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Lowenstein Sandler LLP

Kenneth A. Rosen

Kenneth A. Rosen

Partner
Chair, Bankruptcy, Financial Reorganization & Creditors' Rights

Expertise

  • Bankruptcy, Financial Reorganization & Creditors’ Rights
  • Bankruptcy, Financial Reorganization & Creditors' Rights

WSG Practice Industries

Activity

WSG Leadership

Bankruptcy
Chair
Financial Reorganization & Creditors
Chair
ABA Group
Member
WSG Coronavirus Task Force Group
Member

Lowenstein Sandler LLP
New York, U.S.A.

Profile

With more than 35 years of proven experience, Ken is the first call for companies seeking a strategic plan for recovery from financial distress.

Ken advises on the full spectrum of restructuring solutions, including Chapter 11 reorganizations, out-of-court workouts, financial restructurings, and litigation. He works closely with debtors, creditors' committees, lenders, landlords, and others in such diverse industries as paper and printing, food, furniture, pharmaceuticals, health care, and real estate.

For each matter, Ken starts by developing a strategic direction based on a clear understanding of his client's needs. His goals are to preserve the business or business relationship, to minimize disruption, and to move quickly toward a workable solution. His success is reflected both in his long list of accolades—including top rankings from Chambers USA (2008-2020) and The Deal's "Bankruptcy Insider"—and the fact that the majority of his practice is referral-based. Clients laud Ken's practical approach and sensitivity to the needs of their business, as well as his strong track record of successful outcomes. Clients and peers alike recognize Ken as "definitely a standout."

In his spare time, Ken serves on several philanthropy and nonprofit boards primarily devoted to health care and education. He currently serves as Interim Chair of the Board of the New York City Opera. 

Bar Admissions

    New York
    New Jersey

Education

Columbia University (M.B.A. 1980)
Benjamin N. Cardozo School of Law (J.D. 1979)
Cornell University (B.S. 1975)
Areas of Practice

Bankruptcy, Financial Reorganization & Creditors' Rights | Bankruptcy, Financial Reorganization & Creditors’ Rights

Professional Career

Significant Accomplishments

Speaking Engagements

Bruce Nathan and Ken Rosen will present "Mining for Hidden Assets and Liabilities: Unlocking a Financially Distressed Customer's Balance Sheet," along with William A. Brandt Jr., Development Specialists Inc. The program will identify potential assets and liabilities that do not appear on a balance sheet, finding hidden value in a balance sheet when the liabilities side of a balance sheet does not tell the whole story, and when hidden liabilities arise in a bankruptcy or liquidation. The program will also cover unlocking the value of unreported or undervalued intellectual property and below market leases and how other contracts could substantially increase recoveries for unsecured trade creditors in their customer's bankruptcy case. Bruce and Ken will be joined by Bruce Buechler in co-hosting a private dinner with ABC-Amega for invited attendees at the conference.

Ken Rosen, Bruce Nathan, and Jeffrey Prol will lead a discussion entitled "Spotting and Reacting to Warning Signs of Financially Distressed Customers: Dodging the Bankruptcy Bullet." The program is sponsored by NACM Connect and NACM Midwest.

Ken Rosen will present "Spotting and Reacting to the Warning Signs of a Financially Distressed Customer: Dodging the Bankruptcy Bullet." Sponsored by the National Association of Credit Management, this program will address the early warning signs hovering over a company at risk of a future bankruptcy filing and how a credit executive can dodge a huge loss by quickly identifying and reacting to these warning signs as they accumulate and point toward the inevitable customer bust.

Ken RosenBruce Nathan, and Mary Seymour will present "The Impact of Increased Private Equity and Hedge Fund Activity on Creditors' Rights in the Chemical Industry: The New Normal?" The program focuses on the increased use of prepackaged and pre-negotiated Chapter 11 plans and section 363 sales, loan to own and credit bidding issues, and the increased frequency of make-whole and prepayment penalty protections in favor of secured noteholders that have raised the risk of a de minimis or no recovery to trade creditors, and the resulting heightened importance of an unsecured creditors' committee to maximize trade creditor recoveries. The speakers will also discuss the unique warning signs of a distressed company controlled by private equity or a hedge fund and the disposition of preference claims in such cases.

 

The presenters discussed the future of retail following the COVID-19 pandemic, including which retailers are most likely to survive; which are likely to file chapter 11; how retailing will change; and how mall owners will react to the pandemic.

Presenters

  • Kenneth A. Rosen, Lowenstein Sandler
  • Ian Fredericks, Hilco Global
  • Kyle Shonak, Gordon Brothers


Professional Associations

R.W.J Barnabas Health
  • Trustee
  • Audit Committee
  • Compliance Committee
  • Strategic Planning Committee
Lincoln Center Business CouncilNew York City Opera
  • Chair of the Board
The All-Stars Project
  • Board Member

Professional Activities and Experience

Accolades
  • New Jersey Super Lawyers (2005-2007, 2016-2018) - Ken Rosen

Articles

When Financial Stress Turns to Distress–Restructuring Tools to Avoid Disaster Parts 1 and 2: Chapter 11 Checklist and What Else Is in the Toolbox
Lowenstein Sandler LLP, April 2020

When Financial Stress Turns to Distress–Restructuring Tools to Avoid Disaster Parts 1 and 2: Chapter 11 Checklist and What Else Is in the Toolbox In this Client Alert series, Lowenstein’s Bankruptcy, Financial Reorganization & Creditors’ Rights Department will introduce the various restructuring tools available to help businesses avoid financial catastrophe in the current environment...

Brand Management and Retail Survival
Lowenstein Sandler LLP, October 2016

It’s been a tough couple years for retailers – many of whom are struggling through bankruptcies or turnaround efforts amid online competition and rapidly evolving consumer tastes. But at least one company is doing something that should catch the attention of other retailers: Abercrombie & Fitch, in August 2015, named a six-person brand leadership team as part of its turnaround efforts – and the company returned to growth early this year. This is refreshing...

Information Wish List to Evaluate a First-Day Asset Sale Motion
Lowenstein Sandler LLP, June 2016

[1]Chapter 11 has largely become the sale chapter of the Bankruptcy Code. If the case is not a quick sale case, then it probably is a debt-for-equity swap. A traditional chapter 11 reorganization is expensive and, because of its relatively low success rate, is viewed by many lenders as not worth it.The typical “first day” sale motion asserts that the debtor is hemorrhaging cash, that there are no options besides a quick sale and that delay will severely erode the estate...

Additional Articles

Find out the truth and protect yourself when a supplier seems to be in financial distress.

There have been a number of high-profile cases of companies dealing with bankruptcy and other financial problems recently, and many businesses are now taking a closer look at their partners and suppliers to head off potential issues. However, when a supplier is in financial distress, it won’t always be obvious that there is a problem.

Fortunately, there are almost always signs signaling that you need to delve deeper to find out the financial truth. Perhaps you’ve noticed slower or late deliveries from one of your longtime parts suppliers. You’re concerned that if the supplier continues to fall behind schedule — or worse yet, fails to deliver altogether — a ripple effect will disrupt your company.

Reorganizing Failing Businesses, Third Edition, is the culmination of more than two decades of work by dozens of experts in bankruptcy, insolvency, and myriad other areas of law that impact the restructuring of a troubled business. Revised and expanded, this valuable, two-volume, desk reference presents the totality of the restructuring process as it is practiced today, with detailed explanations of the laws, customs, and techniques that are central to restructurings. This comprehensive treatise covers in-depth treatment of chapter 11 reorganizations; out-of-court restructurings; specialized restructuring situations (such as prepackaged plans, transnational restructurings and cross-border insolvencies, mass tort cases, and airline cases); and the implications of related areas of law, including taxation, securities, environmental, intellectual property, labor and employment, lender liability, criminal, financial market, and competition law.

THE HEADLINE. The typical Chapter 11 debtor (the entity that is in bankruptcy) issues a press release shortly after commencing its bankruptcy case announcing to the world that the debtor has obtained “DIP” (debtor in possession) financing. The headline is a big number. The goal is to obtain new, post-bankruptcy trade credit from suppliers by convincing them that the Chapter 11 debtor now has liquidity sufficient to enable the debtor to pay its bills on time. Therefore, give the debtor more credit.

SO, WHAT’S LEFT? Assume that a debtor owes its bank $20,000,000 pre-bankruptcy. Also, assume that the bank has a “blanket” lien – a lien that covers all of the debtor’s assets. When I review a debtor’s financing, my first inquiry is whether or not there are any unencumbered assets from which I can be paid if the case becomes Chapter 7 liquidation or in case the bank forecloses on its collateral.

My first job was working for the United States Trustee (“UST”)  for the Southern District of New York. The UST program came about with the amendments to the Bankruptcy Code in 1979. Congress decided that administrative functions – such as appointing examiners, creditors’ committees and trustees – should be performed by an independent party rather than by the presiding Bankruptcy Judge. As a financial analyst and attorney for the UST, we oversaw cases where no one else would have done it, we assured compliance with the  Bankruptcy Code and with the Federal Rules of Bankruptcy Procedure and we made appointments that were in the best  interests of creditors as well as debtors. Congress was smart to implement the UST program.

Representing creditors’ committees in Chapter 11 cases is a big business. There can be a lot of fees earned by attorneys, financial advisors, investment bankers, appraisers, claims agents and disbursing agents representing a creditors’ committee. If creditors do not watch over the fees charged and, as a result there is less money to pay a dividend, the creditors only have themselves to blame.

Successful Chapter 11s for retailers have become few and far between. Sears, Toys "R" Us, Barneys New York, Forever 21, Coldwater Creek, Fred's, Fairway and A&P are just a few examples of recent retail disasters.

Chapter 11, of course, occurs after all hope of restructuring the debtor outside of bankruptcy court is lost. Once bankruptcy commences, the race to avoid liquidation is on. Lenders, justifiably, have very little patience when losses mount after the petition date. Most debtors do not successfully reorganize in chapter 11 – especially if the word “reorganize” excludes a plan that is an orderly liquidation.

A common issue, which was the case for Sears and Toys “R” Us, stems from debtors being administratively insolvent, meaning that liabilities accrued after the petition date cannot be paid in full. In another such instance, Forever 21, creditors that had already lost $200 million lost another $100 million for goods sold to the debtor after the bankruptcy case commenced.

This reveals a deep problem with our bankruptcy system: Every debtor says it is safe to sell them goods after the date of bankruptcy, citing the administrative status of such claims. Administrative claims are supposed to be paid ahead of all other claims except secured claims, and administrative status is supposed to be equal to that of the claims of professionals in the case. However, professionals magically get paid even though trade creditors’ administrative claims are unable to be paid in full.

Bottom line, creditors should no longer believe that having an administrative claim is an assurance of payment.

Further, trade creditors should understand that when they supply goods to a debtor after the petition date, they bolster the collateral of the bank financing the debtor's business. The debtor’s secured creditor/bank has a tremendous amount of control over the debtor, most of whom prefer to induce vendors to supply post-petition goods and services if, by doing so, they can bring in additional collateral for their secured lender. This in effect is a way to buy time from the secured lender by relieving the pressure that the lender otherwise will exert as a result of continuing losses.

Of course, every debtor wants time to figure out a plan. But most of the time is being purchased by the debtor with trade creditors’ dollars.

There are other factors in play. Creditor committees never like shutting a debtor down. Bankruptcy judges like to preserve jobs. Suppliers like to retain a customer. Landlords never like to lose a tenant (and the loss of a large tenant can create a domino effect with cotenancy clauses). 

But trade creditors need to know when to say that enough is enough. Forever 21 is a case that should have been shut down before vendors got stuck for another $100 million. If the secured lender does not see the benefit of providing financing to keep the Chapter 11 case going, then trade creditors should not be using their inventory to subsidize the secured creditor.

It is sad that the success rate for retailers in Chapter 11 is so low, and it’s understandable and respectable that vendors always want to preserve a customer. But increasingly keeping the debtor alive comes at the additional expense of vendors. Debtors should not get more time by involuntarily causing vendors to subsidize the collateral position of the bank.

Trade creditors must pay closer attention and be much more aggressive when things are turning sour. They also need to be a lot more skeptical of what they are told when asked for more credit.

Reprinted with permission from the March 2, 2020, issue of Chain Store Age (CSA). © 2020 EnsembleIQ. All Rights Reserved. Further duplication without permission is prohibited.

A company commences a Chapter 11 bankruptcy case, obtains “debtor in possession” financing and then asks its vendors for more unsecured credit because (according to the debtor) the debtor just got lots of new financing and the vendor will have an administrative claim in the case – which is on par with professional fees and is entitled to 100% payment off the top. Therefore, giving credit during the bankruptcy is safe. I find these assertions to be very humorous because none of it is true anymore.

Sears, Barneys and Toys R Us are recent examples of administrative insolvency. In other words, debts incurred during Chapter 11 are not able to be paid in full. So, the vendor gets burned twice.

When a debtor says that it has obtained “DIP” financing, it wants you to believe that it has obtained more needed liquidity. However, many times, the debtor continues on a shoe-string and the new financing simply replaces the pre-bankruptcy financing. Not a lot of fresh cash is provided. The question is not how much DIP financing has been obtained - that will be the headline number. The better question is how much additional liquidity the debtor really is getting from the financing.

Is the secured lender increasing or decreasing the advance rates to the debtor? That is a good question to ask. Is the aggregate amount owed to the secured lender (the pre-bankruptcy amount outstanding as of the petition date plus the post-petition amount that will become outstanding) greater than what was owed to the lender as of the petition date? If not, then the debtor probably is treading water and has not been given a “jump start.”

Preferences. A debtor has the power to recover from creditors money paid to the creditor during the 90 days preceding the date of bankruptcy if the payments were past due when made. Lenders frequently ask that they get a lien on these potential recoveries. By doing so, the vendors subsidize the secured lender’s recovery. It also is a double “hit” to the vendor since the vendor gets burned for what is outstanding to it as of the petition date and then potentially has to disgorge what it was previously paid as a result of its diligence as a credit executive. The answer is simple. The vendor should not consider giving post-bankruptcy trade credit until after the Court says that the bank will not have a lien on preference recoveries.

Yes, administrative claims (claims arising during the pendency of the bankruptcy case) are entitled to 100% payment in order to confirm a plan of reorganization. But, fewer and fewer debtors or lenders care about confirming a plan of reorganization. They just want a fast sale of the assets to get the secured lenders out of the case. After that, the Chapter 11 bankruptcy case can be dismissed or else converted to Chapter 7. And, if you believe that vendors’ administrative claims get treated equally to the administrative claims of professionals, then I have a bridge in Brooklyn that I would like to sell you. Somehow, vendor claims always are treated as if they are subordinate.

One thing that I like to do if my client feels that selling to the debtor post-petition is necessary for business reasons, is to file a reservation of rights whenever professionals seek compensation. Put the professionals on notice that, if your client does not get paid, you reserve the right to seek a reduction or even disgorgement of their professional fees. This approach does not make lots of friends, but it makes a debtor and its advisors think twice about who the debtor does not pay timely.

Know the milestones in the case! If the secured lender has set dates by which assets must be sold, make sure that you are ratchetting down your claim sufficiently in advance of the sale date. Not every sale yields enough to pay the secured debtor in full and leave enough over for administrative claimants to be fully paid. Once a sale [that has not resulted from spirited bidding] is done, it probably is too late to recover fully on your administrative claim.

Every debtor says that it intends to reorganize and confirm a plan of reorganization. But, when push comes to shove, it frequently does not happen absent special situations where there are remaining assets to liquidate (such as litigation) or where insider releases are sought. Lenders may not see much benefit to themselves from funding a bankruptcy case post-sale and often decline to do so. The statement that a plan of reorganization cannot be confirmed absent paying all administrative claims should not be a basis for extending new credit.

Why did the turtle cross the road? To get to the Shell station.

To the Editor:

I am worried about nonprofit institutions, which make important contributions to our society. I have represented museums, opera companies, social-work agencies, hospitals, and domestic-violence organizations in bankruptcy or in out-of-court restructurings, mostly on a pro bono basis. In other words, I do not get paid to do so. My “compensation” is knowing that my client will continue fulfilling its mission.

Our economy is now shut down or close to it. Many nonprofits must suspend operations — which means that cash flow dries up. Many corporate donors will hold off on philanthropy. Potential philanthropists may hold back while the stock market (we hope) recovers. Smaller donors may hold back until they have a better idea about their personal cash flow.

So, now is the time for professional advisers (including me) to step up to assist the organizations that rely largely upon philanthropy for survival. It is more important to step up in bad times rather than in good times. Many of these organizations are safety nets for the people in our society who need them the most. For other organizations, the importance is to preserve the culture that we appreciate in daily life.

I make my living in the courts — including the Bankruptcy Court. In my opinion, the courts will not be very friendly to creditors, lenders, or landlords that declare defaults or seek to exercise remedies against customers or tenants whose business has been honestly stricken by the pandemic. That is particularly true for nonprofit organizations.

This is not to say that the creditors, landlords, or lenders should be taken advantage of, but that it is a time for bilateral cooperation, workouts, and restructurings out of court. That is what judges expect to occur. If they do not see it, their control over their calendars can make the goals of anyone seeking judicial relief become more difficult to achieve.

Many people expect that fundraising will become very difficult in a recessionary economy. So, organizations will need to buy time until finances improve.

I tend to look at the world in terms of “What is the worst that can happen?” After all, I am a bankruptcy and restructuring attorney.

Here is the good news: Nonprofits can expect a sympathetic reception in any court — whether it is a foreclosure, eviction, or collection proceeding. This should provide leverage in achieving settlements outside of the courthouse. My fellow professionals (legal and financial) need to step up to assist the nonprofit world, and we can make a difference.

Kenneth A. Rosen
Partner
Lowenstein Sandler
New York

To see our other material related to the pandemic, please visit the Coronavirus/COVID-19: Facts, Insights & Resources page of our website by clicking here.

Some problems in the Chapter 11 bankruptcy process — namely, how unsecured creditors committees and their professional advisers are being selected — have emerged in recent years. Moreover, they are only getting worse.

The problems stem from the fact that the Bankruptcy Code empowers U.S. trustees to appoint official unsecured creditors committees to represent interests of all unsecured creditors — not simply the interests of members of the committee. The committees can retain professional advisers to assist in the performance of its duties.

When the appointment of committee members becomes partly controlled by proxy solicitors, the exclusive role of the U.S. trustee in the committee selection process becomes nonexclusive — which is not what Congress intended. Further, a principal role of the U.S. trustee is to assure that the committee is representative (as much as is feasible) of all unsecured creditors. If proxy solicitors partly control who becomes a committee member, then the U.S. trustee is unable to represent to the court that the committee is representative of creditor interests without outside influence.

However, the selection process has gotten murky.

It begins with the fact that the average percentage recovery on creditors’ claims is nothing to brag about. Too many Chapter 11 cases end up as bulk asset sales (followed by confirmation of a liquidating plan of reorganization) instead of true reorganizations. As a result, many creditors do not want to throw good money after bad by hiring local counsel when a debtor files hundreds, if not thousands, of miles away from the debtor’s principal place of business.

Consequently, a practice akin to “ambulance chasing” has evolved. Unscrupulous individuals cold-call creditors with offers to get them appointed to the creditors committee — without the creditor having to hire local counsel or travel to where the Chapter 11 case commenced. The cold-calling begins promptly after petitions are filed — and creditors are proving quite susceptible to their sales pitches.

The callers offer to find someone to act as a proxy for the creditor but often avoid the topic of exactly how the proxy holder will exercise the creditor’s right to select professionals for the committee. Creditors don’t realize that they are giving up a fundamental and substantive right — and they rarely know much, if anything, about the proxy holder. They don’t know have any idea that there could be an arrangement between the cold caller and the proxy holder to vote to hire a particular professional firm, which likely will handsomely reimburse the cold caller.

These professionals are supposed to be selected based on such things as a creditor’s previous experience with them, the professional’s industry credentials, the professional’s case insights and understanding of the issues, and the professional’s thoughts on how to maximize recoveries for creditors. But that’s just not happening in many cases.

That brings us back to the U.S. trustees who oversee the appointment of creditors committees and the larger role they need to take in policing the process. It’s not enough to say that the rules apply to lawyers and not to other professionals — or that the “marketplace should deal with the problem.”

The appointment of proxy holders to creditors committees has become rampant in places like Wilmington, Delaware. Unlike a proxy holder whom a creditor has contacted directly through ordinary connections to represent the creditor at the committee formation meeting, this article addresses a different sort. Rather, in some instances, committee members are increasingly nothing more than proxy holders with specific instructions to vote for certain professionals selected by the proxy solicitor.

Often, multiple proxy holders are lined up by the proxy solicitor (cold caller). The creditor giving the proxy knows nothing more than the fact that the solicitor offered to get them onto the committee free without a trip cross-country.

Without adequate oversight from a U.S. trustee, a creditor who does not want to join a committee can no longer assume that its members will be appointed fairly or that the committee will select professionals based on proper qualifications. Moreover, bankruptcy judges cannot assume that the professionals standing before them were fairly selected by the committee or that the committee was fairly appointed without undue influence.

This problem is taxing a Chapter 11 process where creditors are supposed to act as foils for the debtor. U.S. trustees do good work, but they should ask more in-depth questions about how proxies were arranged. It makes a difference whether a creditor was referred to a proxy holder by its general counsel or by a cold caller, and that information should be communicated to judges.

The entire Chapter 11 system works best when the court and creditors know that the selection of committee members as well as the professional advisers was done the right way. Better oversight of how proxies to the committees are selected would go a long way toward that outcome.

Questions that the United States trustee should ask:

  1. Did anyone call you and offer to help you become appointed to the creditors committee?
  2. Did the person who called you regarding this case recommend someone to hold a proxy for you, or offer to find someone to hold a proxy for you? Who first called you with the idea of finding a proxy holder?
  3. Who recommended that you give a proxy to the proxy holder?
  4. Did you or another representative of your company know the proxy holder prior to this case?
  5. Did the proxy holder disclose to you that they would vote for committee professionals on your behalf?
  6. Do you wish to be heard on the selection of professionals by the creditors committee if you are appointed to the committee?

Reprinted with permission from the April 1, 2020, issue of Law360. © 2020 Portfolio Media, Inc. All Rights Reserved. Further duplication without permission is prohibited.

A bankruptcy trust for creditors (including former workers and trade vendors) who lost significant sums of money in the Toys “R” Us Inc. (TRU) bankruptcy sued former Chief Executive Officer David Brandon, several other directors and executives of TRU, and its former private equity owners.[i]The lawsuit accuses Brandon and other TRU executives and board members of, among other things, conspiring to keep suppliers in the dark about TRU’s real financial condition in the months preceding TRU’s collapse. As a result, post-bankruptcy suppliers and other creditors collectively lost $800 million, an additional $1.76 billion in pre-bankruptcy claims were left unpaid, and 31,000 employees lost their jobs, according to the complaint.

The complaint asserts that the company continued to purchase goods from suppliers on credit even after it became clear to directors that financing would evaporate because of a terrible fourth quarter. Between December 2017 and March 14, 2018, TRU supposedly placed $600 million of orders on credit, at the instruction of the company’s board, while assuring suppliers that TRU would emerge from bankruptcy.

Under Delaware law, the duties of directors of a solvent corporation run to the corporation, which is to be managed for the benefit of its shareholders. No fiduciary duties are owed to creditors of a solvent corporation. The general rule is that directors do not owe creditors duties beyond the relevant contractual terms.

When a corporation becomes insolvent, or approaches insolvency, directors of such a firm still do not owe any particular duties to creditors, but continue to owe fiduciary duties to the corporation for the benefit of all of its residual claimants, a category which includes creditors. They do not have a duty to shut down the insolvent firm and liquidate its assets for distribution to creditors – although they may make a business judgment decision that this is indeed the best route to maximize the firm’s value. If the board of an insolvent corporation, acting with due diligence and good faith, pursues a business strategy that it believes will increase the corporation’s value, but that also involves the incurrence of additional debt, it does not become a guarantor of that strategy’s success. That the strategy results in continued insolvency and an even more insolvent entity does not in itself give rise to a cause of action.Disinterested directors therefore continue to be substantially protected from ex post facto second-guessing by courts and other constituencies by the business judgment rule, even if the corporation is insolvent.

Decisions made by officers and directors of corporations typically have not subjected the individuals to personal liability. Even if an officer or director makes what turns out to be a bad business decision, such decision does not render the person liable.

The duty of care that an officer or director must exercise relates to the diligence that the person uses to make decisions. In order to fulfill this duty, it is strongly recommended that an officer or director follow several practices, including the following: (a) regularly attend board and committee meetings; (b) remain informed about the business and affairs of the corporation; (c) rely on information provided by others, such as reports, financial statements, and opinions; and (d) make inquiries about problems that may arise with respect to the corporation.

The responsibilities of the board are separate and distinct from those of management. The board does not manage the company. To inform its decisions, a board relies on materials prepared by management. The “duty of care” requires that directors make decisions with due deliberation. A “duty of care” is violated when a director has committed gross negligence by failing to inform him- or herself fully and in a deliberate manner.

Under the “business judgment rule,” a court will not second-guess a board’s decision if such decision was made (a) on an informed basis, (b) in good faith, and (c) in the honest belief that the action to be taken (or not taken) was in the best interest of the corporation. Directors are given the presumption that the business judgment rule has been satisfied unless the directors are interested/engaging in self-dealing, lack independence, are shown to not be acting in good faith, or reach their decision through a grossly negligent process. Thus, where a board (a) followed a reasonable process under the circumstances, (b) took into account the key relevant facts, and (c) made its decision in “good faith,” the board will generally be insulated from liability related to a particular decision or action it takes. Note that acting in “good faith” requires, among other things, that the board act in advancing the best interests of the corporation, without conflicts of interest, and without demonstrating a disregard for its duties such as by turning a blind eye to issues for which it is responsible.

Successful Chapter 11 reorganizations can be very difficult to achieve–especially in certain industries, such as retail. The time within which the debtor must turn things around has been shortened by the Bankruptcy Code’s deadline by which to assume or to reject unexpired leases. Further, in retail cases, secured lenders are very conscious of the required timing of a potential liquidation sale if a successful turnaround cannot be achieved. It is necessary to capture the right season for a sale. The fourth calendar quarter may be best. The third calendar quarter may be worst. Landlords become most aggressive in wanting their stores back in order to fill a “dark hole” for the critical fourth quarter–which means a lead time to retrofit the store for a new tenant. Despite the tools that the Bankruptcy Code provides, it is a race against the clock with impatient lenders and impatient landlords. We are not blaming them.

The creditors’ committee and the Bankruptcy Judge want to facilitate job preservation and also the retention of a customer, but those goals may not be achievable in the face of ongoing operating losses and in the face of lenders and landlords who have witnessed a relatively low success rate in retail Chapter 11 case.

Sears, Forever 21, and TRU are examples of recent “administratively insolvent” cases. In each of these recent cases, the company was left with insufficient funds to satisfy post-petition claims. So vendors that sustained losses prior to the petition date got burned a second time when they were unable to be fully paid on account of goods and services supplied to the debtor after the bankruptcy filing.

Allegations in the TRU complaint include that the board was inattentive to the likelihood of growing administrative insolvency and/or that the board knowingly permitted management to incur additional indebtedness–including continued purchase of new product–when it should not have done so. The TRU complaint also alleges that the board gave direction to obtain additional credit from vendors at a time when the board knew that such credit could not be repaid.

Should the board be liable, and if so, what should the plaintiffs be required to prove?

In each of the Sears, Forever 21, and TRU Chapter 11 cases mentioned above, there was a chief restructuring officer (CRO) retained by the debtor who was accountable to the board. CROs are engaged so that management can focus on turning around the business rather than on the day-to-day handling of the Chapter 11 case. CROs are presumed to know the rules of Chapter 11 – one of which is that a debtor must remain “administratively solvent,” i.e.,maintain sufficient assets to satisfy all obligations incurred from and after the bankruptcy petition is filed. Counsel undoubtedly knows that.

The debtor is not expected to become profitable instantaneously on the petition date. But after a fair opportunity to prove that a turnaround is possible (i.e.,more likely than not to occur based upon current knowledge and reasonable assumptions), the debtor should not be falling increasingly behind on its administrative liabilities beyond the point of no return. That allegedly happened in the TRU case. We have no inside information. The Delaware Chancery Court in a recent case[ii]held that “directors cannot be held liable for continuing to operate an insolvent entity in the good faith belief that they may achieve profitability, even if their decisions ultimately lead to greater losses for creditors.”

Therefore, it would be bad precedent to hold the TRU board liable if the TRU board asked the right questions, received reasonable answers, and relied on management and/or the CRO without a basis on which to disbelieve or distrust management or the CRO. A board is not a guarantor of results promised by management. Board membership of distressed businesses should not be discouraged.

It is appropriate for the board to rely on a CRO and other restructuring professionals to keep the board informed of when the debtor is getting too far out on the limb. That is a principal function of the CRO. The CRO is the bankruptcy business/finance expert who is charged with overseeing the debtor’s business and financial affairs as they relate to compliance with the Bankruptcy Code and Bankruptcy Rules. The CRO is typically part of the interface between management and other professional advisors. It is the task of the CRO to rein in management and to alert the board if the debtor is making purchases beyond its reasonably likely ability to pay, but even in such situations, if making such purchases/incurring such debt is based on the good faith belief that incurrence of such debt in the short term will ultimately maximize value for all creditors (and potentially yield sufficient funds to satisfy such obligations), such actions, if properly informed, could be protected under the business judgment rule. It is the job of the CRO to ensure that unsecured creditors are not unfairly being taken advantage of–including in favor of a debtor’s secured creditors–in order to buy time to get a deal done that does not maximize value for the corporation and all of its creditors. At a minimum, the CRO must ensure that the board is aware when the CRO believes that additional debt is being incurred beyond a company’s ability to repay such debt.

A prudent board of a company in Chapter 11 bankruptcy should require of management, and especially of the CRO and other bankruptcy/restructuring professionals, regular reporting, including but not limited to the following:

  1. Accrued post-petition liabilities to vendors, employees, taxes, etc.
  2. Accrued post-petition professional fees (net of “carve outs” from the secured lenders)
  3. Outstanding purchase orders for goods not yet received
  4. Goods in transit/awaiting acceptance by the debtor
  5. Rolling payments to vendors versus accrual of additional liabilities–is the net number increasing?
  6. Projections of further expense reductions to improve cash flow
  7. Projections of income and expenses on an accrual basis, excluding Chapter 11-related expenses
  8. Projections of cash flow, including Chapter 11-related expenses
  9. Actual to projected results of cash flow and of operations
  10. YOY results
  11. Outstanding and future quarterly Chapter 11 operating fees owed to the United States Trustee (which fees are now assessed at 1% of quarterly disbursements for all amounts disbursed greater than $1 million (capped at $250,000 per quarter).
  12. Outstanding liabilities for “20 day” Section 503(b)(9) claims.

It is the job of the board to challenge the reasonableness of assumptions underlying projections. The board should obtain the input of the CRO and other bankruptcy professionals/advisors as to whether management is realistic or overly optimistic. The CRO and other bankruptcy professionals/advisors have the most credibility, on which the board should rely in this regard.

What are the limits to be established by the board on unpaid/unpayable administrative claims? It should not be zero. Businesses do not turn around immediately upon commencement of a Chapter 11 case. But the board should, after consultation with the CRO and management, inquire of management what will be the guardrails not to be breached absent extraordinary (positive) circumstances or a good faith belief that doing so will maximize the value of the corporation for the benefit of all stakeholders, including creditors.

Assuming that a board has abided by the protocol described above, it should be insulated from liability for administrative insolvency – unless the board knowingly or unreasonably permitted or directed unreasonable excesses. If the board asked the right questions, received the right reporting, and reasonably relied on the CRO and management, the board should not be liable. And, when it comes to “reasonableness,” the board should not be second-guessed by Monday morning quarterbacks unless the board’s reliance was reckless or evidenced self-dealing or other personal gain, the antithesis of maximizing value for the company and all of its residual stakeholders.

[i]See Bloomberg News, Toys ‘R’ Us Creditors Sue Directors and Private-Equity Owners, available athttps://www.bloomberg.com/news/articles/2020-03-13/toys-r-us-creditors-sue-directors-and-private-equity-owners.

[ii]Quadrant Structured Prods. Co. v. Vertin, 115 A.3d 535, 547 (Del. Ch. 2015).

For an excellent treatment of the topic, see

  • Columbia Law School Millstein Center for Global Markets and Corporate Ownership, Fiduciary Duties of Corporate Directors in Uncertain Times, Ellen J. Odoner, Stephen A. Radin, Lyuba A. Goltser, and Andrew E. Blumberg (August 2017).
  • Thomson Reuters Practical Law Bankruptcy, Crucial Steps to Be Taken by the Board of Directors of Financially Troubled Companies (2016).
  • Westlaw Journal Bankruptcy, Nearing the End Zone: Developments in the ‘Zone of Insolvency’ (2016).
  • ABI Journal, The Fiduciary Duties of Directors of Troubled Companies, Marshall S. Huebner and Darren S. Klein (Feb. 2015).
  • In North American Catholic Educational Programming Foundation, Inc. v. Gheewalla, the court summarized the duties of directors of solvent corporations. 930 A.2d 92, 99 (Del. 2007). These duties were further clarified and explained by the Delaware Chancery Court in Quadrant Structured Prods. Co. v. Vertin, 115 A.3d 535, 547 (Del. Ch. 2015).

Reprinted with permission from the April 2, 2020, issue of Global Banking & Finance Review. © 2020 GBAF Publications Ltd. All Rights Reserved. Further duplication without permission is prohibited.

No one wants to consider bankruptcy. But as the downturn persists, CFOs will benefit from understanding their lenders' tactical goals.

If you haven't thought about how to position your company for bankruptcy protection, now is the time. For many companies, the $2.1 trillion stimulus package, and other steps the federal government has taken, won’t be enough to keep business afloat as people stay home to limit the spread of the coronavirus.

The first rule for you, as CFO, is to understand negotiations typically favor the lender from which you seek post-petition financing, otherwise known as debtor-in-possession financing. For that reason, going into the bankruptcy process with visibility into the ways lenders will try to leverage their position can help you respond in the best way possible.

Companies in chapter 11 seeking debtor-in-possession (DIP) financing, or to spend the proceeds of accounts receivable that have been pledged to them (their cash collateral), must obtain bankruptcy court permission. You submit a motion to the court, along with your budget, and explain how you want to use the financing. The typical DIP financing term is 13 weeks. 

Administrative claims

In your DIP request, you're seeking to show you'll have funds to pay claims that arise after you enter chapter 11. These are known as administrative claims. However, some claims incurred before bankruptcy have administrative status, too. Section 503(b)(9) of the bankruptcy code states that claims of vendors for goods received within the 20 days before the bankruptcy also have administrative status. This is a relatively new provision intended to discourage you from "loading up" on a lot of goods on the eve of bankruptcy.

In the budget negotiations, the lender wants to restrict your spending to uses that benefit its collateral and which are the minimum necessary for your operations. You're seeking enough dollars to operate your business and, you hope, reorganize. The lender, though, has a great deal of leverage over you in the budget negotiation; it knows that a protracted fight over financing can impair your ability to stabilize your business.

That means some of your requests will be denied, possibly including money for more inventory purchases, professional fees, capital expenditures, payment of 503(b)(9) claims, or for your critical vendors. Those are the vendors you believe you must pay despite the commencement of bankruptcy or else risk being further damaged.

Part of the negotiations involves concessions you’re willing to make to the lender in exchange for getting DIP financing without a destabilizing and costly battle.

Negotiations, rollups and preferences

On the negotiating table for lenders are non-default interest rates, default interest rates, commitment fees, unused line fees, monitoring fees, early termination fees, maturity dates, letter of credit fees, and whether any debtor assets that previously were unencumbered will become subject to the lender’s liens and security interests. 

A common practice, called a rollup, is when you establish a new loan facility upon bankruptcy and the funds borrowed are used to pay off your pre-petition loan. Eventually, the pre-petition loan is repaid and only the post-petition loan is outstanding.

This benefits lenders who obtain a security interest in your assets not previously encumbered. But how much is the additional collateral worth and how does that value compare with the additional dollars being lent by the lender?

A rollup can be a disguise to improve the lender’s position at the expense of your unsecured creditors. Look at it carefully, because it might be too expensive when the value of new collateral is compared to the amount of new money to be borrowed.

You should consider analyzing whether you're better off seeking to use cash collateral (the dollars you receive each day from proceeds of receivables) and letting the bankruptcy judge determine what protections the lender is entitled to.

Lenders usually seek a security interest in avoidance actions, also known as preferences. These preferences are claims you have against your own vendors to recover payments (outside the ordinary course) made during the 90 days preceding the date of bankruptcy.

In other words, a price for the lender financing your operations is that the lender will receive the proceeds of claims against your unsecured creditors. Many courts will not permit this. But the practice is not unheard of in certain circumstances. When being asked to extend post-petition trade credit, a vendor may condition credit on a waiver of preference claims, if any.

Unused line fees

Another key concept revolves around unused line fees, which are the fees paid for money that you’re permitted to borrow (with certain conditions) but don't actually borrow. A lender may provide a $10 million credit line, for example, but it’s conditioned on you having sufficient working capital (accounts receivable and inventory) to justify the advances under agreed-upon advance rates.

Additionally, be wary of oversized bankruptcy loans. This is when the stated loan-facility amount far exceeds the amount you’re projected (or able) to borrow. Having the extra can sound like a positive but you pay a fee for the excess. 

It's also important to remember that when calculating the cost of money, you should not simply look at the rate of interest. The question is how much will be borrowed and what will be the aggregate of interest plus all of the extras. When fees are added to interest, and when the loan will be outstanding for a limited time, the total amount of dollars paid to the lender during the life of the loan divided by the amount of dollars actually borrowed from the lender can dwarf the stated interest rate.

There's also the matter of administrative claims. Lenders typically won't approve a line item in the 13-week budget for 503(b) (9) claims. As a result, if the chapter 11 case fails, there is risk of such administrative claims not being paid in whole or in part.

Track lenders’ progress

A 13- week budget is prepared on a cash basis rather than on an accrual basis. Thus, it is difficult to determine profitability. However, when the budget reflects the weekly borrowing base, there is some insight into whether your business is continuing to erode.

The prudent creditors committee in a chapter 11 case will demand information on sales (versus receipts), margins, backlog, year-over-year performance and will drill down to get to your "normalized" operations post-petition. Normalized operations are operations without all of the baggage of the bankruptcy – professional fees, court costs, filing fees, extra bank fees, and so on. They also may be a snapshot of your company as if it were not still burdened by assets or businesses held for sale. 

The United States Trustee (part of the Department of Justice) oversees the administration of bankruptcy cases. One of its requirements is the filing of monthly operating reports. These reports usually are on a cash flow basis. They should not be heavily relied upon for an accurate picture of your post-petition operations. They don't provide much insight into the level of risk in providing post-petition credit.

DIP budgets tend to be constructed on a conservative basis with regard to things like the amount of post-petition credit expected and revenues. There’s typically a temptation on your part to tell the lender and the creditors committee that it beat its budget, but beating your budget is not all that significant; it can simply be the result of timing differences or very conservative assumptions. 

Finally, financing in chapter 11 is subject to default triggers. These include exceeding permissible line item variances in the budget, exceeding the permissible variance in the overall budget, or missing milestones required as a condition to continued financing. 

The milestones can include a deadline to obtain a contract of sale for the business, deadline for filing a plan of reorganization, deadline by which to commence a liquidation, and so on. Re-evalute the amount of post-petition credit, and when that credit should be reeled in, when approaching key milestones.

This might seem like a lot to understand. But amid our latest bout of economic turmoil, it makes sense to prepare to navigate the complexities of the bankruptcy process with an eye on what the lenders' goals are. 

Reprinted with permission from the April 4, 2020, issue of CFO Dive. © 2020 Industry Dive. All Rights Reserved. Further duplication without permission is prohibited.

To see our other material related to the pandemic, please visit the Coronavirus/COVID-19: Facts, Insights & Resources page of our website by clicking here.

At the moment, the bankruptcy court may be an unfriendly place for impatient lenders.

As the United States and much of the world reel from the coronavirus pandemic, many businesses’ revenues have been shut off (or close to it). Employees must stay home, and customers are holding back payments. Companies looking to make it out of these dark times need to remember a few things.

Avoiding running out of cash and preserving liquidity is a top goal. There are a few related questions, including whether vendors will give better terms for purchases until businesses can recover. Additionally, banks, vendors, and landlords expect timely payments.

For many companies, the questions are who to pay, how slow or fast to do it, and in what pecking order. Negotiating with all stakeholders is imperative, and it starts by looking at the likely worst-case outcomes for each party. Chapter 11 can be a valuable restructuring tool, but it can be costly for all stakeholders.

Unsecured creditors. For unsecured creditors (vendors), the alternative to working cooperatively with companies is litigation. Today, in any state court, cases will move at a snail’s pace. Vendors will spend valuable dollars on legal fees but may not see a recovery until long after the debtor would have paid them under a compromise. That means vendors are better off permitting the debtor to term-out payments.

Further, in Chapter 11, the recovery to unsecured creditors likely will be less after accounting for Chapter 11 costs, the delay in payment caused by Chapter 11, the relatively low success rate in Chapter 11, and the associated devaluation of the debtor’s assets.

Landlords and tenants. Second only to employee costs for many service providers is rent. Astute landlords likely anticipate tenants withholding rent, but tenants must be proactive — and notify the landlord of predicaments and intentions. The landlord will remind tenants that it has debt-service obligations, insurance, and taxes to pay.

Tenants should advise the landlord of all measures taken to reduce costs. The landlord does not want to shoulder the entire burden, and they may threaten to exercise default remedies and lease termination. But state courts during the pandemic (and during recessions) are unlikely to process landlord/tenant actions quickly.

In addition, building and property owners will be hard-pressed to rent vacant space in a recessionary economy — which means they will not want to lose tenants. Re-renting to new tenants (if available) will cost the owner concessions, to say nothing of having an empty space for an unknown period. Vacant space causes other problems, especially in shopping centers where co-tenancy clauses can enable other tenants to escape leases due to vacancy thresholds being exceeded.

Banks and borrowers. Banks have been advised by regulators to work with borrowers toward out-of-court consensual resolutions of the borrowers’ cash-flow difficulties caused by the pandemic. Banks can declare a default, and that can result in the need to seek relief under Chapter 11 of the bankruptcy code. But, at the moment, the bankruptcy court may be an unfriendly place for impatient lenders.

The bankruptcy court will consider whether the lender’s collateral is eroding during the pendency of Chapter 11 and what the lender’s alternatives are if the bankruptcy court grants the lender relief to take possession of its collateral. Even if the lender’s collateral is declining in value, would it decline more if the bank is granted relief? Does the lender want to win its motion, or is the lender seeking just to improve its position?

A debtor can commence Chapter 11 without the lender’s approval and without the agreement of the lender to provide financing during the proceeding. The debtor also can seek court permission to use cash collateral (cash proceeds of collections from accounts receivable) over the lender’s opposition. The debtor must develop a budget reflecting its ability to operate only on cash collateral proceeds.

Additionally, secured lenders must be cautious about asserting that they are under-secured, and that assertion does not necessarily translate to bankruptcy court relief. No prudent lender wants to go on record at the beginning of a Chapter 11 case as to the value of its collateral, as it may come back to haunt the lender at the end of the case. Technically, a secured lender may be paid only the value of its claim. Further, under the U.S. bankruptcy code, an undersecured creditor is not entitled to post-petition interest or legal fees associated with collection.

Personal guarantees change the case dynamic because the guarantor is worried about a hostile lender pursuing the guarantee despite the corporate debtor’s reorganization. While the commencement of a Chapter 11 case does not necessarily entitle a guarantor to the protections of bankruptcy without the guarantor itself commencing a bankruptcy case, there are bankruptcy code provisions for the bankruptcy judge to enjoin actions against a guarantor under certain circumstances.

During times of a pandemic and the accompanying recession, prudent lenders should not test the willingness of these judges to extend protections to guarantors if the judges have a basis on which to believe that a successful corporate reorganization is feasible and that the guarantor will not dispose of its assets.

We can take lessons from what happened in 2008 and 2009 when bankruptcy judges were sensitive to many economic and social factors.

One such factor is job preservation. Unsecured creditors’ committees and lenders should expect the bankruptcy judge to ask, “How many employees does the debtor have?” whenever they seek to terminate the debtor’s operations. But this does not mean the judge will tolerate protracted losses or a hopeless reorganization.

Chapter 11’s long-term success rate is not high. And changes in the marketplace make reorganizations in specific industries — such as retail — particularly tricky. But few debtors will say that using the tools available in Chapter 11 is not worth it. Understandably, debtors are optimistic, especially given the typical preexisting investment of time, effort, and money.

However, Chapter 11 is expensive as there are numerous stakeholders. Each stakeholder will retain professionals. Each will seek to be paid by the debtor, meaning precious capital gets diverted from the business. Also, bankruptcy diverts management’s attention, reduces going-concern value, reduces brand (intellectual property) value, and makes normal operations more difficult — whether in attracting new sales or procuring goods on credit. Nevertheless, Chapter 11 cases often happen if creditors give the debtor no reasonable options.

It is far better for vendors, debtors, and secured lenders to develop consensual solutions. Regardless, a clear understanding of everyone’s downside paves the way to mutually beneficial compromises.

Reprinted with permission from the April 3, 2020, issue of CFO. © 2020 CFO. All Rights Reserved. Further duplication without permission is prohibited.

To see our other material related to the pandemic, please visit the Coronavirus/COVID-19: Facts, Insights & Resources page of our website by clicking here.

The Covid-19 pandemic has shut down most of the economy and retailers are among the businesses that could be closed for months. Even when they reopen, they will have suffered devastating losses of revenue.

For most of these companies, the biggest fixed expense is rent -- which means many will consider asking their landlords for some relief. Before they do that, they should develop a strategy for the upcoming negotiations built on understanding landlords’ needs, limitations and psychology.

Here are some tips for doing just that:

Think Like a Landlord

Recognize the landlord’s perspective. A single company might have many tenants, and providing relief to you could set a bad precedent. The landlord does not want to make individual, one-off judgments about relief as doing so could open up a Pandora’s Box. Every tenant will assert (perhaps truthfully) that its situation is unique. But most landlords won’t want to be expected to sort through the differences from multiple tenants.

That said, you should prepare to disclose financials (subject to a nondisclosure agreement) if your landlord wants to see them. The landlord’s representative must demonstrate to their boss that relief is justified, so holding back information makes your request less credible.

You also should be able to demonstrate that you’ve trimmed costs by cutting expenses, furloughing employees, reducing salaries and stretching out trade vendors. The landlord probably won’t help a tenant that has failed to seek relief from all stakeholders.

Consider the Tenant Mix Around You

Your landlord probably has its own institutional indebtedness, and it may have default covenants triggered when a minimum level of occupancy is not maintained. It also has other tenants that likely have co-tenancy provisions permitting exits from leases if overall occupancy drops below a certain level. If you’re seeking to surrender premises rather than a rent reduction or deferral, you should recognize that the landlord cannot risk cascading tenant losses.

Also, think about how important you are to the landlord. What would be the impact on other tenants if your space became a “dark hole?” How large are you in terms of percentage of aggregate square footage? How large are you in terms of percentage of aggregate square footage in the landlord’s portfolio of properties? How long would it take to replace you as a tenant?

Be Creative in Your Requests

If your financial condition is strong and you have sufficient liquidity, you might be able to agree to a creative but mutually beneficial arrangement with your landlord. Given that many retailers may be unable to pay rent and that the pandemic will inevitably hit the landlord’s cashflow, you could be positioned to obtain a present-value discount for prepaying rent.

If the occupied mall location performs well for you in a normal economy, consider offering the landlord a lease extension in exchange for interim relief. And, if your location is desirable, consider offering to move to another spot as part of a relief package.

Sometimes, a short period of interim relief is easier to achieve with a promise to revisit the situation later. But if you prefer longer-term help, consider a provision enabling the landlord to recapture some of the relief if revenue exceeds projections.

This is an instance where sharing financials, including sales figures pursuant to a nondisclosure agreement, can be helpful if you can provide with additional payments when you exceed projected results. It is preferable to work from a percentage of sales minus returns and allowances in these cases. Working off cashflow or net income invites too much inquiry and verification effort by the landlord. 

Besides rent concessions, what can the landlord otherwise provide? Review the lease against your strategic plan and consider paying full rent now (or close to it) in exchange for concessions that should be valuable when business returns to normal. If the tenant mix has changed, can your lease permit the sale of additional products? Can your hours of operation be amended? Are there other restrictions that can be loosened?

And a most-favored-nation clause is worth asking for -- especially if you are told that the landlord’s offer is the best that any other tenant is receiving.

Leverage Your Size (if You Can) and Understand the Moment

If you lease multiple properties with the landlord, assess how many are profitable, marginal or loss-generating. You could offer full rental payments on the historically profitable stores and extensions of those leases in exchange for relief on the other stores.

If you have unprofitable stores in a property that is profitable for most other tenants, you could surrender the underperforming locations in exchange for relief elsewhere. You also could package the surrender of some good locations with those that are underperforming. The landlord might value locations differently than you do.

It’s also important to remember that the property owner does not want to spend on legal fees and that bankruptcy judges are sympathetic to business owners affected by situations out of their control, especially in unprecedented moments. In other words, understand the landlord’s risk when it comes to pushing you into bankruptcy while being careful to not overplay your hand.

Find out if the landlord has a security deposit or letter of credit that can cover rent in the near term. The landlord can tack on additional rent over the remaining life of the lease to replenish the security deposit. A draw on a letter of credit might be much more difficult for a struggling retailer if it will trigger other consequences from an already nervous lender.

You also should review your insurance coverage for force majeure applicability. If there is coverage, what amount should be anticipated -- it’s possible that it can be pledged or assigned to the landlord in exchange for interim relief.

Businesses are in a perilous moment, especially bricks-and-mortar retailers that were struggling even before recent events. They need to be smart and strategic right now, especially if they ask for help from landlords -- who typically hate making rent concessions.

Reprinted with permission from the April 13, 2020, issue of Chain Store Age (CSA). © 2020 EnsembleIQ. All Rights Reserved. Further duplication without permission is prohibited.

To see our other material related to the pandemic, please visit the Coronavirus/COVID-19: Facts, Insights & Resources page of our website by clicking here.

With a host of commercial real estate owners likely to declare chapter 11 bankruptcy as a result of the coronavirus pandemic, organizations that lend to these companies should keep one thing in mind: bankruptcy court judges are aware of the unprecedented economic damage of COVID-19—and they handle cases as such.

In good times and bad, there are many ways a commercial real estate owner might end up in bankruptcy—loss of a major tenant, inability to lease a property in the time period originally projected, construction delays, construction cost overruns, etc. Lenders tend to act quickly once the filing happens and they often seek relief from the automatic stay implemented at the commencement of the bankruptcy. If it’s granted, they can move forward with foreclosure proceedings in state courts and obtain clear title on the property. 

The bankruptcy court judge, in making the decision about the relief, considers a host of factors, including the value of the property compared with the amount of indebtedness secured by the property. The lender will assert that the equity cushion—the difference between the value of its collateral and the amount of the claim—is negative (or rapidly declining) and thus demand “adequate protection payments” to be kept at bay. That, of course, would defeat the reason why the borrower sought bankruptcy protection in the first place. 

There’s also the thorny issue of valuation, namely whether the property should be valued in the current moment or based on a fair assumption of the property’s worth when market conditions improve. Valuation in a “once in a hundred year” market doesn’t make sense, and a lender could conceivably take advantage of other large parties in interest who also have large stakes in the property. Regardless, the drafters of the bankruptcy code never anticipated the shutdown of the economy that we are seeing. 

Additionally, the bankruptcy code was designed to preserve value whenever reasonably possible, which is inconsistent with permitting foreclosure at the bottom of the market. Bankruptcy judges should (and probably will) ask the question “What can the lender do with the property that the borrower is not doing?” If the borrower is a mall operator—and the lender is not—the answer is fairly obvious. 

With all of this as a backdrop, lenders should remember that bankruptcy judges take current events into account in their decisions during times of economic hardship—particularly in unprecedented moments. We saw that after the Sept. 11, 2001, terrorist attacks and after the global financial crisis. 

Generally speaking, equitable considerations prevent bankruptcy judges from contravening express provisions of the bankruptcy code. But they do exercise the equitable powers granted to them to provide relief where Congress has been silent or to further the congressional intent behind the code. And while these judges are bound by precedent, they also understand business and finance—to say nothing of current events. 

Judges also appreciate alternative dispute resolution procedures such as mediation or settlement conferences and they know how to control their calendars and interpret the law to bring about a fair outcome. We’ve already seen examples of this sort of discretion from bankruptcy judges in the early days of the coronavirus pandemic. 

Recently, some wise jurists permitted chapter 11 cases to be suspended when the borrower couldn’t control its circumstances and environment amid the COVID-19 pandemic, which is far from unusual these days. Some of these decisions have occurred when granting the lender relief that it seeks would not necessarily benefit the lender—or would disproportionately benefit the lender at the expense of other parties. 

Those instances showed judges who were being wise and fair, and it lends credence to the idea that bankruptcy judges are a combination of social workers, financial engineers and lawyers. 

Those qualities are especially important in unprecedented moments like the one we’re living in. And if the proper message is sent clearly to real estate lenders, they will properly calibrate their actions regarding bankrupt properties—and possibly avoid some messy disputes. 

Reprinted with permission from the April 21, 2020, issue of GlobeSt.com. © 2020 ALM Media Properties, LLC. All Rights Reserved. Further duplication without permission is prohibited. ALMReprints.com – 877-257-3382 - [email protected].

To see our other material related to the pandemic, please visit the Coronavirus/COVID-19: Facts, Insights & Resources page of our website by clicking here.

Many borrowers already have drawn down much or all of their available credit line in order to have the liquidity to ride out the COVID19 pandemic. Other borrowers are contemplating doing the same.

It may be too late. Lenders have begun to restrict such borrowings. Most loan documents have a provision that provides the lender with discretion over whether to fund a borrowing request.

Lenders are increasingly concerned about the value of their collateral and about their ability to liquidate collateral in the event of a borrower's default. Borrowers, unable to survive without a credit line, have no choice but to accommodate their lender’s concerns.

Rather than risking covenant default when financial results are published, prudent borrowers should anticipate their operating results as well as the bank’s reaction and be proactive in demonstrating that the borrower has a feasible plan to improve what would otherwise be in the borrower’s reporting package.

Lenders expect their borrowers to take appropriate measures to avoid putting at risk the collectability of their borrower’s obligation. Lenders want to see that executives have reduced compensation, that all expenses — including payroll — have been appropriately reduced and that the borrower is seeking relief from unsecured creditors.

This includes seeking retroactive vendor discounts, deferred payment terms and return of goods.

Many retailers are stocked with spring merchandise but now may lose the entire spring season. Their stores will eventually open up – probably in time for the summer season to commence. Moreover, they may be compelled to take large markdowns on spring goods in order to replace those goods with subsequent seasons’ merchandise. For the lender to a retailer, this means that the value of its collateral will be less than anticipated. The only question is one of degree.

For the retailer who takes widespread markdowns, this risks eventually providing its lender with operating results that may trip a loan covenant and thereby result in the lender restricting additional borrowing or demanding more collateral. The same outcome applies to non-retailers whose sales have been suspended.

Some businesses may respond by asking their vendors to term out or discount pending unpaid novices. Other businesses that have sufficient clout may seek to return goods to vendors for credit. For a retailer that is a major customer of a manufacturer, the manufacturer may have few options but to accept retroactive discounts or to accept returns. The supplier may be reluctant to risk the loss of future business.

Return of goods or retroactive discounts are superior to terming out vendor payments for what have or surely will become slow moving goods. It has less impact on the borrower’s income statement.

However, lenders may be opposed to returning goods because doing so reduces the lender’s collateral. Consequently, returning goods in exchange for new merchandise- even if the credit is for somewhat less than the full invoice amount of the returned goods, will be more palatable to the lender.

Borrowers must evaluate on a one-off basis their ability to return merchandise or obtain retroactive discounts. Is the borrower essential to the vendor's business? Is the vendor readily replaceable by the borrower on a going forward basis? Does the vendor have pending purchase orders for programs for future seasons? Will the vendor likely commence litigation if it is not paid or if goods are involuntarily returned?

When negotiating returns or retroactive discounts with vendors, remember that they have their own vendors to pay. They need to resell the goods that are returned. So, in evaluating what goods to return, the borrower should take into account the ability of its vendor to resell the goods that are returned.

Goods out of season in one market may not be out of season in another market. Moreover, some goods are not seasonal; so, the manufacturer may only need to warehouse the goods pending future sales. The vendor also may be willing to accept the return of certain least desirable goods if the customer includes other, more desirable goods in the return, which enable the vendor to better resell the less desirable, returned goods.

If a borrower is unable to make returns or has finished goods that are seasonal, those goods should be promoted first. Seasonal inventory should be cleared out rather than conducting general sales promotions.

Goods which have the borrower’s name on them or packaging with the borrower’s name will be more difficult to return because the manufacturer probably will be unable to replace labels or packaging because it is not worth the cost or effort.

It is likely that credit markets will tighten for non-investment grade borrowers despite the federal government passing the CARES Act. Borrowers with lower credit ratings may find it more difficult to replace existing lenders - which are becoming increasingly risk-conscious and which already have excessive troubled loans in need of restructuring. Therefore, retaining one’s existing lender is of paramount importance.

In the event that the existing lender seeks to terminate its lending relationship, the borrower should have an analysis demonstrating that, with modest relief and an action plan based upon reasonable assumptions, the borrower can be restored to covenant compliance. This requires a detailed turnaround plan for the borrower.

The borrower should also analyze the likely recovery to the lender in the event that the lender exercises default or termination remedies. What would be the lender’s recovery in the event of bankruptcy or liquidation? Are personal guarantees sufficient to make up the shortfall? Will the lender have an ability to liquidate its collateral at fair values given current market conditions?

The CARES Act enables banks to carry loans that would otherwise be deemed troubled loan restructuring (TLRs) as if they were normal performing loans. However, ultimately, a loan that is not repaid eventually impacts the balance sheet and income statement of the bank. Consequently, even short-term relief favored by bank regulators should be premised upon a turnaround plan.

The key to survival in a recession is to anticipate a lender’s every move and every question. Be proactive in doing the things that the lender will want to see happen. You will accomplish those things faster if you understand the thinking and the limitations of your lender and of your vendors.

Reprinted with permission from the April 24, 2020, issue of Chain Store Age (CSA). © 2020 EnsembleIQ. All Rights Reserved. Further duplication without permission is prohibited.

To see our other material related to the pandemic, please visit the Coronavirus/COVID-19: Facts, Insights & Resources page of our website by clicking here.

A consequence of the COVID-19 pandemic is that many companies are unable to operate their businesses partially or completely. As a result, they have been compelled to seek relief from their landlords, vendors and lenders.

This has imposed tremendous strain on property owners which themselves have debt to service. In order to preserve precious liquidity, property owners may need relief (deferral, forbearance, restructuring, extension) from their lenders and real property owners may consider withholding payment on their mortgage indebtedness.

Now is the time for owners of real estate to review their mortgage documentation, especially with regard to the assignment of rents. Defaulting on mortgage indebtedness can divest the owner of the ability to use the rental income and place the owner in a weaker bargaining position with its lender. Furthermore, it may make a Chapter 11 reorganization more difficult.

A commercial mortgage lender often obtains a direct interest in the rents flowing from income producing property [that it has financed] to itself in the event of the borrower’s default. An assignment of rents – a standard loan document or component of the mortgage or security agreement – assigns the property’s leases and all rent and other income to the mortgagee. In addition, it is also common for all rent and other income to be required to be deposited into a dedicated lockbox account that is pledged to the lender. In many instances, the assignment is automatic and default notice is not required.

There are three general types of rental assignments: (a) absolute assignment, (b) absolute assignment conditional upon default, and (c) assignment for security purposes. However, only absolute assignments commonly are used in commercial mortgages today.

The absolute assignment is an assignment of all leases and rents that immediately transfers to the lender the right to receive rents from the encumbered property for the term of the mortgage. When an absolute assignment is used, the lender typically grants the borrower a license to collect the property’s rental income until some triggering event.

The mortgagee’s rights under an assignment of rents clause depends upon, among other things, the state’s interpretation of mortgage law, which will determine to what extent the agreement negotiated by the parties will be enforced and to what extent the mortgagee will be able to reach the rents of the encumbered property.

Does the mortgage loan provide for cash management provisions that require tenants to pay rent into a dedicated lockbox, and, if so, does the lender have the right to cut off the borrower’s access to those funds in the event of a mortgage default? Commercial mortgage loans often include hard or springing lockbox protections for the lenders. A hard lockbox prohibits the borrower from having unfettered access to the rents and other income on day one of the loan, a springing lockbox cuts off the borrower’s access upon the occurrence of a trigger event, like a payment default or a breach of a financial covenant.

The majority of states take the approach that the parties may bargain for a provision granting the mortgagee a right to rents and profits upon default. Examples of triggers are:

  • Failure to make any payment.
  • Failure to perform or observe any term or condition of the mortgage, the note or any other loan document.
  • Any representation, statement or warranty made by or on behalf of Mortgagor to Mortgagee at any time shall be materially incorrect, incomplete or misleading when made in any respect
  • Judgments, warrants or tax liens.
  • Casualty.
  • Any spill, discharge, disposal, seepage or release of any Regulated Substances.
  • Impermissible encumbrance.
  • Covenant breach.
  • Any other typical default.

In Chapter 11, a debtor (borrower) typically will seek permission of the bankruptcy court to use the income (rents) generated by the property for maintenance and operation of the property. However, if the license to use rents was terminated prior to bankruptcy because of the type of trigger described above, the rental income no longer is considered property of the debtor. Therefore, the bankruptcy court is not able to permit its use over the objection of the lender.

Chapter 11 provides powerful tools to a borrower. It is a tool that a prudent borrower should never inadvertently surrender.

Commencement of a chapter 11 case requires advance planning. Moreover, the borrower must anticipate and prepare for the relief that the lender is likely to seek from the bankruptcy court. Being equipped to commence a well thought out chapter 11 case is a valuable tool to avoid chapter 11.

Chapter 11 is not necessarily a panacea for either side. For lenders Chapter 11 may foreclose the ability to receive current interest or principal payments. Bankruptcy judges also may recognize the inequity of granting relief to lenders to enable them to foreclose at a low point in the market. For borrowers, it is a race against time that can be contentious and expensive- especially if the market recovery or property recovery takes an extended period of time.

In coping with Covid19, property owners need to be knowledgeable of their applicable loan documentation – including a rent assignment agreement- before developing a negotiating strategy with the lender. The borrower also should assure that no triggering event occurs without proper planning. Otherwise, the outcome may be very negative.

Reprinted with permission from the April 29, 2020, issue of GlobeSt.com. © 2020 ALM Media Properties, LLC. All Rights Reserved. Further duplication without permission is prohibited. ALMReprints.com – 877-257-3382 - [email protected].

To see our other material related to the pandemic, please visit the Coronavirus/COVID-19: Facts, Insights & Resources page of our website by clicking here.

Understanding the role of the chief restructuring officer has never been more important. Here’s what a CRO can and cannot do.

In recent years, chief restructuring officers (CROs) have increasingly been assigned to assist companies struggling as a result of mistakes by company leaders. But with COVID-19 wreaking havoc around the globe, well-run organizations might soon be forced to work with a CRO.

Besieged by other worries, company leaders might not give that idea much thought. But given that CROs may develop the political power to cause the ouster of chief financial officers, and even chief executives, it’s time to brush up on what a CRO can and cannot do.

CROs are sometimes used as an alternative to a trustee in bankruptcy in a reorganization proceeding. Lenders, bondholders, and other parties in interest often want to bring in an outsider to take steps that are necessary but unpopular. And it’s definitely true that a CRO frees up managers to focus on fixing the business rather than on running the day-to-day Chapter 11 process.

But CROs can come with loyalty to lenders, who often recommend individual CROs and make the appointment of one a condition of cooperating toward a workout or restructuring. This can somewhat understandably lead to CROs feeling indebted to lenders, which means that the debtor’s CFO and other C-suite executives should make sure to have oversight powers.

After they’re appointed, CROs report to the board of directors, who determine the CRO’s powers and authority. As many potential CRO functions are normally performed by the CFO, the CEO, or both, the board and senior management should carefully circumscribe the scope of the CRO’s duties, which need not be delegated all at once. Duties can be added to the CRO’s portfolio at later dates as appropriate.

Further, CRO retainer agreements should lay out the limits of the CRO’s authority. A generic retainer agreement can empower a CRO with an ever-expanding budget and an ever-expanding sphere of influence. The board should limit CRO actions that can be taken without CFO and/or CEO and/or board authorization. The executives who report to the CRO and the persons to whom the CRO reports should be well defined.

There may be an increase in claims against board members when a debtor is administratively insolvent, i.e., unable to pay debts in full that arise after the date of bankruptcy. That makes regular and detailed financial reporting critical for the board to avoid potential individual liability. The CRO must be directed to keep the CFO, CEO, and the board informed as to outstanding post-bankruptcy liabilities and the ability of the debtor to honor them. The board is entitled to rely on the CRO for comfort that the debtor does not unreasonably reach the point of administrative insolvency.

That said, lenders typically have clout over a debtor. A forbearance agreement and the lender’s willingness to provide continued funding may be tied to specific borrowing-base formulae and to covenant compliance. Boards and C-suite executives should also recognize the CRO’s motivation out of the loyalty noted above and the possibility of future referrals.

The debtor’s CFO is management’s and the board’s key interface with the CRO in assuring that the company has obtained the best deal with lenders. Lenders often request that the CRO be permitted to speak and to provide information to the lender outside the presence of management. The danger there is obvious. No information should flow from the CRO to the lender or other adversaries without the prior sign-off from management, which is typically the CFO and/or CEO. Despite the CRO’s expertise and diligence, the risk of errors, omissions, or incorrect assumptions on which the lender and others will rely is too great. At a minimum, disputes with the CRO should be noted.

Obviously, no company wants to be in the position where bringing in a CRO is even part of the discussion. But give the economic realities that many organizations now face, understanding how CROs work has never been more important.

Reprinted with permission from the April 28, 2020, issue of CFO. © 2020 CFO. All Rights Reserved. Further duplication without permission is prohibited.

To see our other material related to the pandemic, please visit the Coronavirus/COVID-19: Facts, Insights & Resources page of our website by clicking here.

Now is the time to be extra vigilant and to carefully watch over the creditworthiness of your customers. Assume that all of your customers are in, or soon will be in, financial distress. If they have not called you yet to seek relief, they probably will do so very soon. It is understandable. Almost all companies are partially or fully shut down. And, the ones that are still fully (or close to fully) operational, have their own customers stringing out payment.

Before you extend more credit or agree to term out existing debt, certain questions should be asked in order to properly evaluate your risk. You do not want to be the vendor that provides more collateral for a customer’s bank lender. You do not want to extend credit only to find yourself participating in a bankruptcy or workout at a later date. And, if you already have extended credit, you do not want to be treated inferior to other creditors. So, ask these questions and do not be afraid to probe deeply. If you cannot get answers, there is a reason! It is OK to say that the time is not right for you to give credit if you are not receiving satisfactory answers. It is always a good idea for your customer to know that you will not be taken advantage of.

  1. Are you current with your rent?
  2. How many months are you in arrears?
  3. Have you sought relief from your landlord?
  4. If so, what relief did you seek and what was the landlord’s response?
  5. What percentage of your payables are over 60 days old? Over 90 days old?
  6. Have you sought to term out or discount any accounts payable from your vendors?
  7. Have any vendors sent demand letters or filed legal actions?
  8. Have you asked for relief from your bank?
  9. What relief have you requested from your bank?
  10. What has been the response of your bank?
  11. Are you in default to your bank?
  12. If you have an ABL (asset-based lending) facility, have advance rates been reduced?
  13. Are you in breach of any loan covenants?
  14. Have you signed a forbearance agreement with your bank? Have you been asked to do so?
  15. Have you been asked to sign a pre-negotiation agreement with your bank?
  16. Has the bank asked you for additional collateral?
  17. Are any of your customers seeking to return goods to you?
  18. Have any of your customers sought retroactive discounts on previously purchased goods?
  19. Have you agreed to purchase on consignment from any of your vendors in the preceding 60 days?
  20. Have you given a security interest to any vendors in the preceding 60 days?
  21. Have you asked any vendors to hold up deliveries in the preceding 60 days?
  22. Have you engaged an attorney or financial advisor to assist you in dealing with the current economic situation?
  23. How do your current inventory levels compare year-over-year (YOY)?
  24. How does your current aggregate A/R compare YOY?
  25.  Have customers been cancelling purchase orders? What is the aggregate dollar amount of dollars that have been cancelled in the preceding 60 days?
  26. Have customers asked to hold back shipments on pending orders?
  27. What expenses and costs have you eliminated recently? Aggregate annual dollar amount?
  28. How many employees have been furloughed, terminated or laid off recently?
  29. By what aggregate dollar amount has executive compensation been reduced? By what percentage amount has executive compensation been reduced?
  30. Have you applied for funds under the Federal government CARES Act program? If so, how much did you apply for and have you received a response?

 

Reprinted with permission from the April 30, 2020, issue of eNews. © 2020 National Association of Credit Management. All Rights Reserved. Further duplication without permission is prohibited.

To see our other material related to the pandemic, please visit the Coronavirus/COVID-19: Facts, Insights & Resources page of our website by clicking here.

Periods of uncertainty and distress create many questions that businesses must answer. Will they have the human resources and materials with which to produce goods and perform services for your customers? Will their customers pay their bills? What will their cash flow look like? Can they retain all or most of your employees until things improve? How much can they cut expenses and delay payables so that liquidity does not run out? How much (if any) availability do they have on open credit lines?

For many businesses, lender relief is the first and most critical step to bring immediate financial relief. For other companies, maintaining current lending arrangements and avoiding cancellation of credit facilities due to a default are critical to survival. Either way, communicating early, openly, and honestly with your lender is critical to survival during periods of uncertainty and distress. Below is a suggested approach to addressing your lender, but note that there is no “one size fits all” answer. The unique aspects of every business situation, when taken together with the more global issues, should be taken into account.

Initial Lender Communication Action Plan

  • Reach out now to your lender. Do not wait–even if just to tell your lender the obvious. Your intent is not to cause panic, but rather to gently provide notice that a further discussion of your company's situation may be coming: “We are not seeking relief from the lender at this time. We're closely monitoring the situation. We have implemented an action plan. Stay tuned. We will keep you informed.”

  • Give the lender a detailed list of the things that you have done to preserve cash and to stabilize the business during this period of disruption. Explain that it is an ongoing process to identify further reductions/cost savings. All lenders want to know that you have done everything to help yourself before seeking relief from them (assuming that you plan to seek lender relief at a later date).

  • Lenders do not like surprises. And they especially dislike borrowers who are dishonest, unrealistic, or do not give sufficient notice of a brewing problem. Accordingly, convey one of the following:

    • There is no “crisis” at this time; you have enough liquidity for the time being, but an extended period of little, greatly reduced, or no revenue may cause you to take action to preserve the business, and you are just calling so the lender knows that you are on top of the situation.

    • You already are experiencing a cash flow crisis due to revenue being reduced or shut off, you have developed an action plan to conserve cash, and you would like to walk the lender through that plan.

  • You welcome the lender's advice on how to address your situation and any requests for financial information. You have nothing to hide. Your message is: “We need to work together.”

  • You do not know what your future cash flow will look like, and you are revising your cash flow projections continuously.

  • Given the uncertainties, projected revenue and income in the short term are questions that cannot be answered yet.

  • Prior financial projections should not be relied upon.

  • You are staying close to your customers so as to know what their purchasing needs and plans are. (Lenders expect prudent borrowers to conserve cash until they have a better idea of how the borrower's customers will react.)

  • You are in constant contact with your vendors. (The lender is likely to ask you to stretch out payments to vendors before considering any relief from the lender.)

  • Your business is fundamentally strong. Upon a return to normal business conditions, everything will be fine.

  • If no immediate relief from the lender is needed at this time, note to your lender that it is possible that relief may be required at a later date depending on how economic and business conditions unfold.

  • Keep in mind that the Federal Deposit Insurance Corporation (FDIC) is recommending that financial institutions work with borrowers affected by the Covid-19 pandemic. Lenders should be more willing to work with borrowers that show that their issues are pandemic related and can be resolved with short-term solutions designed to get the borrower through the issues created by the pandemic.

  • Consider taking a draw down on your existing credit line to cover your expenses over the near term before your lender(s) takes steps to restrict availability.

Include Senior Management

The lender will observe which members of the borrower's management team attend any initial meeting(s) with the lender (whether by conference call, videoconference or otherwise). The most senior management of your company (and equity stakeholders, if privately owned) should participate. That demonstrates respect for the lender. The lender takes the matter seriously, and so should you. A seasoned middle-market lender once said that they observe whether the borrower's management is appropriately dressed and whether the guarantor has brought appropriate parties to the bank meeting.

The Role of Borrower's Professionals

  • One of the first things that your lender will observe is who the borrower's legal professionals are and whether the professional has the requisite expertise in restructurings, workouts, and bankruptcy/distressed situations.

  • The lender will also take notice of who is providing financial advice to the borrower and the level of the adviser's experience with distressed situations, especially in the borrower's industry. Lenders prefer dealing with professionals with experience in advising their clients regarding making hard decisions about reducing expenses.

  • The lender will also want to see that management's business practices and assumptions are appropriately challenged.

  • The role of the borrower's professionals is to anticipate every question that may be asked of the borrower and to demonstrate to the lender that the borrower is in control of the situation, including reducing expenses (as may be necessary) and preserving liquidity. The lender also wants comfort that all steps are being taken to preserve its collateral value.

  • Your initial presentation to the lender must anticipate the questions that will be asked. And, the answers must be thorough, with well-based assumptions. Alternatively, clearly state the variables that are unknown or uncertain.

  • A turnaround consultant and/or chief restructuring officer (CRO) works in tandem with management, but reports to the board of directors. A board should take comfort in knowing that a CRO and/or other turnaround consultant is on-site advising and challenging management as appropriate, and that such a professional is not jaded by any specific history and is able to see the forest from the trees.

  • The lender may require that the borrower hire a financial adviser that the lender has worked with in the past and has confidence in.

The Presentation Supporting the ‘Ask’

  • Prepare projections of income and cash flow. These projections may be prepared with a range of conservative, likely, and optimistic scenarios. It is better to hit the low numbers than to miss a single set of presented numbers.

  • For key metrics such as sales, receivable collections, vendor credit terms, and SGA/human resource costs, detailed sub-schedules are appropriate. These sub-schedules should reflect the drivers that could cause the financial projections to be met or missed. They also should reflect that management and its professional advisers have fully considered the projections presented and the need for relief from the lender.

  • With ABL financing, what will the projected indebtedness due to the bank be under each of the conservative, likely, and optimistic projection scenarios, assuming that loan relief is provided and assuming that no loan agreement relief is provided?

  • If you are seeking relief from the lender, including but not limited to increased advance rates, reduced reserves, reduced block, or a payment deferral, project outstanding lender indebtedness under each scenario and if/when you might expect to be able to return to the contractual terms of the current loan agreement.

  • For internal purposes initially, including your overall lender negotiation strategy, prepare a liquidation analysis. What is the lender's collateral worth (net of liquidation/administrative costs and any senior secured indebtedness) if the lender refuses to cooperate? Does the lender really want to accept the responsibility or liability of conducting the liquidation? How would the assets need to be liquidated? How long would it take? What are the likely liquidation sale values? What would be the costs?

Sequential Negotiations

A lender negotiation is not a single-session negotiation. A prudent borrower should not seek to achieve too much too fast. That does not mean, though, that negotiation sessions should be spread out over an unreasonable period of time while the borrower implodes. The sequential negotiations may be expedited. The steps for negotiation should be:

First Contact: Advise the Lender That:

  • A problem has arisen (or that the borrower sees a problem arising in the near future).

  • The borrower is developing an action plan to address the problem.

  • Seeking relief from the lender may be necessary.

  • The borrower will be keeping the lender well-informed.

  • Any information sought by the lender will be provided.

  • The borrower's representatives can and will be introduced.

Second Contact: Demonstrate to the Lender That:

  • Presented financial projections of income, cash flow, etc. have been well-thought out and have sound bases.

  • The borrower understands the lender's concerns and how the lender prefers to address the borrower's problem–to the extent feasible.

  • The borrower is taking appropriate action to solve its problems, such as cost cutting.

  • Other constituents, such as vendors and labor, also are being asked to make concessions.

  • Lender relief is critical; there are no alternatives.

  • The borrower can and will return to a satisfactory repayment plan after a period of relief.

  • The proposed relief sought from the lender is in the best interests of the lender, given the alternatives.

Third (and Further) Contacts:

  • Create a list of bullet points to discuss.

    • Which requests are absolutely essential?

    • Which ones can be compromised?

    • Which requests are throwaways?

  • Develop a strategy for further potential relief at a later date without the need for further expensive and time-consuming additional negotiations; i.e., the agreed-upon concessions or “price” to be paid to the lender should include optionality.

  • Do not get “ratcheted.” You will have to pay or make a concession every time you seek further relief. Get relief for as long a period of time as is possible.

  • Offer the lender something (such as a portion of sale proceeds from assets to be sold, excess cash flow payments if and to the extent projections are exceeded, etc.) in exchange for a longer relief period.

The Threat of Bankruptcy

For uncooperative creditors (whether secured or unsecured), there is always the alternative of the threat of a Chapter 11 bankruptcy filing. Borrowers and creditors should understand how bankruptcy may play out in order to see why a consensual out-of-court workout is a superior option.

  • Bankruptcy judges like to preserve jobs and maximize value/recoveries for all creditors, including unsecured creditors. Shutting down a debtor, particularly at the outset of a Chapter 11 bankruptcy case, is not consistent with that desire.

  • Bankruptcy courts may not be a friendly place for an uncooperative lender that forces a borrower derailed by distress into an avoidable or free-fall bankruptcy.

  • A bankruptcy judge may ask a lender seeking foreclosure or to shut the debtor down how it would do anything different than what the debtor is doing in Chapter 11, or why the debtor should not be given the chance to turn things around using the toolkit available to companies in Chapter 11.

  • Chapter 11 is expensive. Ultimately, the costs of Chapter 11 may largely come out of the pocket of the lender.

  • With relatively few exceptions, the total enterprise value of a debtor's business will dramatically decline in Chapter 11. Large customers may be reluctant to place orders. Customers may be concerned about future deliveries. Vendors may immediately go onto COD terms. This will further exacerbate cash flow problems.

  • If the lender seeks to cause the debtor to sell its assets (through a quick “363” bankruptcy sale), until the uncertainty in the economy has settled, there may be no buyers other than vulture purchasers.

  • Obtaining expedited “first day” bankruptcy relief from the bankruptcy court typically needed to provide a company/debtor with a “safe landing” in Chapter 11 may not happen.

  • Lenders need to be cooperative with borrowers in order to mutually work to preserve a debtor's going-concern value and in order for vendors to continue supplying the debtor to allow for the debtor to attempt to catch up for prior losses. Obtaining expedited relief from the bankruptcy court may not happen.

Reprinted with permission from the May 11, 2020, issue of Bloomberg Law. © 2020 The Bureau of National Affairs, Inc. All Rights Reserved. 800.372.1033. For further use, please visit: http://bna.com/copyright-permission-request/.

To see our other material related to the pandemic, please visit the Coronavirus/COVID-19: Facts, Insights & Resources page of our website by clicking here.

The Federal bank regulators which supervise banks have made a statement encouraging workouts necessitated by the coronavirus. Loans which would otherwise be classified as TDRs (Troubled Loan Restructurings) will not have to be classified as such under certain conditions. For example, if the workout was necessitated by the pandemic and if the loan was otherwise in good standing as of December 31, 2019. The government’s intent is clear: Everyone gains more by a workout or restructuring than by liquidation or litigation. Value is often severely diminished in bankruptcy or in a liquidation.

Here is the problem: In recent years, Chapter 11 has increasingly become the sale chapter of the bankruptcy code rather than the reorganization chapter. This could have sweeping effects given the bankruptcy wave expected as a result of COVID-19’s shocks to the economy.

In fact, this trend likely means that, contrary to the statements of the Federal government that restructurings (a principal goal of Chapter 11) are good for the national economy, unsecured trade creditors–such as the vendors who supply shirts for department stores, food service products to restaurants or raw materials to manufacturers that have been shut down and which themselves are having difficulty getting paid–will get a lot less than expected out of their customers’ Chapter 11 cases.

The problem starts with section 363 of the bankruptcy code, intended as a way for debtors to sell assets outside the ordinary course of business if the assets could become worthless without quick action. Think a supermarket where the fruit and vegetables would go bad if not sold immediately.

But well before our current economic problems, debtors have been pressured by their lenders to put forward justifications under section 363. Lenders (banks), figured that it makes more sense to (a) promptly swap debt for equity, or to credit bid for the assets and thereafter restore value that need not be shared with the debtor’s other creditors or (b) promptly convert their collateral to cash, take the loss, and relend the money. And courts, heavily pressured by talk of the need for quick action, were approving accelerated 363 sales–even if some important questions were going unanswered.

For these reasons, creditors struggling to cover their own costs and pay their employees during the pandemic shutdown (and afterwards) should be very worried.

How Section 363 Went Wrong

In traditional reorganizations, creditors could get a dividend out of a case as a result of debtor reorganization, e.g., downsizing, reducing debt, eliminating unprofitable products lines, or getting out of certain geographic markets. But with the influx of accelerated 363 sales processes to accommodate lenders, that is no longer the case. On day one (or close to it) a debtor presents the court with a tale of woe. Herculean efforts were made to turn things around prior to bankruptcy and a lot of money was lost. Now, the iceberg is melting.

General Motors was not a real reorganization case. But, it did teach us that 363 sales of substantially all going concern assets was permissible even in a “mega” case. GM’s assets were sold to “newco.” Thereafter a liquidating plan of reorganization was filed with the bankruptcy court. GM set a pattern for future Chapter 11s.

The judge rarely is offered much more information–such as why the debtor cannot be downsized in Chapter 11, why expenses cannot be cut further, or why the tools provided by Chapter 11 cannot facilitate reorganization. The judge, unfortunately, is asked to believe that all hope of a reorganization is lost based on the debtor’s summary presentation and prepetition track record. And, understandably, bankruptcy judges are reluctant to call a lender’s or debtor’s bluff when they hear that the sale is essential to preserving jobs.

Now, with the anticipated wave of Chapter 11s due to the coronavirus, more proof should be required. Will a representative from the debtor say something like this under oath? “I cannot figure out a feasible solution even though I was paid very well to do so and I do not think it is worth the effort to try now even with the many protections of the bankruptcy code. The debtor’s problems cannot be fixed within a reasonable time period. I, therefore, support a fast sale.”

If you hadn’t guessed, that sort of proclamation hasn’t been happening. But the 363 sales go forward anyway.

Forgetting Chapter 11’s Intent

It’s important to remember that Chapter 11 is an alternative to a secured creditor’s exercise of state law remedies and that it facilitates greater value to be obtained for collateral than what the lender would otherwise achieve in a foreclosure. Some observers have said that if the lender seeks to block a true reorganization–one that might yield a recovery for unsecured creditorsthe lender ought to pay a price (carve out a recovery for unsecured creditors) for depriving unsecured creditors of the opportunity.

That’s unlikely to happen, especially in an economic downturn. But there are ways the parties involved could improve this situation.

Judges are well qualified to prevent the debtor from exploiting the reprieve in Chapter 11. Attentive creditors’ committees also are watchdogs and could help assure against incurring unpayable liabilities after the date of bankruptcy. And, smart lenders could incorporate the risks in Chapter 11, being compelled to tolerate a debtor’s final efforts to reorganize with the benefits of Chapter 11 protection, into the pricing of their loans or by requiring the commencement of Chapter 11 cases sooner.

Bankruptcy judges should place greater weight on the statutory goals of Chapter 11 and also recognize the federal government’s stated desire for restructurings. They should probe deeper as to the extent to whether the debtor was in good standing with its lenders and vendors prior to the pandemic, the extent to which the debtor commenced its case due to the pandemic and why the debtor is unable to do a traditional restructuring given the tools of Chapter 11. It is not just the bank and the creditors of the debtor with interests in the debtor’s Chapter 11 case. There are creditors of the debtor’s creditors who have an interest in the debtor’s case. Liquidations and bulk sales that strip away going concern value has a ripple effect. Until some of this happens, unsecured creditors should be on alert: They won’t get much of anything when companies they’ve served end up in Chapter 11.

Note: The views expressed herein are those of the author only and are not necessarily shared by others at Lowenstein Sandler. Each case is unique. The law is subject to interpretation.

To see our other material related to the pandemic, please visit the Coronavirus/COVID-19: Facts, Insights & Resources page of our website by clicking here. 

Due to the costs, time, and uncertainty that a bankruptcy proceeding necessitates, professionals dealing with a financially distressed business often consider alternative schemes that can accomplish some of the same outcomes as in a bankruptcy proceeding, but in a simpler and more efficient manner. One of these alternatives is the creditor composition.

A composition is a contractual settlement between a debtor and its creditors that allows a business to restructure its debt obligations and continue as a going concern.

This Note addresses the process for conducting creditor compositions, including considerations when negotiating with creditors, preparing for creditor meetings, and reaching a creditor consensus.

One well-known and painful irony of COVID-19 is that many hospitals across America are struggling, even as healthcare has arguably never been more important.

These hospitals face an array of problems — from a reduction in elective procedures to a pivot to telehealth to high costs of new technology to falling government reimbursement rates. As a result, chapter 11 might be inevitable for many in the coming months and years.

But the process as currently outlined in the bankruptcy code has a major flaw – and now’s the time to fix it.

How the Bankruptcy Process is Unique for Hospitals

Even more so than in most cases, emotional ties, politics, self-preservation and self-interest overlay hospital bankruptcies. It is never politically correct for an elected official to support a local hospital’s closure — even if the hospital probably should close. It’s presumed that saving the hospital is in everyone’s best interest, a position buoyed by hospital boards of trustees, who will choose any alternative to closure.

Simultaneously, lenders concerned about reputational damage will defer to debtor hospitals, as no bank wants to send a message to the community (which includes its customers), that it is forcing a hospital closure. Lenders might believe that the debtor cannot or should not be saved, but they must be cautious of what they say in public to the judge.

Bankruptcy judges are said to be part social worker, part lawyer, part mediator and part financial analyst and they generally prefer reorganization over liquidation. Chapter 11’s goal is to preserve the going concern value of assets, which are usually worth more as a going concern than when liquidated. Bankruptcy judges also want to preserve jobs — especially in times of high unemployment.

These factors, on their own, are understandable and even admirable in some cases. But put them together, and you have a situation where the tough decisions aren’t always getting made.

Time for a Change?

Chapter 11 is largely premised on the principal of creditor oversight by a creditors committee. Creditors have a vote on a plan of reorganization and bankruptcy judges listen to all parties, including regulators, unions, the PBGC, indenture trustees, banks and landlords.

But that does not assure that the outcome of the case will be in the best interests of the entire community rather than select members of the community. What’s needed is a truly unvarnished and impartial view of what is best for the larger community – and for that view to be communicated to bankruptcy judges with in cases involving nonprofit hospitals.

The interests of the community and public at large sometimes must outweigh other interests, and too often, judges aren’t getting the right information to do the weighing. For example, in communities where too many hospitals compete for too few patients, some hospitals should close even if there is an approvable sale or confirmable reorganization plan. Being able to reorganize does not always mean that a hospital should be reorganized, and the current voices in the judges’ ears don’t always relay that information.

Saving a hospital that maintains an over-bedded market is bad for the healthcare delivery system and for the citizens it serves. Selling a nonprofit hospital to a for-profit hospital system that results in continuing the community over-bedded results in the same outcome, reducing surplus at surrounding hospitals as inpatient volume is spread thinner.

This isn’t to say that all struggling nonprofit hospitals should close. Sometimes, a hospital simply must be preserved because its absence would put the surrounding community at risk. Keeping truly essential hospitals open, even if pain must be inflicted on certain parties in interest (including lenders) is good public policy. Banks have an obligation to invest in the communities that they serve, and the risks associated with lending to nonprofit hospitals can be compensated for.

But what we really need is an outside voice who can provide necessary clarity about community needs to bankruptcy judges.

How to Make the Call

The bankruptcy code should require the appointment of an examiner in nonprofit hospital bankruptcy cases. The examiner would function similar to a public advocate or ombudsperson and render reports available to the court and other parties in interest as to what is in the long-term best interests of the community and public at large. An examiner would also provide valuable information – and frankly, cover — for elected officials, the bankruptcy judge, management, trustees and lenders.

The examiner should be available to opine about whether relief sought by or proposed to be granted to secured lenders is appropriate, whether relief from a collective bargaining agreement is really necessary, or if there alternatives, and whether confirmation of a plan or approval of a sale is merited after considering all macroeconomic and social factors. There’s also a broader question of how involuntarily reducing or extending secured debt should be less difficult if the examiner deems it essential to long-term feasibility — including, but not limited to, having the requisite funds for investment in order to maintain high quality care.

Put simply, these suggested revisions to chapter 11 would enable bankruptcy judges to receive independent advice from someone whose sole mandate is protection of the public interest. Such advice is in addition to input from the traditional advocates in a chapter 11 case.

This proposal simply recognizes that the many self-serving interests in a chapter 11 bankruptcy case often do not result in the best outcome in accord with public policy and for the community at large. The outcome of chapter 11 for one hospital has a direct impact on the cost and delivery of healthcare for an entire community – and the way to assure that the public interest is best served is the appointment of an examiner who serves as a public advocate or ombudsperson.

The views expressed herein are of the author only and are not necessarily shared by other persons at Lowenstein Sandler LLP. This article is not intended to provide legal advice. Each case is unique. The law is subject to interpretation.

Reprinted with permission from the June 9, 2020, issue of Healthcare Business Today. © 2020 Healthcare Business Today. All Rights Reserved. Further duplication without permission is prohibited.

To see our other material related to the pandemic, please visit the Coronavirus/COVID-19: Facts, Insights & Resources page of our website by clicking here.

With COVID-19 having shut down many businesses, lenders increasingly are worried about their borrowers’ ability to repay loans. Lenders are concerned about the value of their collateral because of the loss of the spring season and the distress of their borrowers’ customers. Further, many borrowers are reducing their sales projections for when the economy reopens and gets back to normal–whatever normal may turn out to be.

It should be anticipated that banks will reduce their lending to distressed borrowers either by reducing advance rates or by classifying assets as ineligible (no value for purposes of borrowing). Lenders may demand additional collateral as a condition for maintaining the outstanding loan amount or for maintaining current advance rates.

A lender may request from a shareholder a guarantee of what previously was a nonrecourse loan. Alternatively, the lender may request additional collateral not owned by the borrower. The pledge of collateral by a non-borrower is pursuant to a hypothecation agreement. The collateral can be assets of the borrower that are not currently encumbered or assets of a third party such as the borrower’s stockholders.

It is important to memorialize clearly the relief being granted by the bank. Most loan documentation provides that despite a loan commitment, the lender has discretion in making advances. Therefore, the guarantor (or additional collateral provider) should ascribe a value to the additional collateral and also set forth the specific remedies that the bank is refraining from exercising. The borrower also should require that upon the borrower’s curing a covenant breach or getting back into formula, the side/additional collateral will be released.

Persons giving guarantees must anticipate the possibility of bankruptcy even though the goal is to avoid it. In Chapter 11 bankruptcy, insiders and related parties are natural targets of the unsecured creditors committee. The committee may seek to subordinate the claim of insiders (making the insider claim payable only after other claims have been fully paid), disallow the insider claim, or recharacterize an insider claim as equity. The argument typically is that the debtor was undercapitalized at the time the additional collateral was pledged.

In order to avoid risk of subordination or recharacterization, it is better for the provider of additional collateral to purchase a participation in the existing lender’s loan. Nevertheless, anticipate that the bank will permit only a last-out participation. In other words, the bank receives payment of its loan first from proceeds of collateral.

A benefit of a participation is that it is not a new loan. It is more difficult to disallow, subordinate, or recharacterize.

Persons providing additional collateral pursuant to a new, second-position loan behind the bank would have to “perfect” the new loan by filing a UCC-1 (Uniform Commercial Code Form 1) document that is a public record for all creditors to see. There is the potential for other creditors of the borrower to see the UCC-1 and to think that the insiders are seeking to place themselves at an advantage over other creditors or are self-dealing. Purchasing a participation does not require the filing of a new perfection document.

The lender that requires a participation will often require that the participant give up all rights to question how the lender liquidates its collateral. If the provider of the additional collateral is making a new loan subordinate to that of the lender bank, the parties will need to execute an intercreditor agreement that sets forth the right of the new lender vis-à-vis the bank lender. Typically, the new lender will have very few rights.

Options for the junior lender or guarantor to negotiate:

  • The right to purchase the senior lender’s claim.
  • That the senior lender exhaust all remedies as to its borrower’s assets before pursuing the guarantor or before seeking to recover from the junior lender’s assets.
  • To require the bank wait until the expiration of a specified period of time before the bank can pursue remedies against the guarantor or against the additional collateral.
  • For the bank to consult with the guarantor during the liquidation process.
  • A pecking order pursuant to which collateral (if other than cash) can be liquidated.
  • The method by which the additional collateral will be liquidated.
  • Consent of the bank for the pledger to substitute new collateral for the previously pledged collateral.

Lenders are likely to become more aggressive and more cautious until the economy settles down and there is more certainty in the marketplace. At the first sign of default or insecurity, they will seek to improve their position. Prudent borrowers should anticipate the next move of their lenders–especially including what they will ask of their lenders in return and also the potential impact on their business of accommodating their lender.

The views expressed herein are those of the author and are not necessarily shared by other persons at Lowenstein Sandler. Each case is unique. The law is subject to interpretation. The author is chair of the Bankruptcy, Financial Reorganization & Creditors’ Rights Department of Lowenstein Sandler. This article is for general information purposes and should not be taken as legal advice.

To see our other material related to the pandemic, please visit the Coronavirus/COVID-19: Facts, Insights & Resources page of our website by clicking here.

What makes the current economic crisis unique is that it is systemic. Despite businesses historically being well managed, not being overly leveraged, innovating in the marketplace and not facing a large litigation judgment, many such businesses are being devastated by the COVID-19 pandemic.

The post-pandemic world will be very different from the pre-pandemic world. As we learn more about the speed at which the economy will return to normal and what the new normal will be, few, if any loans in a bank’s loan portfolio will not need review, amendment, or restructuring.

The economic situation triggered by the current pandemic can be relieved in part by providing regulatory flexibility to banks that enables them, in turn, to provide relief to their customers to avoid bankruptcy. Secured loans (and the collateral encumbered by such loans) lose more value in chapter 11 proceedings. As a result, net losses to the bank increases. Out of court workouts preserve more value for all stakeholders.

The CARES Act provides regulatory relief to financial institution lenders for loan modifications that otherwise would be considered to be Troubled Debt Restructurings (TDRs), thereby incentivizing lenders to engage with borrowers about loan modifications and providing additional flexibility for lenders to modify loans. However, the relief is not adequate.

Under Section 4013 of the CARES Act, during the period beginning on March 1, 2020, through the earlier of Dec. 31, 2020, or 60 days after the termination date of the national emergency concerning the COVID-19 outbreak declared by the president on March 13, 2020, under the National Emergencies Act, a financial institution may elect to suspend the requirements under U.S. Generally Accepted Accounting Principles (GAAP) for loan modifications related to the COVID-19 pandemic that would otherwise be categorized as a TDR, including impairment accounting.

This TDR relief is applicable for the term of the loan modification, but solely with respect to any modification that defers or delays the payment of principal or interest, that occurs during the applicable period for a loan that was not more than 30 days past due as of Dec. 31, 2019.

Further, Section 4014 of the CARES Act provides that banks are not required to comply with the current expected credit losses methodology for estimating allowances for credit losses (CECL), from the date of the law’s enactment until the earlier of the end of the National Emergency or Dec. 31, 2020. However, the relief above is for regulatory and supervisory purposes only. It does not impact a bank’s income statement and, therefore, does not sufficiently encourage or enable a lender to be sufficiently flexible or to accept greater financial risk in a workout or restructuring.

The problem with the relief under the CARES Act is that GAAP accounting still impacts the bank’s income statement. No bank executive wants to explain that to shareholders. Regulatory relief is one thing. But, concern over profitability is another—and it is equal or more important.

The CARES Act is beneficial to fostering workouts by providing regulatory relief. However, it fails to connect regulatory relief to real financial incentives. Providing banks with additional relief is needed for banks that enable them to agree to an out of court workout with less impact on their income statement and balance sheet. This can be accomplished by reducing taxes on income derived from loans that have been worked out or restructured as a result of COVID-19.

Reprinted with permission from the June 16, 2020, issue of Bloomberg Tax. © 2020 The Bureau of National Affairs, Inc. All Rights Reserved. Further duplication without permission is prohibited.

To see our other material related to the pandemic, please visit the Coronavirus/COVID-19: Facts, Insights & Resources page of our website by clicking here.

As more companies file for Chapter 11 amid the pandemic, expect to see more filings focus on reducing labor, legacy and environmental costs as key to a successful reorganization.

This theme will come from debtor management hoping to mask broken promises of performance improvement.

It will be heard behind the scenes from secured lenders and investors that have placed too much debt on the debtor or relied too much on underperforming management.

Of course, one way to improve the bottom line is to reduce leverage, which immediately improves profitability and cash flow. But that often requires concessions and contributions that equity holders are unwilling to make.

Consequently, under pressure from lenders and equity holders, debtors will seek to reject or renegotiate collective bargaining agreements, or CBAs, and legacy benefits. Labor is the first place in the budget from which debtors will seek a subsidy — often only after key employee retention plans for senior management have gotten board approval.

Secured lenders can do a big "favor" for the debtor by mandating that the debtor reject or renegotiate CBAs as a condition to continued financing.

Then, management can blame its lenders for the fire-drill timeline within which to complete negotiations or obtain a ruling by the court.

Politics make it unlikely that the creditors committee will oppose reducing labor and legacy costs. Committees often sit on the sidelines reluctant to choose sides or make enemies. Plus, anything that enhances valuation is viewed by the committee as a big positive.

And the banks will sit by, not looking to make enemies, and relying on the debtor and the mandates of the debtor-in-possession financing order.

Shareholders are pleased for the debtor to be under extreme pressure and remain silent.

The idea is to ram a collective bargaining rejection process through the bankruptcy court as quickly as possible while claiming that "Rome is burning" and that the success or failure of the Chapter 11 case is wholly dependent upon renegotiation of the CBAs.

The court is often placed in a position of great discomfort. A goal of Chapter 11 is to preserve jobs and going concern value and so the court is squeezed between wanting to protect the rights of employees for whom jobs are critical in periods of high unemployment while at the same time wanting to facilitate a reorganization.

The judge may be of the view that reducing compensation and benefits or modifying work rules is painful, but it is better than risking the alternative.

Chapter 11 is perceived as a good forum in which to renegotiate CBAs. A debtor seeking to reject a CBA or modify retiree welfare benefit obligations is required to first satisfy the procedural and substantive requirements set forth in Sections 1113 and 1114 of the Bankruptcy Code.

The list of the requirements includes the requirements that the company must provide the union or other authorized representative with complete and reliable information about the company; make a formal proposal to the union to reject and modify the CBA or the retiree benefits; and meet in good faith with the union in an attempt to negotiate the changes.

The CBA can be rejected, or the retiree benefits modified, only if the union/other authorized representative rejects the proposed changes and the bankruptcy court ultimately finds that the changes are "necessary" for the debtor's reorganization.

However, in many instances, labor costs are not the real problem, or they are only one of several problems. The debtor may be carrying too much indebtedness. The indebtedness may be from a prior leveraged buyout or acquisition. Shareholders refuse to invest more capital in order to pay down debt; nor do they want to give up equity. And, in many instances, management has simply failed to achieve the goals that it promised would be transformative in order for the debt to be serviced.

Section 1114 motions are also typically fast-tracked and the union often is at a disadvantage because the debtor has had months to orchestrate its crisis.

However, bankruptcy judges should be reluctant to expedite the Section 1114 process.

The remedy, instead, is for the court to have the benefit of someone akin to an ombudsman or public advocate — someone able to provide the court with an impartial view as to the cause of the debtor's need for reorganization, the appropriate remedy, and how the cost — or blame? — should be allocated.

Reducing wages or benefits for union employees solely in order to increase value for the benefit of equity holders and lenders is unjustified.

An examiner functioning as a public advocate or ombudsman should determine whether the relief sought is reasonable, necessary and equitable given the relative contributions proposed to be provided by secured lenders and by equity holders. Often, Section 1114 relief is sought before the final terms of a plan of reorganization even are known.

All parties are more likely to be reasonable if they know that an examiner will be looking over their shoulders. In order to better assure that the resolution of Section 1113 or Section 1114 motions is fair and equitable to all parties in interest and in order to assure that the public interest is protected, the Bankruptcy Code should be amended to require the appointment of an examiner with the limited scope of responsibilities described above upon the filing of a motion to reject CBAs or to modify benefits.

The threat of appointment of an examiner will cause all parties — not just the debtor and labor — to work harder toward a fair and equitable resolution of the debtor's financial difficulties before filing motions.

In an economy where unemployment is reaching a level not seen since the Great Depression, it is especially unreasonable for labor to bear a disproportionate portion of the cost of a debtor's reorganization.

Instead, the cost should be borne first by the parties who are responsible for the problem and the parties who have the most to gain from its resolution: lenders, which provided more debt than was justified, and equity holders, which have the upside.

Reprinted with permission from the June 17, 2020, issue of Law360. © 2020 Portfolio Media, Inc. All Rights Reserved. Further duplication without permission is prohibited. 

To see our other material related to the pandemic, please visit the Coronavirus/COVID-19: Facts, Insights & Resources page of our website by clicking here.

For the trucking industry, problems in 2019 stemming from U.S./China trade tensions look small when compared with the damage caused by COVID-19. Tens of thousands of truckers are out of work.

So, industry executives should get familiar with the nuances of the reorganization chapter of the Bankruptcy Code. Chapter 11 is intended to enable companies to restructure debts and to reorganize and revitalize their businesses. But preplanning and speed are key.

In a Chapter 11 case, the creditors’ committee is given broad powers to oversee and investigate the past and current business of the debtor (§ 1102, Bankruptcy Code). The committee can make document requests, speak with the debtor’s employees, depose the debtor’s management and board of directors, subpoena records, and generally use any appropriate form of discovery for its inquiry.

It is key for the creditors’ committee to understand the true causes of the debtor’s Chapter 11 filing and how or if the debtor’s problems can be fixed by use of the Chapter 11 process to maximize recovery for unsecured creditors. In addition to understanding how Chapter 11 can be used to preserve, restore, or increase a company’s value, creditors’ committees must also investigate and understand the debtor’s prepetition business and the financial issues confronting the debtor that led to the debtor’s distress.

Few debtors accept blame for the mistakes, lack of vision, or failure of management or the board of directors to act in a timely manner. Therefore, committee counsel must ascertain the root cause of the debtor’s financial failure and ensure that the debtor is taking the necessary steps to effectively rehabilitate itself before the company’s going concern value dissipates and liquidation become inevitable.

Get ready for a spate of healthcare bankruptcies.

The sector is facing some ugly realities. Medicaid payments are not keeping up with inflation and the disproportionate number of deaths in nursing homes as a result of COVID-19 may draw stricter regulatory scrutiny, as well as litigation. Additionally, states facing budget crunches will likely reduce reimbursements.

This means anyone in healthcare sector to know the ins and outs of chapter 11.

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Reprinted with permission from the July 10, 2020, issue of McKnight’s Long-Term Care News. © 2020 Haymarket Media, Inc. All Rights Reserved. Further duplication without permission is prohibited.

To see our other material related to the pandemic, please visit the Coronavirus/COVID-19: Facts, Insights & Resources page of our website by clicking here.


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