Lenders are faced with difficult circumstances when a borrower’s business and the bank’s collateral is deteriorating. The downward spiral often includes declining or negative earnings, insufficient cash flow, declining enterprise value, escalating trade debt and “tripped” financial covenants. Further, management has not been able to reverse these negative trends and worse, have likely not been able to forecast these problems before they were reported. This will certainly erode trust between a borrower and their banker. When a lender is primarily concerned with protecting its collateral in a deteriorating situation, measuring alternative options can be considered relative to control, time, exposure and cost.
An overview of some common strategic options facing the lender include:
Voluntary Chapter 11 Bankruptcy Proceeding: The borrower typically maintains control as the Debtor in Possession and timing is also driven by the borrower and its circumstances. A Chapter 11 case is often expensive and paid from the lender’s cash collateral. Professional fees often include the debtor’s professionals and depending on the case size, may also include an unsecured creditors committee and their professionals (attorneys, financial advisors, etc). The lender will also be represented by their legal counsel and financial advisors and the U.S. Trustee’s office will be paid a quarterly fee based upon disbursements. On the benefit side, the lender will gain additional visibility into the borrower’s liquidity and put limits on the use of cash. From a timing perspective, a bankruptcy doesn’t have to be lengthy, but they often march down a long winding road.
Foreclosure: Often a less appealing option as it can be time consuming and the process may or may not generate a buyer. Buyers will certainly discount their offers based solely on the foreclosure process and they will heavily discount value if they believe they are the only serious buyer. A major drawback of foreclosure in Michigan is the six-month redemption period after the sale in which the borrower/debtor remains in control of the property. In the event a buyer doesn’t materialize, the lender may run the risk of having to credit bid and take title to the property which could also bring additional unwanted risks to the lender.
Receivership: A receiver is an officer of the court focused on the management, protection and operation of the business and property within the receivership. Typically, a receiver protects the interests of the creditors, shareholders and all others who claim interest in the receivership’s property. Courts have generally held that the appointment of a receiver does not alter the ownerships rights or change title to the property. Rather, a receiver stands in the shoes of the persons or person(s) whose assets are contained in the receivership.
The powers of the receiver are typically identified in the Order Appointing the Receiver, but they are generally not limited to: 1) Obey the orders of the court 2) Maintain accurate business records 3) preserve and protect the receiverships property 4) Operate or wind up the affairs of the business. As a practical matter, a recurring strategy should ultimately surround marshalling the assets, stabilizing the business and expeditiously market and sell the assets for highest value.
Receiverships offer a lender the opportunity to appoint a court empowered neutral party to receive, preserve, and or sell/liquidate its collateral. Special issues may arise within receiverships when the collateral is located in multiple states or jurisdictions. Receivership actions are commonly filed in the state court in the county in which the debtor is located. State court jurisdiction is confined to the state in which the court and property are located, while Federal receivership actions are conducted in the Federal district court. Federal receiverships allow a receiver to exercise nation-wide jurisdiction. Having said that, in order to seek the appointment of a receiver in a federal court, there must be federal jurisdiction and a cause of action. The motion to appoint a receiver is not by itself a cause of action, but rather ancillary to the complaint.
Receivership Benefits include:
• Control – The party seeking the appointment (typically the secured lender) often nominates the receiver subject to court approval. Conversely in a Chapter 11 bankruptcy proceeding, ownership often remains in control as Debtor in Possession (DIP) or in a Chapter 7 proceeding, the US Trustees office will appoint a Trustee from its panel.
• Cost – Compared to a bankruptcy proceeding, a Receivership is a lower cost alternative. There are no US Trustee quarterly fees and there’s no unsecured creditors committee and their associated professional fees. There will be fees associated with the receiver and its legal counsel, but fees overall will be much less than those in a bankruptcy.
• Asset Preservation – Upon appointment, a receiver will quickly assume the day to day management and control of the bank accounts and assets. Cash flow planning is a critical starting point to understand the current and projected liquidity and to identify any necessary changes to slow or eliminate any cash shortfalls. Distressed assets are often the result of mismanagement, fraud, theft, general misconduct or a combination of the same and that’s why it’s critical to initiate the receivership to preserve value.
• Bankruptcy Qualities with Faster Resolution – The authority of a non-bankruptcy court can be used to accomplish the goals of the receivership. Fox example, the receivership order (RO) typically includes a stay provision which mirrors the automatic stay in a bankruptcy. A well-crafted receivership order combined with an experienced receiver can navigate the process to create the highest recovery values in a bankruptcy-like environment. The receiver may also choose to pursue legal claims belonging to the borrower to enhance creditor recoveries.
• Plan for Success – Selecting a receiver with both turnaround and industry experience is critical to a positive outcome. Turnaround experience is important because the situation will likely have liquidity and profitability issues and Turnaround experience will be necessary to stop the “cash bleed” to improve recoveries. This is extremely important to the lender since if there isn’t enough cash flow to pay the operating costs and the receiver, the lender in almost all cases will be required to fund the receivership. The Turnaround professional will also have the expertise to appropriately measure the progress and determine whether or not the changes are working and what steps will be needed to address the variances to plan. Further, it’s likely the Turnaround professional will have experience with improving enterprise value and marketing the business for sale to generate numerous interested parties and guide the transaction to an expeditious close.
Secured lenders wrestle with alternative choices when borrowers experience declining enterprise value and collateral values. Time is typically short and, more often than not, confidence in ownership and management to effectuate a turnaround or discontinue the deterioration is low. In these circumstances, the margin for moving forward to repay the bank’s credit is often slim and none. When the loan documents were signed, the lender held up its end of the bargain by funding the transaction, but the borrower has fallen short of its expectations, promises and responsibilities. The time for action is now.
In the right circumstances, placing the borrower’s assets into a Receivership can be an excellent vehicle to maximize recoveries through a sale process, wind-down or combination of the two. A receivership combines bankruptcy like benefits with more control and less cost. Receivership control is shifted to a court appointed receiver (often suggested by the lender) who in turn reports to the court. The Receivership process is typically shorter than a bankruptcy and contains less exposure to the secured lender for potential successor liabilities associated with foreclosure and it avoids the six- month redemption period consistent with a foreclosure sale.
Plan for success by identifying a Receiver with both turnaround and industry experience. The turnaround professional has the skillset to establish a plan, solve liquidity and cash-flow issues accordingly and measure the variances to plan to establish next steps. Further, the turnround professional will have experience marketing the company to identify numerous potential buyers and marching a sale process to a close. Further, if a winddown of operations is the best path to recovery, then the turnaround professional has the expertise to maximize value in this arena as well.
About the Author
Michael Boudreau CPA, CTP CFF is a Director with Morris-Anderson, a financial consulting firm focused on restructuring and workouts, court appointed receiverships, debt refinancing, performance improvement, CRO and interim management, transaction advisory and other fiduciary services. Mr. Boudreau has operated and sold numerous business enterprises as court appointed receiver. Examples include manufacturing operations, senior living facility and real estate developments. He has 25+ years’ experience in the automotive supply chain as Financial Advisor, CFO and Treasurer. Mr. Boudreau also has extensive experience in numerous Commercial & Industrial (C&I) as well as real estate matters. Examples include health care, construction and contractors, aerospace, restaurant chains, plastics, agribusiness, consumer products, logistics and others.