Today businesses are meeting unprecedented challenges. Principles of turnaround management, i.e., turning struggling businesses into successful businesses, are now essential to almost every business. As in any crisis, business managers will face difficult decisions concerning treasury management, creditor relations and, potentially, seeking bankruptcy relief.
Strategies to Preserve Cash
The central mantra of turnaround is “Cash is King.” Business managers will likely need to be selective about expenditures to preserve cash in order to survive. This includes extending some of their payables by delaying payments to suppliers and other creditors. It is important to analyze the contractual and practical consequences of delaying repayment of each payable, in order to have a cohesive strategy to treasury management. This analysis will be more complicated during the supply chain disruptions caused by the COVID-19 crisis, as some suppliers may command more urgent payment. Likewise, it may be advisable to draw down available lines of credit to ensure liquidity in the near term. Business managers should be analyzing these decisions with their legal advisors and other professionals to establish an optimal treasury management strategy.
Creditor Relations, Forbearance and Standstill Agreements
When cash flow is limited, disputes with creditors are bound to arise. In such an unprecedented crisis, creditors may be more amenable to agree to cooperate. There are several reasons why creditors would be more willing to cooperate with forbearance arrangements in the midst of the pandemic. First, access to courts is limited. Many courts have delayed civil hearings concurrently with applicable “shelter in place” orders, or longer. Therefore, the creditor may not be able to enforce its rights as effectively or expeditiously, making forbearance more attractive. Second, taking action could hurt the creditors’ recovery by diminishing going concern value, or their ultimate likelihood of recovery. Third, parties in general may be more willing to act cooperatively for humanitarian or other reasons in the midst of such a crisis.
Forbearance agreements generally provide that a creditor will refrain from enforcing their collection rights, for a defined period of time, in exchange for certain concessions, payments or other covenants granted by the debtor. It will make sense to resolve many debtor-creditor disputes during the COVID-19 crisis by entering into forbearance agreements for the duration of the crisis, or longer, rather than proceeding with foreclosure or other litigation.
A variation on the forbearance agreement is the standstill agreement, which seeks to simply freeze the status quo. Generally, the standstill agreement provides that the creditor will not seek legal remedies for an agreed upon period of time, while the debtor agrees not to engage in transactions outside of the ordinary course of business. The American Bar Association has developed a universal form of standstill agreement specifically for use during the COVID-19 pandemic which may act as a reliable touchstone [Model Standstill/Tolling Agreement]. The benefit of the standstill agreement is that it provides a simple interim solution--basically, kicking the can down the road.
Cash Flow Projections
For any business in a distressed or turnaround situation, cash flow and projections of cash flow are essential. At a fundamental level, a business manager must look at a relatively short time horizon and ensure that the business will generate sufficient revenue streams to meet costs and survive. The industry standard typically utilizes a 13-week projection to predict income and expenses in the near term.
Such projections are critical not only for the manager of the business, but also for any lenders or other parties in interest from whom any cooperation will be sought in the restructuring process. They are even more critical if the business is contemplating seeking Chapter 11 relief, because such projections are generally required by the Bankruptcy Code and other applicable rules.
It is a serious challenge for business managers to project cash flow in the midst of disruptions caused by a pandemic with an unforeseeable end. Stakeholders like lenders expect to see projections that are realistic, and, ideally, conservative. Business managers whose cash flows are impacted by the pandemic will have to utilize resources like surveys by financial institutions and other research groups which predict when a return to normalcy may occur, to provide some guide in order to generate realistic projections.
Chapter 11 Relief
Chapter 11 can provide a distressed business the “breathing room” from creditors necessary to survive, while simultaneously allowing the business to continue its existing management structure. Ideally, that breathing room allows the business to stabilize and then formulate a plan, which, once approved by the court, will provide for an orderly treatment of creditors’ claims.
There are many drawbacks to filing Chapter 11. The process imposes onerous reporting requirements that put the business’s dealings under a microscope. The bankruptcy court and the US Trustee’s office impose fees throughout the process which are significant. Moreover, the legal fees in navigating the process can be much greater than the legal fees the business would otherwise incur outside of bankruptcy.
Nevertheless, Chapter 11 will present an opportunity for some businesses facing cash flow disruptions to survive the COVID 19 crisis. In some instances, it may be the best opportunity to obtain necessary financing through a debtor in possession financing arrangement. It is also a potentially viable alternative for businesses that have access to cash sufficient to meet payroll and other obligation for the near term but face one or more aggressive creditors seeking to leverage potentially severe creditor rights such as foreclosure or termination of critical contracts.
Small businesses have new options under Chapter 11 to seek relief under the Small Business Reorganization Act (“SBRA”). In response to the COVID-19 pandemic, Congress expanded the availability of SBRA relief to businesses with debts of up to $7.5 Million. The SBRA contains a number of potentially favorable provisions for small businesses to restructure their debt, including reductions in the costs associated with a chapter 11 case, removing the requirements for filing of a disclosure statement, and easing the limitations imposed by the “absolute priority rule”. A more detailed analysis of the SBRA is set out in the prior blog entry “Bankruptcy Insights: The Small Business Reorganization Act.”
Lugenbuhl is closely monitoring this fluid situation as it develops and will provide updates as they become available. Until then, individuals or businesses in need of guidance should contact Lugenbuhl for support.
The Lugenbuhl Lending Issues/Forbearance/Restructuring Task Force are members of the firm's Bankruptcy, Restructuring and Creditors’ Rights practice. If you have questions about the information in this update or would like additional information on how we can help you and your business, please feel free to contact us at (504) 568-1990. If you have questions, or would like more information about our Bankruptcy, Restructuring and Creditors’ Rights practice, click here or contact one of our Task Force attorneys at the following:
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