Bankruptcy -- Lesson One -- Introducing The Team

Almost immediately after posting my last blog entry, I received some suggestions among the responses. As some of these came directly to my email, rather than being posted to the blog’s comments area, I’m taking the liberty of recreating them here with modest edits, and they will serve as a starting point for the subject. [As I mentioned previously, this is not a “how to”, but is intended to de-mystify the process somewhat. This is also primarily geared toward corporate or commercial bankruptcies; while some of what we discuss also pertains to individual or small business bankruptcies, many of the complexity wrinkles don’t exist -- unfortunately, neither do some of the more positive features.]

You’ll note a couple of common themes in the two comments below, and I want to expand on one of them today.

1) "I’m sure you have already thought of this, but here are a couple other ideas to reinforce -- along with seasoned counsel (repeat three times). You need to get after this process early -- it is expensive to go broke so don't wait until the liquidity crisis is extreme. Hope is not a strategy, though it is usually deployed. Especially for businesses in distress, I usually see pollyanna-ish financial forecasts, even for the 13 week cash forecast...makes for a crash landing, or a hard one at minimum."

2) "It takes a lot of money to go bankrupt; it also seems to take a village".

The first comment was provided by Allan Hickok, a FohBoh member who’s been analyzing and advising restaurant companies for many years. He makes several useful, and interrelated, points. I want to start with:

Seasoned Counsel -- not to equate this with cardiac surgery, but when you’re going into any sort of specialized procedure, you want a specialist on your side. Most attorneys have one or two areas of specialty, and are very good at those. The attorney who drafted your lease or franchise agreements is likely NOT the one who spends most of his or her professional hours focused on the finer points of bankruptcy, especially as it varies from one jurisdiction to another.

Seasoned Counsel -- depending on the size and complexity of your company, financing, and prospective filing, seasoned counsel also means having a financial advisor who understands that a recapitalization or sale of a business in bankruptcy is rather different than one “in the ordinary course”. For larger transactions, it’s more often than not the case that you’ll need both an investment banker and a restructuring or “crisis” manager. The former prepares the transaction which will bring you out of bankruptcy, whether by selling certain assets, attracting new investors, selling the company, or some combination of all three; the latter focuses on ways to preserve cash, deal with suppliers and creditors, and generally get you through the time of bankruptcy with as little damage as possible.

Now to the “village” comment, by a former client who’s been through this process:

Remember that, for any bankruptcy of size (involving, say, a company [the “Debtor”], and its lender or lenders, landlords, and suppliers [known collectively as the “Creditors”], the reason for the bankruptcy is an inability to meet financial obligations while keeping the company whole. As a consequence, someone among the creditors (the lenders, landlords, and suppliers, or some special creditor like the beneficiary of a lawsuit settlement) stands to suffer a loss. Because of this, those parties will also be represented by Seasoned Counsel (both legal and financial) and may also require that the Debtor use a crisis manager like the one described above. I haven’t yet mentioned all the likely players, but these are basically the First String for each team.

Here’s the catch -- since the Debtor is causing all this commotion, the Debtor is responsible for paying the costs of all those Seasoned Counselors. (And you wondered why bankruptcy seemed so complicated.) In a “fair” world, this makes a certain amount of sense, since it’s the Debtor’s desire to get something out of the Creditors -- a reduction or elimination of certain debts or obligations -- which prompts the bankruptcy proceeding in the first place. Still, because of all these costs, it’s obvious that less is left over at the end of the process, which means that either the Creditors end up with less, or the Debtor sacrifices some of its assets or businesses (if they can be separated), or both.

That last issue is very important. In future columns, as we talk more about the costs of bankruptcy and the possible options for Debtors and Creditors emerging from the process, it’ll become a big part of how the U.S. bankruptcy system works -- who benefits at someone else’s expense, and why.