CHAPTER 5 Workout and Restructuring Alternatives for the Troubled Supplier

• Jurisdiction: United States

CHAPTER 5 Workout and Restructuring Alternatives for the Troubled Supplier

A. The Workout Milieu

Out-of-court negotiations for the financial and operational restructuring of a financially troubled supplier are often triggered by a number of circumstances, many of which occur simultaneously. A cash-strapped supplier may institute a substantial price increase for the production of parts. Vendors to the supplier may refuse to extend credit terms, insisting on cash-on-deliv-ery or cash-in-advance terms, and may in critical cases commence collection actions against the supplier. The troubled supplier's revolving credit line established by its financing bank may become out-of-formula, or the supplier may default on regularly scheduled term loan payments to the bank. The supplier may fail to pay federal and state withholding taxes and use those funds for working-capital purposes instead.

When the troubled supplier's financial problems come to light, three primary categories of stakeholders may begin negotiations with that supplier for financial and operational restructuring. These groups are (1) the supplier's customers, which might include OEMs; (2) the supplier's financing bank; and (3) the supplier's vendors. These negotiations may be aimed at the continuation of the troubled company's business for a limited period of time to allow for its orderly liquidation and resourcing by customers or for a long-term reorganization of the business. These workout negotiations are conducted by the parties with the realization that an immediate liquidation of the supplier could be catastrophic, resulting in a shutdown of the customer's production lines and the piecemeal liquidation of assets at hammer-sale prices. The objectives of these groups in out-of-court restructurings can be summarized as follows:

1 . Customers

The customers of the troubled supplier may be higher-tiered suppliers dependent on certain parts or modules for ultimate delivery to OEMs or the OEMs themselves. If the debtor is a sole-source supplier to these customers on a just-in-time delivery basis, the customers will often want to keep the debtor operating, at least until the customers have the opportunity to build up inventory banks of parts and resource the work to other suppliers. These customers will also want to assure themselves of the location, safety and integrity of all special equipment needed for production of their parts so that if resourcing is necessary, the equipment can be promptly repossessed and delivered to new suppliers. In order to achieve these objectives, customers (especially OEMs) have agreed in restructuring negotiations to substantial increases in prices in order to reduce the timeframe for payment for goods purchased from the supplier and to provide short-term financing to suppliers in tandem with the supplier's bank or bank group.

2. Lenders

Depending on the supplier's size and working capital requirements, the supplier may have only one financing bank or lending syndicate supplying its financing needs. Often, the supplier's bank or bank group will provide secured term loans and a revolving line of credit with advances made thereunder pursuant to a borrowing base. This indebtedness will most likely be secured by first-priority security interests and liens in all of the debtor's tangible and intangible real and personal property. Depending on the value of its collateral, the bank or bank group financing the debtor may be over- or undersecured. If the liquidation value of its collateral is less than the amount of the debt at the time of the workout, the bank may decide to continue funding the debtor with the anticipation that it will successfully restructure or that the going-concern value of its assets will be preserved pending a sale of the business on a turn-key basis. The bank will be concerned about customers exercising setoff rights against the debtor's accounts receivable, especially if the amount offset is the result of large, consequential damages from a line shutdown. In addition, the bank's work-in-process inventory may have only scrap value in an immediate liquidation scenario. Alternatively, if the bank deems its position to be oversecured, then its appetite for funding the troubled supplier pending its hoped-for reorganization may be diminished and it may decide to proceed to liquidate its collateral on an immediate basis.

3. Vendors

The troubled supplier's vendors often have the most to lose if the supplier is liquidated, especially when the debtor's secured creditors are under-secured. The ultimate distribution to these creditors in a liquidation scenario may be nothing more than pennies on the dollar. In addition, the demise of the supplier may result in a domino effect, especially when the troubled supplier constitutes a substantial part of the vendors' sales. These vendors themselves, suffering the loss of substantial revenues, may be required to restructure or liquidate themselves when a large customer shuts its doors. These vendors sometimes organize into unofficial creditors' committees in workout negotiations, thereby focusing their negotiating power on a few large vendors with the resources and sophistication to negotiate on behalf of the class of unsecured trade suppliers.²⁴⁷

B. Accommodation Agreements

As a result of this confluence of similar and conflicting interests, the troubled supplier, its customers, its lender and its unsecured trade vendors often negotiate what is commonly referred to as an "accommodation agree-ment" to provide for the continuation of the troubled supplier's business during the period in which it will attempt to restructure its finances or prepare for an orderly liquidation of its assets. An example of an accommodation agreement can be found in Appendix B. Common provisions in an accommodation agreement include the following:

1 . Limitation on Resourcing

As previously stated, customers endangered by a potential line shutdown will want to make preparations for resourcing parts production from the troubled supplier to a replacement supplier. On the other hand, the troubled supplier and its financing lender will not want to lose this business and its attendant revenue. Consequently, accommodation agreements often prohibit customers from resourcing unless a default occurs, such as the supplier's failure to produce and deliver quality...