuring strategy. For example, is there a payment obligation the company is unable to meet, and what will be the consequences of not making the payment? How much time will the company have after the missed deadline before the creditor is able to
Guiding Clients Down a Winding Road exercise its remedies? Is the company obligated to complete performance under a material contract? Are there any impediments to fulfilling its obligations, and what are the consequences? Is there a deadline in ongoing litigation such as a foreclosure sale that must be averted in order to preserve value for the company? Answers to these questions may be determinants as to the company s strategy and the time within which it must act. Current Issues in Bankruptcy Law and the Need for Pre-Bankruptcy Planning On October 17, 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 became effective. The new Bankruptcy Act includes significant changes that will affect the commercial side of the Chapter 11 process. A company in need of rehabilitation or restructuring will be under tighter time constraints to address critical issues and will potentially face increased costs that will make it more expensive to reorganize under Chapter 11. For example, a debtor has the exclusive right to develop and file its plan of reorganization provided it is filed within a specified time frame. While previously the company could readily obtain extensions of this exclusive period, the new Bankruptcy Act imposes an absolute deadline of eighteen months from filing the Chapter 11 petition. After that date, any creditor may file a plan and the debtor loses exclusive control of the reorganization. For example, a creditor whose only goal is to recover on its claim and has no interest in the continued operation of the company may file a plan that proposes a sale of the company. In most cases, eighteen months should be sufficient, but in light of the shorter time frame, a company should be advised to engage advisors and undertake prebankruptcy planning so it has a business plan and strategy for reorganizing through Chapter 11 in advance of filing the petition. For companies with significant commercial real estate leases, the time within which the debtor must assume or reject its leases also is abbreviated. After a maximum of 210 days, the debtor must assume or reject its leases unless the landlord agrees to an extension. Under the Bankruptcy Act, the landlord has increased leverage in these negotiations since the debtor now is faced with a choice of assuming a lease prematurely, before it has fully developed its business plan and strategy to exit Chapter 11, or reject the
Inside the Minds lease, a potentially valuable asset. Either choice may have significant consequences. Rejection of leases may force the debtor into a liquidation, whereas premature assumption and then later rejecting the lease will increase the administrative expenses (the landlord will have an administrative claim for two years of rent) that will make emergence from Chapter 11 more costly. For a retail company with hundreds of leases, the necessity to make this decision early in the case could prove particularly problematic. On the expense side, the new Bankruptcy Act created additional obligations the debtor must satisfy in Chapter 11. For example, debtors must now provide deposits to their utilities or some other form of assurance of continued payments, and unsecured trade claims for goods sold to the company within twenty days prior to the petition date are treated as administrative claims that must be paid before emergence, as are employee claims up to $10,000 per employee for wages that are unpaid within 180 days prior to the filing for Chapter 11. Under Chapter 11, it is necessary for a company to pay all of its administrative claims in full in order to obtain approval of its plan of reorganization. In certain cases, a company faced with these and other administrative expenses could have difficulty funding operations under Chapter 11 or obtaining financing to support its plan of reorganization and exit from Chapter 11. The changes in the new Bankruptcy Act also make it more difficult for a company to provide incentives to its senior management and key employees to ride through the Chapter 11 with the company and not seek employment elsewhere. Over the past several years, it has become routine for a debtor to propose a key employee retention program that frequently provided payments or bonuses retention bonuses to employees at specific intervals, performance bonuses when certain benchmarks in the Chapter 11 are met (i.e., a sale or confirmed plan of reorganization), and a severance plan in the event the employee is terminated during the Chapter 11. As a result of the corporate abuse in recent years, the new Bankruptcy Act has clamped down on these plans and permits such bonuses only if the debtor can demonstrate that the employee has another job offer and that the bonus plan does not exceed certain limitations on amounts.
Guiding Clients Down a Winding Road It remains to be seen whether the changes in the bankruptcy law will hinder or help a company seeking relief under Chapter 11. One thing is clear: As a result of the new Bankruptcy Act, it will be necessary for companies to approach the reorganization process with a great deal more preparation than had been necessary in the past. Because of the changes, it is more likely that companies may sell assets through Chapter 11 rather than restructure, and that any restructuring challenges will be heightened because of the time limitations and additional administrative expenses and other new and untested changes. Conclusion Recognizing when a company is in financial distress and in need of outside professional assistance is never easy. Often, the officers and board of directors will attempt to right the ship themselves and may not appreciate the challenges they face in identifying the critical drivers causing the financial and operational difficulties and developing the optimum strategies to address the problems. The best advice is to bring in talented, experienced consultants early in the process and be open to change. Often, a company can avert bankruptcy or liquidation if it takes appropriate steps to remedy the problems in a timely manner. Bonnie Glautz Fatell is the practice group leader of Blank Rome s business restructuring and bankruptcy group, and for over twenty-five years has concentrated her practice on bankruptcy reorganizations and related litigation and out-of-court workouts. She represents parties in all aspects of bankruptcy including creditors committees, debtors, institutional lenders, trade creditors, landlords, plan of reorganization proponents, equipment lessors, and asset purchasers. Ms. Fatell also focuses her practice on banking and commercial lending matters including loan restructuring, debtor-in-possession financing, inter-creditor relationships, and lender liability prevention and defense. Ms. Fatell is the co-editor of Collier s Commercial Bankruptcy Forms Manual, Third Edition and a frequent speaker and lecturer on bankruptcy and insolvency matters. She is a fellow in the American College of Bankruptcy, listed in Chambers and Partners (USA) in Pennsylvania and Delaware among America s leading bankruptcy lawyers, and listed in Best Lawyers in America, 2006 edition. Ms. Fatell can be reached at fatell@blankrome.com.
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