Thomson Reuters Bankruptcy Series: The Key Elements of an Out of Court RestructuringApril 14, 2020 – Publications / Mentions
Goulston & Storrs bankruptcy attorney, Doug Rosner, recently worked with Thomson Reuters to create a three-part series that explains some of the various options for companies in financial distress. This third video in the series discusses the key elements and real-life examples of an Out of Court Restructuring.
If you have questions about this topic, please visit our Bankruptcy & Restructuring page or reach out to your usual Goulston & Storrs attorney.
Hello and welcome. This is a video about out of court restructurings and the key elements. My name is Doug Rosner. I'm a bankruptcy and restructuring attorney at Goulston & Storrs in Boston, Massachusetts. In this video, I'm going to give detailed examples of some out of court restructurings that we have worked on. And I'm also going to discuss the key elements to try to make an out of court restructuring successful.
Generally, with the middle-market company, the out of court restructuring starts with negotiations with your senior secured lender. And the reason for that is because the senior secured lender is lien usually on substantially all the assets of the company and also provides liquidity to the company especially when they're facing financial difficulties. So if a company is unable to reach an agreement with the secured lender, then it's unlikely they'll be able to reach an out of court compromise with any other creditor constituents. So typically you start with a senior lender. And the other advantage of starting with a senior lender is if you are able to reach an agreement with the senior lender, then you can take that agreement and shop it around to the other constituents as a way to get them to agree as well.
So I think the best way to explain how it works is through an example. And it's a real-life example from one of our clients. So we have a client, it's a middle-market company, about 100 million dollars of revenue in the home decor sector. They operate in four different countries, the United States, China, the UK, and Canada. And they were at the time they were over-leveraged, they were suffering liquidity issues, and they needed to come up with some solution to their financial difficulties. And what they did or what we did in that context was we first went to the senior lender, and we asked the senior lender to take a 50% haircut. Which is very significant. But by that time by the time these discussions started, the senior lender was fully aware of, of what the problems were, as well
as the likelihood that if the company were to sell or liquidate at that point in time, the senior lender would not get paid in full. So we provided the senior lender with a plan, we provided them with additional financial information. And we made the proposal to them to take the haircut and where those negotiations ended up is the senior lender agreed to take a 50% haircut, and that alone allowed us to then go out to other lenders and refinance that 50% piece. And then for the balance of the loan, the senior lender agreed to put it into a separate note, we'll call it a B note. And that note would be tied to the sale of the company's China operations. And any excess cash flow coming from the sale of the China operations would be shared with the senior lender to satisfy that note.
With that agreement in place, we were then able to go out to the other constituents which included the Chinese Bank Group. So we were able to go out to them and reach an agreement with the Chinese Bank Group to accommodate a sale process in China that ultimately would pay the Chinese banks in full. And what ended up happening was that sale process generated excess proceeds as we planned, and those excess proceeds were used to pay down some of the what we call the B note that the US lender held.
We also then took the agreement with the senior lender and went to our retirees and they're the retirees were part of what I'll call an underwater deferred compensation retirement plan. And we again shared our financials with the retirees. We share the terms of the agreement with the senior lender and they quickly understood that in a liquidation or sales scenario, they would probably be completely out of the money. And so we were able to reach an agreement with the retirees where they agreed to cut their benefits under the deferred compensation plan by 50%.
We then at the same time, we're going out to the unsecured creditors, primarily the critical vendors and trade creditors, and ask them to take make concessions primarily in the form of deferring payments on existing trade that until after we were able to complete the refinancing and restructuring of the senior secured debt. The landlord also provided us with some lease concessions that reduce costs. And then once all of these things were tied up, which probably took about four to six months, let's say we came out with a company that had 50% less long term debt so they were no longer over-leveraged - a company with additional liquidity, reduced costs, and ability to continue their plan, which was to diversify into other segments of the home decor industry. And they had enough liquidity for example, that within about a year of the out of court restructuring, they acquired a failing company in their space that allowed them to diversify into other areas of home decor. And the company continues to operate and continues to do well.
So that's a good example of where we avoided the expense and disruption of a chapter 11 process. We had creditors across the board who were willing to listen and be reasonable, and the company was transparent. And over the course of a few months, we were able to reach an agreement and restructure the company's balance sheet.
For the unsecured vendors, the steps that would be taken and typically after we've already reached some agree met with the senior secured lender is first and similar to what we've done with the senior secured lender. The first thing is transparency and to provide these vendors with historical financial information as well as a business plan as to why we're asking them to make concessions and what improvements that will provide to the company to allow the company to restructure. And we also explained to the vendors what the benefits are to completing the out of court restructuring as opposed to doing a chapter 11 bankruptcy, or even worse, a liquidation or closure of the company.
So there are different ways to go about doing this. And we've done it in different ways with different clients. So, in some cases, we've gone out to creditors through a letter, and it's a form letter that goes out to all the vendors asking them to take a significant haircut or make a concession. We explained in the letter why the company is in control. And why we're asking them to make the concessions and why we believe that with these concessions and other concessions made by other creditors will resolve many of the company's financial difficulties and allow them to continue to operate. With that letter, we typically get a decent response rate. And that opens up conversations with many of the creditors.
Another way of going about communicating with the vendor group is to go first start with the largest or what we call the most critical trade creditors and ask them to come either one on one or form a group and have what we call a committee meeting. So form a group of largest spenders into a committee, perhaps even like a chapter 11 process, fund their lawyer and financial advisor share with them the more detailed financial information the business plan and what concessions we're looking for, and negotiate with that committee body to try to reach an agreement. And if we're able to reach an agreement, then to go out to a larger creditor population with that agreement.
We did that, for example with a hardware distributor where we formed a committee, and we met with the committee and got the committee to agree. Then we shopped that agreement to the rest of the creditor constituents and we ended up with a 99% acceptance rate. There was one creditor that didn't accept and for that creditor, that creditor was not able to share in the distributions to creditors and never followed up either. And the company was able to accomplish what, at that time, was a sale.
Another example of what we've done is actually call creditors. And again, it's usually you start with the critical vendors and sometimes we bring in an outside consultant To help with the calls, and they'll start with calling the largest creditors. And as deals are reached with the larger creditors, those deals can be replicated with the smaller creditors.
And sometimes we've done a combination of all of that. Where it gets more difficult is with equipment lessors, which are party to leases of personal property such as copiers or manufacturing equipment or construction vehicles. And those lessors are in a more difficult position because they themselves have borrowed money to buy the equipment that they're leasing to you. And they rely on the leasing revenue to repay those loans. So they have less room to make concessions than maybe a general unsecured creditor. So in many of those cases, we try to structure the restructuring in a way that we leave the equipment leases alone as for real estate leases like a headquarters lease or distribution center leases and things like that. We do try to obtain concessions from landlords to reduce rent, to reduce the term to maybe even eliminate some locations to reduce costs. And in many of those cases, again, it's the transparency is a critical component. We share the financial information with the landlords and try to reach an agreement with the landlords to give us the concessions we need under the leases.
So I mentioned earlier, an alternative to an out of court restructuring is an assignment for the benefit of creditors. And assignment of the benefit of creditors is primarily a sale of substantially all the assets of a company. And when the assignment for the benefit of creditors is that there's a neutral fiduciary, a trustee that's that the company designates and appoints and then assigns all of its assets to the neutral fiduciary, and then that neutral fiduciary will run the sale process and interact with all the creditors. And so it's no longer the company management that's interacting with the creditors. It's this fiduciary. And the reason why we might use an assignment for the benefit of creditors is for various reasons. One, is it could comfort a buyer that they're buying from a neutral fiduciary and perhaps the sale will be better insulated from attack if creditors were later to attack the sale process. Another reason might be a lack of trust, that creditors may have lost trust in management. And therefore you need to bring in a third party and a neutral third party fiduciary such as a trustee to interact with the creditors and explain to the creditors the situation and try to negotiate with those creditors a creditor compromise as part of the sale or liquidation of the assets.
So those are the primary reasons why you might use an assignment for the benefit of creditors' structure. And the way it would work. I mean, again, we've done this a few times is the company assigns all its assets enters into an agreement with the trustee to assign all of its assets to the trustee. The trustee then sells those assets, takes the money and distributes it out to creditors pro-rata.
In many cases in an assignment for the benefit of creditors, also known as an ABC, is done in the context of a liquidation. But we've done a few where the company has been sold as a going concern. So the assignment for the benefit of creditors may take place after we've already found a buyer. And so the assets are then assigned to the trustee. The trustee is persuaded that this is a good buyer, that the company has been marketed and it's an arm's length transaction and for the highest value. And so then the trustee actually closes the transaction and then takes the proceeds and distributes it to creditors.
So we've done that in the context of some internet retailers. We did that in the context of a catering equipment company, and they were able to continue in business throughout the process and end up on the other side with the new owner and still operating. In other cases, the assignment for the benefit of the creditor is strictly a liquidation. The company closes and the assignee liquidates the assets. And whatever money is generated from the liquidation is then distributed to creditors and creditors get what they get. The assignee will ask the creditors to consent to the assignment for the benefit of creditors. And if they consent, they get a piece of the distribution. If they don't consent, then the creditor has a couple of alternatives one is do nothing and get nothing.
The other alternative might be to sue their customer and try to get paid that way or even file an involuntary bankruptcy against the customer and disrupt the assignment for the benefit of creditors. But in many cases, creditors understand that in an ABC, they'll probably get more than they would in bankruptcy because it's a less expensive process. And they'll get that money more quickly than in bankruptcy because it's a much more fast-moving process.
The key elements to a successful out of court restructuring is primarily transparency. And when I say transparency, what I mean is that the borrower or the or the company is transparent with its creditors and is willing to show its creditors its historical financials, its current financials its business plan, so that the creditors can understand the context of the restructuring and understand why it's in their best interest to agree to the restructuring. In addition, strong management and what we call an honest debtor. So there has to be trust. The creditors have to trust the information that they're getting. They have to trust the disclosures that they're getting and they have to trust that as much as they're making concessions, management may be making concessions as well. And that there's no fraud, and there's no misinformation and nobody's enriching themselves by way of the restructuring, so that's important as well.
In addition, another key element is that similarly situated creditors are treated the same. So if you have a body of unsecured trade vendors, they should all be treated the same because if word were to get out that certain creditors are getting better treatment than other creditors that could significantly disrupt any attempt to complete an out of court restructuring. So it's important that everybody gets treated equally. And if you're not able to do that, it does make it a lot more difficult to accomplish the restructuring outside of court.
In addition, one of the things that an out of court restructuring does is it mirrors the priority scheme in a chapter 11 case. And that's the framework that the company would use, and that's the framework that the creditors use. And in a chapter 11 reorganization, unsecured creditors are treated equally. And so you try to do the same thing and an out of court restructuring.
In addition, another key element to an out of court restructuring is a compelling story. So as part of the disclosures that the company makes to its creditors will be the story about how it got into trouble in the first place. And if it's a compelling story and a convincing story, the creditors will normally get on board because the alternative of liquidation or a quick sale is not going to work. result in the same recovery that they would get in an orderly out of court restructuring. So the compelling story is important as well.
And I think those would be the key elements and transparency and an honest debtor are probably the most critical because, without transparency and information provided to the creditors, the creditors will not trust the process and will not feel comfortable that they're making an informed decision which is important.