Financial Restructuring: Issues For All Businesses To Consider

Financial Restructuring:  Issues For All Businesses To Consider

     The current COVID crisis is impacting businesses in all sectors of the economy. While restaurants, hotels, and retailers are feeling the immediate effects, the fallout will likely continue for some time. Thus, it is imperative for all businesses to evaluate their potential restructuring options.  This does not mean that all businesses need to implement restructuring plans at this time, although many will need to do so. Instead, this means that all businesses should fully evaluate their situation to understand what options are available to them so that they will have maximum flexibility when the need arises. When evaluating their options, businesses should take the following steps:

1.         Prepare Cash Flow Projections.  Businesses should prepare 13-week cash flow forecasts and update them weekly. This serves several purposes. First, it will help identify any week where there may be a cash flow shortage and allow the business to plan accordingly. Second, preparation of the forecast will allow the business to identify those costs which can be eliminated or deferred. Third, the forecast will allow the business to determine how much runway it has to continue operations if revenue declines. It is critical to understand how long a business can maintain operations before running out of cash because a business cannot wait until it is at the end of that runway before considering the option of a chapter 11 reorganization. At that point, chapter 11 will likely no longer be a viable alternative. Finally, preparation of a thorough and accurate cash flow projection will assist in negotiations with creditors, if needed.

2.         Review all Loan Documents.  It is absolutely critical for businesses to review all existing loan documents to evaluate what potential defaults currently exist or may exist in the future. Many loan documents contain financial covenants that may be breached even if a company is current on its loan payments.  In addition, an asset-based revolver facility will typically exclude delinquent invoices from the borrowing base. As result, if a company’s customers begin to delay their payments, then the company may find itself in an overadvance situation. Finally, loan documents should be reviewed to evaluate what conditions must be satisfied in order for the company to make additional draws on its line of credit. Companies should consider going ahead and drawing down lines of credit before a potential covenant default exists that would prevent future borrowings.

3.         Review Critical Contracts.  Critical contracts include real estate leases, franchise agreements, customer contracts, and contracts with critical vendors. These contracts should be reviewed for termination provisions, force majeure provisions, and provisions regarding damages in the event of a default. In the current environment, force majeure provisions may provide some benefit, but many contracts require that notice of a force majeure event be provided within a certain period of time.  While many businesses are currently focused on reviewing agreements that obligate them to make payments, businesses should not ignore reviewing agreements they have with their customers.  It is important for a business to know if its customer can easily terminate a contract so that it can plan accordingly.

4.         Approach Creditors for Relief.  Many lenders are likely to be fairly understanding in the current environment when approached with a temporary forbearance proposal.  Many landlords are already overwhelmed with requests for relief from tenants.  The ability of a landlord to provide relief will depend on its own situation.  Larger, institutional landlords may be more equipped to provide temporary relief than others.  Companies may also approach vendors about deferring payments, or making payments over time.  When approaching creditors for relief, however, there are several items to keep in mind.  First, a company should try to anticipate potential issues and begin discussions with a creditor before a default occurs.  Second, the company should be completely transparent with its financial situation.  Creditors are more likely to be receptive to proposals if they believe they are receiving full and accurate information.  Third, the company should be able to show that it has a plan in place.  This is one of the reasons that it is critical to have accurate cash flow projections.  Finally, the company should not merely ask for relief; it should make a concrete proposal.  Put simply, the company should not approach a creditor for relief until it is able to make a concrete proposal and demonstrate how that proposal will work.

5.         Review Insurance Policies.  Many businesses are already evaluating whether they have business interruption insurance, and if so, whether that insurance will provide any help in the current situation. While standard business interruption insurance provisions may not provide any help in this current situation, insurance policies should still be reviewed to see if they may provide any benefit.

6.         Review Government Programs.  Several government programs have already been announced.  The SBA is offering low-interest federal disaster loans for working capital to small businesses suffering substantial economic injury as a result of COVID.  In addition, Freddie Mac and Fannie Mae have announced that multifamily borrowers may obtain a 90-day forbearance provided that they do not evict any tenants during that time frame. Details of the $2 trillion relief package are just now emerging.  Given the amount of funding provided, it is likely that there will be some form of relief available, and businesses should review all possible options.

7.         Explore All Options – Even Chapter 11.  Many business owners view chapter 11 bankruptcy reorganization as something to be avoided at all costs.  While chapter 11 should be viewed as a last resort, and out-of-court restructurings are generally preferable, the potential benefits of chapter 11 should not be ignored.  Chapter 11 is designed to help viable businesses that are suffering from temporary shocks.  In addition, the bankruptcy code was recently amended to make the chapter 11 process more beneficial to small businesses that have total debts of less than $2.7 million.  Businesses need to understand the potential costs and benefits of the chapter 11 process.  If a business waits too late, then chapter 11 may not be a viable option, and a business will be faced with liquidation as its only choice.  In addition, chapter 11 provides the baseline against which negotiations with creditors occur.  In other words, the goal of out-of-court negotiations is to explain to a creditor why an out-of-court deal will be better for all parties than a chapter 11 reorganization.  Thus, a company cannot adequately negotiate with creditors unless it fully knows what its options are, including chapter 11.  For these reasons, a company should not view an evaluation of chapter 11 as a sign of surrender.  Instead, obtaining an understanding of the chapter 11 process may actually help the company avoid that result.

This list is not an exhaustive list of all issues that a business should consider, and much more could be written about each of these topics. However, this list should serve as a starting point for businesses as they evaluate how to proceed in these challenging times.

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      Felton Parrish represents parties in complex chapter 11 cases and has participated in some of the country’s largest bankruptcy cases such as WorldCom, Inc., Delta Air Lines, and Caesars Entertainment Operating Company. He has represented both debtors and creditors in chapter 11 cases and related litigation.  He was listed in The Best Lawyers in America for Bankruptcy and Creditor-Debtor Rights for 2018, 2019 and 2020.