Dealing with Defaults - When Your Company Runs Into Trouble

© 2016 DailyDAC, LLC d/b/a/ Financial Poise™ 1

Dealing With Defaults: When Your Company Runs Into Trouble

business borrowing basics 2016 seriespremier date: may 4, 2016

Premier Date: MAY 4, 2016

Dealing With Defaults: When Your Company Runs Into Trouble

business borrowing basics 2016 series


WE WOULD LIKE TO TAKE THIS OPPORTUNITY TO THANK OUR SPONSORS



meet the facultyPANELISTS

Richard Carmody Adams and Reese Lewis Grimm Jones DayRick Rosenbloom Fuel Break Capital Partners

MODERATOR Jonathan Friedland Sugar Felsenthal Grais & Hammer


Practical and entertaining education for business owners and executives, accredited

investors, and their legal and financial advisors. For more information, visit

www.financialpoise.comDISCLAIMER: THE MATERIAL IN THIS PRESENTATION IS FOR INFORMATIONAL PURPOSES ONLY. IT SHOULD

NOT BE CONSIDERED LEGAL ADVICE. YOU SHOULD CONSULT WITH AN ATTORNEY TO DETERMINE WHAT MAY BE BEST FOR YOUR INDIVIDUAL NEEDS.

http://www.financialpoise.com/


about this webinarWhen a company defaults under a loan agreement the results can be catastrophic to the company, and any guarantors of the loan. On the other hand, some defaults are much easier to deal with than others and even significant defaults can be dealt with in a manner that avoids disaster.

This webinar explains the different types of defaults, the range of lender reactions to various defaults, and how to best deal with them. In particular it focuses on the steps borrowers and their advisors can take to keep the lines of communication open and mitigate the negative effects of a default.

about this seriesCash is the lifeblood of any business. While some companies operate solely with their own working capital, most must borrow money from time to time. Borrowing, of course, includes something as mundane as buying goods or services on credit (whether on credit terms or by using a credit card). But most companies of any significant size have a revolving line of credit or a term loan, or both, with a bank or other company that is in the business of lending. This webinar series explores where companies should look for business loans, how to negotiate them, and what to do if they default under them.

As with all Financial Poise webinars, each episode in the series is designed to be viewed independently of the other episodes, and listeners will enhance their knowledge of this area whether they attend one, some, or all of the programs. © 2016 DailyDAC, LLC d/b/a/ Financial Poise™ 7

episodes in this series

EPISODE #1 Negotiating a Loan Agreement 2/3/2016

EPISODE #2 Alternative Financing – When the Bank Says “no”

3/2/2016

EPISODE #3 SBA Loans and Other “Special Programs” 4/6

2016

EPISODE #4 Dealing with Defaults – When Your Company Runs Into Trouble 5/4/2016Dates above are premier dates All webinars also available On Demand through West LegalEd Center and Vimeo



What’s the Default?

Payment default Technical default

Financial covenant Other covenant Technical but not covenant


The Changing Landscape of Bank Lending- How commercial lending has changed over the past two decades

Commercial loan officers do not have a prolonged apprenticeship so experience is limited; bank acquisitions have resulted in a loss of seasoned lenders

There is more money to lend than there are good loans to make so there is fierce competition for every deal

Lenders and their supervisors generally have compensation incentives tied to performance

There is a decline of the “generalist lender” and a growth of the specialists and niche lenders

Competition from unregulated lenders has increased

Special thanks to Richard Carmody for allowing the reprint of these points


The Changing Landscape of Bank Lending (con’t)

Compliance issues have become much more important Fee income is receiving more emphasis because of the

competitive pressure on interest rates Timing of write-offs and recoveries has become more important

because of effect on stock price and compensation Some borrowers have become “too big to fail” because of effect

on financial performance of lender Secondary markets for troubled loans have exploded


STRATEGIC ALTERNATIVES FOR DISTRESSED BUSINESSES

Chapter 11

Assignment for the Benefit of Creditors

Creditor Compositi

onWorkout Sale by

Debtor


STRATEGIC ALTERNATIVES AGAINST DISTRESSED BUSINESSES

Foreclosure

Receivership

Article 9 Sale


FACTORS THAT AFFECT THE DECISIONFuture of the

business going forward

Size of the company

Relationship with secured

creditors

Number of creditors and the amount

of debt

Cost and length of the

process

Buyer’s risk tolerance


KEY QUESTIONS THAT DRIVE STRATEGY

• Will customers care that debtor is having financial problems?

• How is the debtor’s relationship with its key vendors? • Are any vendors irreplaceable as supply sources?• How competitive is the debtor’s business? • What is the liquidation value of the debtor?• What does a buyer want to do?• Are there personal guarantees? • Are related entities not troubled?• What are the tax implications? (e.g. CODI)


FIDUCIARY DUTIES

It is well-settled that directors of solvent Delaware corporations generally owe fiduciary duties to the

corporation and its shareholdersIt is also well-settled that directors of insolvent

corporations owe fiduciary duties to exercise their business judgment in the best interest of the

insolvent corporationHowever, a grey area exists for directors of

corporations that are solvent but operating within the zone of insolvency


A BUYER’S PERSPECTIVE• Buyers like to buy cheap but want to avoid risk• Some options are cheaper but pose more risk• Others are more expensive but pose less risk

What Legal Risks?

Successor liability

Allegations of

fraudulent

transfers


CHAPTER 11 REORGANIZATIONSPetition is filed with the bankruptcy court

(either voluntarily or involuntarily)

The debtor, as the debtor-in-possession, acts as the trustee of the business

Debtor-in-possession financing

Automatic stay

Rejection of certain executory contracts

Fixed priority order


CHAPTER 11 REORGANIZATIONSADVANTAGES

Binds all creditors

Automatic stay

(requires all

creditors to cease collection efforts)

Sales are made free and clear

Rejection of

burdensome

contracts

Certain tax advantage

s


CHAPTER 11 REORGANIZATIONSDISADVANTAGES

Higher cost Longer process

Reporting requiremen

ts

Stigma associated

with bankruptcy


ASSIGNMENT FOR BENEFIT OF CREDITORS

Much like a Chapter 7

Debtor assigns all of its assets to

an independent fiduciary for

creditors

Fiduciary sells all the assets

and distributes proceeds to the creditors

Distribution is generally done in

accordance with the

Bankruptcy Code priority

scheme


ABCs (con’t)

Generally quick and relatively inexpensive means of liquidating a company, especially as compared with Chapter 7Priority of claims is known and generally follows Bankruptcy Code

Unsecured hold-out creditors encouraged to participate since title to assets is transferred

Less risk of “Chapter 5”-like lawsuits


ABCs (con’t)Unlike bankruptcy, title to the assets is not delivered free and clear of all liens (unless done in conjunction with Article 9)

Secured creditors can still foreclose

Assignee is appointed by debtor


RECEIVERSHIPS

• Available in state and federal court

• Receiver is similar to bankruptcy trustee

• Distributions Similar to Bankruptcy Code


RECEIVERSHIPs (con’t)• Single Creditor can seek appointment (versus

standards of section 303 of Bankruptcy Code)

• Greater flexibility within Receivership (less procedural rules and statutory regulations)

• Receivership proceeding can be narrowly tailored in drafting the Receivership Order


CREDITOR COMPOSITION

Sometimes referred to as an out-of-court Chapter 11

Creditor composition is a contract between a debtor

and its creditors

All participating creditors agree to accept certain payments in full satisfaction of their claims


CREDITOR COMPOSITION ADVANTAGES

Will allow the company to work with its creditors to continue

operationsMay maximize going concern value

of the company

Less expensive than Chapter 11

No court or trustee oversight

No Chapter 11 stigma


CREDITOR COMPOSITION DISADVANTAGES

HoldoutsMay impose certain

restrictions on Debtor

Lengthy negotiating process


WORKOUTSSince it may be difficult to obtain consent of nearly all creditors as required for a composition, a

company may opt to seek concessions solely from its financial creditors (bank, equipment lessors, bondholders, etc.)

Generally, Creditor will agree to deferred payments, extended

time of repayment, and/or reduced total amount of

indebtedness.

In exchange, Debtor may be required to sell assets, grant additional collateral, meet

certain operational benchmarks and/or be subject to heightened

financial reporting.

A Workout Agreement will restructure the debt of a particular creditor


WORKOUTS ADVANTAGES

Because consent of all creditors is

not required, generally

easier to put in place

Easier to negotiate

because only one party and

may not require

disclosure of financial

condition to other

creditors


WORKOUTS DISADVANTAGES

Financial creditors are generally secured and may have little incentive to renegotiate terms

Financial creditors may insist on restrictions on activities of the business


Tips for a Successful Workout

Borrower’s counsel will gain lender’s cooperation more readily if he or she is perceived by the lender to be part of the solution rather than part of the problem

During a workout, lender typically wants borrower to have access to effective

legal counsel

If borrower believes lender’s actions have created potential liability for the lender, borrower is faced with a choice because it is doubtful that lender will participate in a workout under threat

Replacement lenders do not come cheap, but borrower may want to pay price to preserve its causes of action.


“NAKED” SALE BY DEBTORDebtor sells its assets, generally to a secured lender, or to a third party (potentially to its own

shareholders) with the consent of the secured lender.

Advantages• Quick and relatively inexpensive method of liquidating a

business• May also serve as a quick method for the sale of a

company as a going concern

Disadvantages• Requires consent of all lienholders• Treatment and impact of unsecured creditors.• Possibility of being deemed a fraudulent transfer• Breach of fiduciary duty concerns for board of directors

of debtor


ARTICLE 9 SALES• Fast and inexpensive way to sell secured creditor’s collateral• UCC permits secured creditor to take possession of collateral and, without removing

collateral from debtor’s premises, dispose of it• Sale must be commercially reasonable• Secured creditor may purchase collateral at a public sale but not at a private sale unless

collateral has public market where the price can be readily ascertained• When the rules are followed, all of Debtor’s rights in collateral are transferred and

subordinate security interests are discharged. • A good faith purchaser for value takes title free and clear even when secured party fails

to strictly comply with the statutes


“Friendly Foreclosures”

Insolvent borrower + all assets liened + ready buyer = “friendly foreclosure” ? Lender will want to make sure price being paid reasonably equivalent value of assets,

certainly more than the lender could expect from a foreclosure and lender liquidation sale. Other principal concern for lender is that the borrower and the purchaser are truly arms-

length May also avoid “Bulk Sales” law (in those jurisdictions that have not repealed Article 6 of

the UCC) o Foreclosing lender can sell assets without giving notice to borrower’s creditors because

lender is not a person subject to the Bulk Sales Act. The lender is not regularly engaged in selling the goods being sold


“Friendly Foreclosures”- Process

Once lender has satisfied itself on the price and the independence of the purchaser and seller, lender will engage in an exchange of correspondence wherein the lender will declare a default, accelerate the loan and demand payment

In response, borrower will advise lender that it cannot repay the loan Lender will then foreclose pursuant to its rights in the loan documents and

the Uniform Commercial Code Borrower will waive its rights to notice of the private sale, and lender will

take control of the assets and sell them (usually without moving them) to purchaser who will receive lender’s bill of sale with warranty of title resulting from the foreclosure


Avoiding Lender Liability - The Ten Commandments for Lenders

In 1986, Helen Davis Chaitman writing in The Secured Lender (November/December issue) proposed a list of ten commandments for lenders involved in workout situations. Richard Carmody amplified them, and we thank both.

Do Not Make a Sudden Move • Unless absolutely necessary, give a borrower reasonable notice of your intent to terminate

a lending relationship • Watch out for declaring a default under a “general insecurity clause” in a note (must be

reasonably insecure)• Demand notes may not really be such if inconsistent provisions added• Document and substantiate the reasons for calling the loan

Do Not Tell a Lie or a Half-Truth –

This applies to credit inquiries and also to negotiations with the borrower; if you want to exit the relationship, tell the borrower up front


The Ten Commandments for Lenders (con’t)

Honor Your Commitments • This applies to making loans and to working out loans. Stand by the terms of your loan

documents• Commitments to make loans (or working out loans) or to take (or refrain from taking) other

actions – the barest of writings has been held to be a commitment• If still negotiating, put a specific and explicit disclaimer in correspondence; do not soften

language to make more agreeable to potential borrower

Do Not Run Your Borrower’s Business • Your liability can stretch to borrower and its creditors, including payroll taxes owed to the IRS • Too much control can make you a fiduciary, a principal, or a joint venture; decide how much

control you really need • Potential liability to creditors of borrower if you “prop up” borrower to maximize your

recovery while borrower purchases on credit• Do not control the board of directors and be extremely careful about having a banker serve

as a director. Exercise of voting power can make you an insider under Bankruptcy Code



Do Not Use Third Parties to Bail Out of a Bad Loan Insist on full disclosure to third parties because your desire to exit loan can be used against you

Keep Your Files Clean of Extraneous Comments

• This also applies to your e-mail traffic within office • Disgruntled bank employees could deliver documents to a borrower• Make sure memos (and e-mail) are business like

Have a Workout Officer Take Over Troubled Loans

• Personality problems can lead to cover-ups of bad situations or vindictive attitudes and action by the original loan officer

• Need objective view of officer dedicated to maximizing recovery while minimizing liability



Confer With Workout Counsel • An early review of your situation and documents can be critical • You need an “emergency room” lawyer, not an “obstetrician” who insists on enforcing

documents as written. Lawyer should be firm but not excessively confrontational. Situation may require change to lawyer with different style

Think Carefully Before Pursuing a Deficiency

Judgment proof debtors have nothing to lose by asserting counterclaims that are identified by counsel who would never have been involved but for a lender’s lawsuit

Do Not Be Arrogant • Lenders are not protected species• Put yourself in borrower’s position (are you being fair?) (is your action absolutely necessary

to protect the bank)

More About The Faculty: JONATHAN FRIEDLAND

[email protected] Friedland is a partner with Sugar Felsenthal Grais & Hammer LLP. He regularly represents parties in the purchase and sale of businesses and counsels businesses and their owners in their everyday affairs. Jonathan is also a nationally recognized expert in matters related to financially distressed companies.

Jonathan holds the highest possible rating from Martindale-Hubbell (AV® Preeminent™) and AVVO (10/10), has been repeatedly recognized as an Illinois “superlawyer” in the areas of Business/Corporate Law and Bankruptcy & Creditor/Debtor Rights, and has received several other similar distinctions. He is licensed to in Arizona, Illinois, New Jersey and New York.

Jonathan has been profiled, interviewed, and/or quoted in numerous publications, including Buyouts Magazine; Smart Business Magazine; The M&A Journal; Inside Counsel; LAW360; Business Week.com; The Bankruptcy Strategist; Dow Jones Daily Bankruptcy Review; Bankruptcy Court Decisions; Dow Jones LBO Wire; and The Daily Deal. He has authored three books and more than a hundred articles, and has spoken on more than 100 panels.

Jonathan is also the founder and chairman of DailyDAC, LLC, d/b/a Financial Poise™, an on-line provider of continuing education, information, and business intelligence for business owners, investors, and their trusted advisors. Jonathan graduated from the State University of New York at Albany, magna cum laude, in 1991 after three years of study and from the University of Pennsylvania Law School in 1994. He clerked for a federal judge before entering private practice, spent several years teaching MBA candidates as an Adjunct Professor of Strategic Management at the University of Chicago Booth School of Business, and was the 2006 Clayton Center for Entrepreneurial Law Visiting Professor of Business Law at the University of Tennessee College of Law. Jonathan was a partner with Kirkland & Ellis LLP before joining SugarFGH.



More About The Faculty: D

RICHARD CARMODY [email protected]

Richard Carmody joined Adams and Reese in 2003 as part of a merger with an Alabama law firm in which he had practiced since 1975. He practices primarily in the area of insolvency law (“C&I”), and has a network of referral sources that he has developed throughout his career. A founding member of the American Bankruptcy Institute, Richard has a nationwide reputation for solid counsel in the field of C&I.

As one of the firm’s principal bankruptcy attorneys, Richard represents clients in difficult financial matters. He also provides counsel to lenders for complex commercial transactions and internal policies. In 1992, he became the first lawyer in Alabama to become certified as a specialist in Business Bankruptcy by the American Board of Certification.

More About The Faculty: DLEWIS GRIMM

[email protected] Grimm is a partner at Jones Day. He has substantial experience in New York and Australia representing financial institutions and other entities in debt financing matters, including the representation of financial institutions in connection with senior and subordinated debt facilities, debt and equity securities issuances, acquisition finance, bridge finance, project finance, sports finance, cross-border transactions, and restructuring and bankruptcy matters.

Lewis's financial institution clients include Bank of Montreal, Citigroup, GE Capital, Jefferies LLC, Jefferies Finance, KeyBank, Macquarie Capital, MBIA, and TD Securities.

He also represents a number of private equity firms, hedge funds, and corporations (both investment-grade and non-investment-grade) in financing-related matters, including Cliffs Natural Resources, Cumulus Media, FTI Consulting, FTS International, JBS, Molycorp, Pershing Square Capital Management, Synaptics, Texas Instruments, TransDigm, Viasystems, and WL Ross & Co. and its portfolio companies.


More About The Faculty: D

RICK [email protected]

Rick Rosenbloom is the founding and Managing Partner of Fuel Break Partners (http://www.fuelbreakcapital.com/), a Connecticut-based special situations investment and advisory firm. Rick has over 20 years of distressed investment, restructuring, M&A and operational experience including acting as General Counsel and Senior Vice President of the Hilco/Great American Group, C.O.O and head of acquisitions for a $100M international brand marketing and specialty advertising firm and holding executive positions with several investment banking, distressed investment firms. Rick began his career in Chicago with Kirkland & Ellis and Schiff Hardin and Waite in their bankruptcy and restructuring groups. Rick received a JD-MBA degree from UCLA and graduated With Distinction from the Honors Program of the University of Michigan.


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Important Notes

• THE MATERIAL IN THIS PRESENTATION IS FOR GENERAL EDUCATIONAL PURPOSES ONLY.

• IT SHOULD NOT BE CONSIDERED LEGAL, INVESTMENT, FINANCIAL, OR ANY OTHER TYPE OF ADVICE ON WHICH YOU SHOULD RELY.

• YOU SHOULD CONSULT WITH AN APPROPRIATE PROFESSIONAL ADVISOR TO DETERMINE WHAT MAY BE BEST FOR YOUR INDIVIDUAL NEEDS.