Most restructuring professionals will inform you that there isn’t a “typical” restructuring. That’s completely true. Each financially distressed enterprise is completely different and the character and path of its restructuring shall be extremely dependent upon, amongst others, its capital construction, its liquidity profile, and the extent of help it might probably construct for its reorganization amongst key stakeholder our bodies. However, there are some necessary similarities in the way in which that any firm ought to initially tackle a distressed state of affairs. We focus on under quite a lot of key duties, or “commandments,” that we advocate any firm ought to undertake as quickly because it anticipates doable monetary misery.
Number one: Thou Shall Successfully Handle Thy Runway
As soon as the corporate has consulted restructuring advisors, it ought to flip to negotiating with its principal collectors and different key stakeholders on the phrases of an out-of-court restructuring, recapitalization, or sale transaction. In doing so, the corporate and its advisors ought to contemplate, amongst others, the next:
- The corporate’s liquidity place—the amount of money and money equivalents the corporate has readily available and any availability underneath present credit score services; and
- The vital dates dealing with the corporate, together with, with out limitation, maturity dates, borrowing base redeterminations, upcoming curiosity funds, monetary reporting obligations, termination dates underneath default notices, and the dates on which litigation liabilities might develop into due.
These components ought to offer you a normal sense of the corporate’s “runway”—how lengthy the corporate has till it wants to achieve a cope with its collectors or, instead of final resort, start a case underneath chapter 11 of title 11 of the U.S. Code (the “Chapter Code”). As you would possibly anticipate, money is vital. All else equal, a stronger liquidity place and manageable deadlines will enable an organization time to barter with collectors and keep away from making hasty outcome-determinative choices.
As such, we regularly advise firms to fully draw down their present strains of credit score and, as acceptable, place the proceeds in an account that the corporate’s lenders haven’t any rapid proper to entry. This may guarantee the corporate maximizes its liquidity and minimizes lenders’ sensible capacity to take management of the funds ought to a default happen underneath the related mortgage documentation. As well as, a monetary advisor and, probably, a chief restructuring officer, may help the corporate handle its liquidity by, amongst others, negotiating extra favorable cost phrases with distributors and suppliers and minimizing excellent receivables.
Quantity 2: Thou Shall Try to Develop an Out-of-Courtroom Answer that Avoids Chapter 11
The corporate’s runway or lack thereof, however, we all the time search to achieve an out-of-court answer to monetary misery earlier than pursuing in-court methods as a result of an out-of-court deal is nearly all the time cheaper and faster. In lots of instances, the corporate might not attain a cope with its collectors on the phrases of an out-of-court transaction to deal with its debt obligations earlier than a default is anticipated to happen underneath the corporate’s debt paperwork. If negotiations are ongoing, and can proceed previous any maturity or default occasions, the corporate ought to search to have its collectors conform to enter right into a short-term forbearance or waiver of the default to permit the events time to barter with out concern that collectors will train treatments or any cross defaults will happen. Sometimes, the preliminary forbearance or waiver lasts between 30 and 60 days, however such intervals are sometimes prolonged a number of occasions by settlement of the events.
A profitable out-of-court restructuring nearly all the time requires the unanimous help of the corporate’s funded debt holders, which is incessantly tough to acquire. Particularly, any out-of-court transaction that contemplates the modification of quantities, rates of interest, maturity dates, or amortization—i.e., “amend and prolong” transactions—is probably going going to require unanimous lender consent in an effort to be consummated out-of-court. Because of this, a scarcity of consensus amongst key stakeholders is among the many commonest the explanation why we see out-of-court exercises fail or a chapter 11 chapter turning into essential. The Chapter Code permits a chapter 11 debtor to drive the phrases of its restructuring on recalcitrant lenders and fairness holders underneath sure circumstances.
Quantity 3: Thou Shall Have interaction in Contingency Planning
It could be robust drugs to swallow given the expense of doing so, however it’s vital {that a} distressed firm put together for a chapter 11 submitting lengthy earlier than the corporate and its advisors decide {that a} submitting is critical. As mentioned above, there isn’t a assure that an organization will attain a cope with its stakeholders on the phrases of an out-of-court restructuring. We have now seen many instances through which an out-of-court deal appeared probably, however fell by unexpectedly on the final minute and necessitated a crash chapter 11 submitting to acquire the advantage of the automated keep to forestall collectors from exercising treatments.
In these unlucky circumstances, the very last thing an organization needs is to be caught unprepared to file given the benefit that an orderly submitting supplies and the sheer quantity of labor that satisfactory preparation calls for. With the intention to make sure that its transition out of business is seamless and that its enterprise operations proceed uninterrupted in the course of the pendency of its case, a chapter 11 debtor usually recordsdata various pleadings on the primary day of its case searching for operational and procedural reduction. The corporate and its advisors usually work collectively to arrange these paperwork as they require detailed details about, amongst others, the corporate’s capital construction, monetary efficiency, enterprise operations, and the occasions that result in its chapter 11 submitting. The purpose right here is that these paperwork require vital time to arrange, and having enough time to plan the chapter 11 can be advantageous to resolving points which may be problematic if they’re found after a chapter 11 submitting.
In our expertise, there may be additionally probably a tactical benefit to making ready the corporate for submitting weeks upfront in that these paperwork might be shared with stakeholders as a method to reveal that the corporate is critical a couple of chapter 11 submitting. Usually the specter of a chapter 11 case—together with the Chapter Code’s cramdown provisions—is a powerful incentive for stakeholders to agree with a distressed firm’s proposed out-of-court restructuring. The choice for recalcitrant stakeholders is to incur vital authorized charges in chapter 11 solely to have the phrases of a much less favorable restructuring imposed on them by the chapter court docket. On this approach, subsequently, fairly mockingly, the preparation for a chapter 11 case could make it much less probably that such a case ever happens.
Lastly, the corporate and its advisors ought to give critical thought to precisely the place they could file a chapter 11 case if chapter turns into a essential eventuality. A lot ink has been spilled on the deserves of “discussion board buying” within the chapter context, however from a distressed firm’s perspective, we will unequivocally inform you that the venue through which an organization commences its chapter 11 instances can have a big impact on the end result of the case. And since the present venue guidelines are pretty permissive—a debtor can file chapter 11 in any jurisdiction through which it has its principal belongings, principal place of work, domicile, or any of its associates presently has a chapter case pending—we regularly see debtors interact in pre-filing exercise designed to create circumstances that enable them to file for chapter 11 in a specific jurisdiction. Among the many main causes that company debtors search to start their instances in these jurisdictions is that the judges in these jurisdictions preside over most of the giant chapter 11 instances which might be filed, and, because of this, an organization and its advisors might be comparatively assured of the end result {that a} case in these jurisdictions can present.
Quantity 4: Thou Shall Seek the advice of Restructuring Advisors
One of the crucial vital errors we see distressed firms make is to attend too lengthy to speak to restructuring advisors and thereby considerably hamper their capacity to efficiently tackle monetary misery out of court docket. It’s crucial that the corporate seek the advice of restructuring advisors, together with attorneys, bankers, and monetary advisors, as quickly as doable monetary misery seems on the horizon. Skilled advisors is not going to solely show you how to decide the very best path ahead, however they may be capable to start negotiating with collectors on a possible consensual transaction lengthy earlier than the corporate must make any remaining choices concerning its restructuring. They can even present a layer of safety to the corporate in opposition to doable future claims for improper actions or inactions. Often, creditor teams will arrange and rent counsel as quickly as they believe monetary hassle, and it’s best if the corporate assembles its personal skilled staff of authorized advisors to satisfy collectors’ counsel head-on. Equally, proactively participating an skilled funding financial institution permits an organization to run an extended, extra strong advertising and marketing course of to search out new capital or potential consumers which might be prepared to buy the corporate as a going-concern on worth maximizing phrases.
Quantity 5: Thou Shall Think about Appointing Impartial Administrators
The corporate also needs to contemplate who will truly be tasked with deciding which restructuring proposal the corporate ought to pursue. Always, administrators ought to be free from conflicts of curiosity, and may place the pursuits of the corporate forward of their very own.[1] In lots of instances, subsequently—even when the corporate has D&O insurance coverage (and it higher)—we advise distressed firms to nominate a number of impartial administrators to the corporate’s board of administrators to assist make sure that any restructuring proposal that the corporate finally decides to pursue is just not later efficiently challenged on the premise that a number of members of the board was self-interested.
Whether or not to nominate impartial administrators is of specific significance within the context of personal firms, sponsor-backed firms, or firms through which members of the board are additionally affiliated with a number of of the corporate’s debt holders. For instance, we regularly see an organization’s present non-public fairness sponsor or junior collectors among the many solely stakeholders prepared to help a transaction to recapitalize the corporate. If that’s the case, then we extremely advocate that board members affiliated with these teams recuse themselves from any decision-making concerning the corporate’s restructuring. That, in flip, might necessitate the appointment of impartial administrators. Competent restructuring counsel shall be well-versed in these points and can be capable to assist with the appointment of impartial administrators on the outset of counsel’s engagement.
Quantity 6: Thou Shall Think about Buying “Tail” Protection for Your D&O Coverage
Given the contentious nature of monetary restructuring, particularly within the chapter 11 context, claims and causes of motion in opposition to an organization’s administrators and officers are sometimes threatened by quite a few constituencies searching for to exert leverage and extract worth. To make issues worse, an organization might discover itself unable to indemnify its officers and administrators or in any other case advance their protection prices whereas the corporate is in chapter 11. Because of this, director and officer legal responsibility insurance coverage (“D&O Insurance coverage”) is essential for a corporation in a distressed atmosphere to forestall administrators and officers from bearing the financial burden of any private legal responsibility for claims introduced in opposition to them in reference to their roles on the firm.
Most D&O Insurance coverage insurance policies present for a restricted interval throughout which the insured could make claims for protection underneath the coverage. Usually, claims can not be made upon a “change of management” as outlined within the related coverage. The consummation of a restructuring typically leads to a “change of management.” For these causes, we usually advise firms to buy runoff or “tail” protection to permit claims to be made lengthy after the coverage has expired. This provides administrators and officers peace of thoughts that acts coated by the related D&O Insurance coverage coverage will profit from protection, together with associated protection prices, however {that a} specific declare or reason for motion might have been introduced in opposition to them in a monetary restructuring after the unique reporting interval has expired.
Quantity 7: Thou Shall Think about Whether or not to Pay Retention Bonuses to Key Executives Earlier than a Chapter 11 Submitting (If Any)
In recent times, a number of giant chapter 11 debtors have elected to pay retention bonuses to sure of their senior executives on the eve of their chapter 11 filings. The Chapter Code forbids firms from paying such bonuses to executives whereas in chapter 11. Though paying retention bonuses to executives previous to a chapter 11 submitting is arguably a dangerous technique as these funds may, in idea, be topic to clawback underneath numerous causes of motion, we’re not conscious of a distinguished circumstance through which an govt has been ordered to show over a pre-bankruptcy retention bonus. Moreover, as a sensible matter, would-be challengers to those bonuses might discover it extra hassle than it’s price to hunt an order to disgorge the funds given the price of the associated litigation relative to the dimensions of the bonuses. Because of this, any distressed firm which may be inclined to pay retention bonuses ought to contemplate whether or not it needs to make such funds earlier than commencing a chapter 11 case. Doing so is actually not with out threat, but when previous outcomes are any prediction of future success, there could also be an excellent argument for making the retention bonus funds. As a substitute, the corporate may contemplate searching for approval from the chapter court docket to create a performance-based bonus plan (in any other case referred to as key worker incentive plan or “KEIP”) quite than a retention bonus program.
Conclusion
Though the foregoing “commandments” are all vital for any distressed firm, we don’t imply to counsel that this record is exhaustive in nature or a fulsome treatment for addressing monetary misery. The info and circumstances of a specific state of affairs will all the time drive the last word final result in a restructuring. Nonetheless, by following these commandments, a troubled firm may have positioned itself properly on the street to a profitable final result.
FOOTNOTES
[1] For a extra detailed dialogue of administrators’ fiduciary duties, please see Precautionary and Prudency Measures for Boards Addressing COVID-19 Enterprise Uncertainties – Finance & Chapter Legislation Weblog (financeandbankruptcylawblog.com).
