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What CPAs can expect from bankruptcy and lending in 2009.
April 6, 2009
If ever an economic period was destined for America’s history books, it’s our current environment. After a long run of living above our means, the concept of credit is being fundamentally revisited. It seems we have entered not just a short period of revenue dislocation, but a seriously challenging situation for the rest of 2009 and well into 2010.
When the dust settles, our nation will emerge a more value-oriented society — one that better understands leverage and restraint. Future generations can avoid the mistakes we’ve made by learning how we overcame them.
The Turnaround Professional’s Perspective
There was a time when turnaround practitioners (crisis manager, chief restructuring officers or turnaround advisors) would follow a reasonably standardized process when facing the decision to file for bankruptcy protection. Their response typically involved restructuring a company’s capital structure and operations to strengthen the core business with well-prepared management and sufficient cash to weather the storm.
Today, while the basic concepts of corporate renewal remain valid, even the most astute practitioners cannot easily help clients overcome sustained declining revenues.
Evaluating Credit Issues
As credit quality erodes, so do the various lending options. Asset-based lending (ABL) is still occurring, particularly with small companies, but borrowers generally find decreasing advance rates and increased pricing.
For businesses with non-ABL credit agreement issues, the choices include:
While the first three alternatives can be problematic, success comes from understanding the issues and expectations of everyone involved.
Choosing the Right Lender
It is important to realize that most lenders are in a period of deleveraging and shrinking their balance sheets. Infusions of capital, whether from Troubled Asset Relief Program (TARP) or other sources, are not inspiring lenders to tack on new business loans.
Companies facing credit agreement renewals or defaults may find different lender reactions. Even a company with decent cash flow may find the going more difficult, as lenders who renew most likely do so at a higher interest rate.
Conversely, the lender may refuse to renew and insist on the company finding alternative capital. Should your company be unsuccessful, return to the lender with data showing the effort made to find other financing.
The lender then has two choices:
But assets dumped on today’s market may not yield their collateral value.
Factors to Consider in Bankruptcy
According to the American Bankruptcy Institute, business bankruptcies have increased dramatically — from 4,086 in the first quarter of 2006 to more than 11,504 in the third quarter of 2008.
Before filing bankruptcy, your company should:
Historically, companies filing for Chapter 11 reorganization might propose a plan where (i) secured creditors remain in the same role, (ii) burdensome contracts are rejected, (iii) certain unsecured creditors take a noticeable haircut or become equity holders, and (iv) equity holders are substantially disadvantaged.
The current bankruptcy code permits a debtor to control the process for up to 180 days, leaving management running the business and driving resolution. This also leaves the debtor subject to continuous oversight and professional expenses. The cost of reorganization tends to limit the process to companies that are large enough to bear it and have a solid, sustainable core business.
If liquidation is determined to be an appropriate step, consider your specific circumstances. The primary options are:
One approach that can substantially shorten bankruptcy time is a prepackaged Chapter 11, or a “prepack.” This is a reorganization plan where the debtor’s creditors have agreed to confirm the plan before bankruptcy filing. It enables companies to emerge from bankruptcy in as little as 60 days. The shortened time reduces the cost of monthly operating reports and professional fees.
Unfortunately, this plan signals to creditors that a bankruptcy filing is imminent. This could cause vendors to tighten trade credit terms, reduce working capital, or file an involuntary bankruptcy case against the debtor.
Communication on the Road Back to 'Normalcy'
Throughout this difficult period, there is an acute need for management to ensure full communication with all stakeholders, and especially with secured lenders, to eliminate the element of surprise. The key to success is a highly detailed plan. All parties involved must adopt a collaborative, creative and deliberative style to help minimize risk.
The path through 2009 is unclear and will be constantly changing. We will return to normalcy — a different kind of normalcy, perhaps, but hopefully one that will not lead us, or future generations, to repeat our past mistakes.
Jerry Mozian is a Certified Turnaround Professional (CTP) and the National Segment Leader of Restructuring for Tatum, LLC. His analyses have appeared in Reuters, Forbes.com, Financial Week and the Los Angeles Times. He can be reached at jerry.mozian@TatumLLC.com.