CHAPTER 1 AN OVERVIEW OF RESTRUCTURING
| Jurisdiction | United States |
(May 1986)
AN OVERVIEW OF RESTRUCTURING
DAVIS, GRAHAM & STUBBS
DENVER, COLORADO
TABLE OF CONTENTS
I. INTRODUCTION
II. SOME PRACTICAL ASPECTS OF WORKOUTS
A. Common Workout Components
B. Advantages of Workouts
C. Disadvantages of Workouts
D. Conditions for a Successful Workout
E. Pitfalls to Avoid
III. BANKRUPTCY AND ITS IMPLICATIONS
A. Chapter 7
1. Focus and purpose
2. Role of the Chapter 7 Trustee
3. Role of the Debtor
4. Role of the Bankruptcy Court
5. Role of the United States Trustee
6. Discharge
B. Chapter 11
1. Focus and Purpose
2. Role of the Debtor-in-Possession
3. Role of the Chapter 11 Trustee
4. Role of the Chapter 11 Committees
5. Role of the Bankruptcy Court
6. Role of the United States Trustee
7. Disclosure Statement and Plan of Reorganization
IV. CONFIRMATION OF THE PLAN OF REORGANIZATION
A. Confirmation Criteria
B. The Effect of Confirmation
V. IF RESTRUCTURING COLLAPSES
A. Conversion or Dismissal
B. Walking Away
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I. INTRODUCTION
Success in the current economic climate demands much from even the most determined and resourceful entrepreneur. In the mining industries, however, buffeted by slackening demand, deteriorating prices and shrinking margins, the realistic challenge during the next several years may be survival rather than prosperity. Meeting that challenge will require not only careful and creative financial planning, it may well hinge upon management's appreciation of the principles of "restructuring".
Restructuring, as that term is used in this paper, connotes the modification or conversion of the liabilities and/or capital structure of the business. Restructuring may be accomplished either within or without the judicial arena. The most common form of judicial restructuring is bankruptcy—one of the principal focuses of this special institute. There are other forms as well, however. For example, banks, savings and loans and insurance companies do not qualify for bankruptcy relief,1 and the reorganization or liquidation of those entities must be accomplished under court supervision pursuant to other state and federal laws.2 Restructuring may also be effected without the intervention of judicial process. The generic term for restructuring outside the confines of a judicial forum is "workout".
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II. SOME PRACTICAL ASPECTS OF WORKOUTS
A workout may be quite formal (for example, it may be embodied in one or more detailed, written agreements among the interested parties) or it may be effected more casually (for example, a creditor's parol assurance that he will forbear for a time). Regardless of the approach, however, there are practical considerations which assist in analyzing the workout and evaluating the probabilities of success.
A. Common Workout Components. The most common elements of workout plans are "composition" and "extension". A composition is a plan under which one or more creditors are paid less than the full amount of their claims in complete satisfaction of those claims. An extension is a plan which provides that the debtor is afforded additional time beyond the original due date to retire the indebtedness owed to its creditors. These elements are not mutually exclusive, and frequently a workout will involve both composition and extension aspects. Sophisticated workouts may also include more complex components such as: (i) refinancing, (ii) moratorium on or deferral of interest charges, (iii) fresh infusion of equity, (iv) subordination of existing debt to fresh debt capital, (v) suspension of equity distributions, (vi) merger and/or consolidation, (vii) leveraged buyout, (viii) substitution/addition of obligors, (ix) substitution/addition of collateral, (x) liquidation of surplus or nonperforming assets/divisions/subsidiaries, (xi) elimination of unprofitable operations,
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(xii) implementation of budget restrictions, (xiii) reduction in the labor force, (xiv) surrender of collateral, (xv) a partial or total assignment for the benefit of creditors, (xvi) renegotiation of burdensome contracts/leases, (xvii) retention of a "turn-around" consultant, (xviii) reconstitution of the management team, (xix) developing a pervasive business plan, and (xx) detailed reporting requirements.
B. Advantages of Workouts. Regardless of its form, a workout is utilized because in a given situation it is perceived as being superior to the alternatives (such as surrender of assets, foreclosure, bankruptcy and/or litigation). Some of the more apparent advantages are that, in comparison to bankruptcy/foreclosure/litigation, workouts tend to: (i) be more flexible, (ii) preserve higher asset values, and (iii) be less expensive, both from an administrative perspective and from the viewpoint of avoiding the costs and burdens of foreclosure/litigation/bankruptcy. In addition, workouts afford other tangible and intangible benefits for both debtors and creditors. From the debtor's perspective, a workout generally means that: (a) management retains control of the business, (b) the debtor avoids the "stigma" of foreclosure/bankruptcy, and (c) the debtor's principals may avoid/defer liability on personal guarantees. From the creditor's vantage, a workout may provide an opportunity to: (i) obtain acknowledgments of the outstanding indebtedness and the validity of liens and encumbrances, (ii) obtain waivers of defenses, offsets and counterclaims,
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(iii) obtain additional collateral and/or guarantors and (iv) correct deficiencies in loan/security documentation. In addition, the creditor may avoid adverse publicity for causing or contributing to the cessation of business and the loss of employment.
C. Disadvantages of Workouts. In any given situation, however, there may be a number of drawbacks and limitations with the use of a workout. Among the more obvious result from the fact that a workout is a consensual arrangement. Thus, neither the debtor nor the cooperating creditors can bind nonassenting creditors to the workout plan, nor can they halt litigation/foreclosure/involuntary bankruptcy petitions by uncooperative creditors. Claims by governmental units (such as tax claims) are frequently difficult to deal with in a workout because governmental creditors tend to be less flexible. Furthermore, without the cooperation of the affected creditors the debtor will be unable to: (i) reject burdensome contracts/leases, (iii) recover property in the possession of foreclosing creditors, or (iii) recover transfers that would otherwise be avoidable in bankruptcy. Nor will the debtor be able to use the Bankruptcy Court for its (sometimes) expeditious resolution of disputes. From the creditor's perspective, a workout may also have a number of shortcomings. For example, unlike bankruptcy, the workout does not subject the actions of the debtor and its principals to judicial scrutiny and control. Moreover, participation in a workout: (i) may perpetuate ineffectual or
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dishonest management, (ii) may permit a continued erosion of collateral and other asset values, and (iii) does not prevent a subsequent bankruptcy filing if the workout fails.
D. Conditions for a Successful Workout. Participation in the workout is nonsensical if the crucial components of a successful workout are absent. Obviously, the critical elements depend upon the particular form of workout envisioned. An inability to survive in the long term is inconsequential if the workout contemplates an orderly liquidation of the debtor's assets as opposed to continued operation. In evaluating the proposed workout, some of the more important factors relating to its success include:
(1) Adequate cash available to fund the workout;
(2) Readjusted and realistic expectations by all parties;
(3) Adequate disclosure of information;
(4) Flexibility and creativity;
(5) Appreciation of the legal rights/practical leverage of each of the participants;
(6) Absence of significant avoidable transfers;
(7) Perceived fairness in the treatment of differing creditor/equity classes;
(8) Cooperation of critical creditors, employees and management personnel;
(9) Confidence in management;
(10) Confidence in the business plan; and
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(11) Ability to operate profitably with the applicable regulatory climate.
E. Pitfalls to Avoid. Even assuming that the key elements for a successful workout are present, however, a workout can be fraught with risks for careless creditors. Creditors should guard against: (i) exercising control in the management of the debtor,3 (ii) failing to obtain necessary authorizations, (iii) failing to obtain consents from guarantors/sureties, (iv) inducing others to extend credit to the debtor,4 (v) paying the debtor's employees directly without making adequate provision for trust fund taxes, or funding the payroll with knowledge that debtor's management will not withhold and surrender such taxes to the appropriate taxing authorities,5 (vi) failing to comply with bulk transfer provisions,6 (vii) failing to take immediate possession of surrendered collateral,7 and (viii) becoming enmeshed in unintended admissions, waivers or releases during negotiations.8
Whenever possible, financiers should avoid abrupt termination in funding the debtor's operation9 and should look to objective factors in exercising rights to accelerate indebtedness under insecurity clauses.10 Secured creditors must also investigate the status of title to their collateral — foreclosure may be unavoidable if junior liens encumber the assets. The effect of the doctrine of marshaling should be considered and accounted for to the extent possible.11 Creditors may also strengthen their position with respect to
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subsequent preference and fraudulent conveyance attacks by obtaining representations of solvency from the debtor and...
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