WINSTON ROWE ASSOCIATES
The use of prearranged bankruptcies, which have long been a viable option for companies undergoing a restructuring, are on the rise and for good reason. A well-executed prearranged bankruptcy — in which most of the biggest creditors agree to a plan of reorganization before going to court — allows a company to secure attractive financing; maintain the trust of employees, customers, and suppliers; and move through the bankruptcy process much more quickly and with less expense than a standard bankruptcy filing.
Moving swiftly through the bankruptcy process is particularly important today. Many companies limped through the Great Recession with impaired balance sheets. But with a great wall of debt scheduled to mature between 2012 and 2015, these companies need to act quickly to fix their capital structures.
What’s more, as the economy emerges from recession and begins to grow, companies need to position themselves to capture that growth. Being hobbled by an over leveraged balance sheet or being stuck for a prolonged period in bankruptcy court is certain to put a company at a competitive disadvantage.
This article outlines the five essential elements for orchestrating a successful prearranged Chapter 11 plan of reorganization (POR).
1. Examine the Circumstances.
The first thing to remember is that prearranged bankruptcies aren’t for every company. Prearranged plans are best suited to companies that need to fix an inadequate or over leveraged capital structure and have sufficient unencumbered assets or cash flow to secure debtor-in-possession (DIP) financing and exit financing.
Prearranged bankruptcy is not a viable option for a company that needs to discontinue certain lines of business or to make use of U.S. Bankruptcy Code Section 363, which allows for the sale of individual assets delivered to the purchaser free and clear of any liens or encumbrances.
Neither is a prearranged bankruptcy useful if litigation is involved because court action implies that major parties have taken adversarial positions. Prearranged bankruptcies only work if the major stakeholders can align their positions.
2. Secure Liquidity.
Liquidity is essential to continue smooth operations while a prearranged bankruptcy is negotiated. Liquidity can come from both internal and external sources. Internally, a company can defer some capital expenditures and cut costs to create liquidity. But companies need to be careful because deep cuts can shake the confidence of stakeholders in the company’s long-term viability. For example, a round of layoffs that hurts morale and sends other key employees looking for work could be very counterproductive.
In searching to obtain liquidity from an external source, a company should seek a lender who is familiar with the restructuring process and who will be a good partner. Ideally, a financing package should include (a) DIP financing so the company can maintain adequate liquidity during the bankruptcy period and (b) exit financing so it will emerge from bankruptcy with adequate capital to compete. This is a sophisticated package of financing and requires a lender that is steeped in the bankruptcy process and understands not just the company, but also the marketplace in which it competes.
3. Understand Stakeholders.
Prearranged bankruptcies require that at least 67 percent of the creditors agree to the plan, so an early and clear picture of the different creditors and their primary motivations is essential to line up the necessary votes before formal solicitation. This can be a complicated undertaking. Often creditors have differing views of the enterprise value of the company and what constitutes the fulcrum security, the debt instrument most likely to be converted into equity in a reorganized company.
For example, a second lien lender may perceive that it is the fulcrum security at a certain enterprise value. However, the unsecured note holders may believe that the company value is greater and that they are the fulcrum security. Coming to terms with the business valuation and finding common ground are critical to a prearranged filing.
Not all stakeholders are in the capital structure and get to vote, but it’s important to understand their interests as well. A company’s suppliers, for instance, want a healthy, thriving customer. And key employees want a company at which they can pursue meaningful, lucrative careers.
Adding to this tableau of players is the continued emergence of secondary debt holders and distressed investors. During the financial crisis these investors faded somewhat from the scene, but as the recovery gels and the prospects for a quick return improve they are snapping up debt, often the fulcrum tranche of the capital structure.
4. Document Agreements.
Once a company has won the necessary votes and financing to advance a prearranged bankruptcy, the company needs to properly document formal agreements. Prearranged bankruptcy filings are by their nature somewhat fluid since a third of creditors may not agree to the POR. But plan-support agreements involving creditors that do agree can help keep the process on track.
Plan-support agreements must describe the POR and the financing terms, outline achievable goals and promises, be customized for each investor class, and include the proper disclosure requirements associated with applicable bankruptcy and security laws. These agreements help ensure that everyone remains committed to the plan.
The wild card in the prearranged bankruptcy process is that one-third of the creditors might not agree to the terms and therefore won’t sign support agreements. But a well-documented set of agreements with the key constituents most likely will be well-received by a judge.
5. Clear Communications.
Clear communications with employees, partners, and investors are important so that these stakeholders aren’t thrown off guard or shocked by the bankruptcy plan. When employees understand a bankruptcy plan, they are more likely to cooperate with management and help prevent business disruption. Continuity is crucial to maintaining the company’s competitive position and in preserving the valuation assumptions that will determine how, or even if, the respective parties can come to agreement prefiling.
Poor communications, meanwhile, fuel gossip and create distractions that hurt employee effectiveness and productivity, and can also lead to the exodus of talented employees.
Similarly, clear communications with suppliers and customers helps prevent business disruption. If trade partners withdraw supplies, fearing the company can’t pay for them, or if customers turn elsewhere, fearing the company won’t survive to deliver or stand behind the products it sells, the implications for the company are dire.
By communicating with employees, suppliers, and customers, a company can explain its plan and hopefully convince all concerned that they should continue to do business together. A coordinated communications campaign also ensures that when employees work with suppliers and customers, everyone is on the same page and there are no miscommunications or surprises.
Powerful Tool
A prearranged bankruptcy in today’s economic and investing environment is a powerful tool to move a company through bankruptcy proceedings quickly, in a less costly manner, and with minimal disruption to the business. The end result can be a business that’s leaner, adequately financed, and more competitive.
Not surprisingly, this requires a sophisticated financing partner, one that is experienced with prearranged bankruptcies, has the resources and expertise to finance the process, and understands the market in which the company operates. To secure such a lender, a company must manage the prearranged bankruptcy process carefully by addressing five essential elements — examine the circumstances, secure liquidity, understand the stakeholders, document agreements, and implement clear communication.
This is a complicated, rigorous process, but well worth the effort if a stronger, more competitive company can emerge in the end.
Winston Rowe & Associates 