I N S I D E T H E M I N D S

Best Practices for

Corporate
Restructuring:
Leading Lawyers on Communicating with Creditors,
Analyzing Debt, and Filing for Bankruptcy
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 Best Practices for
Corporate Restructuring:
Leading Lawyers on Communicating with Creditors,
Analyzing Debt, and Filing for Bankruptcy

CONTRIBUTORS

Bonnie Glantz Fatell

GUIDING CLIENTS DOWN A WINDING ROAD

Thomas J. Salerno
AN OVERVIEW OF THE
RESTRUCTURING PROCESS

Lynn P. Harrison III

A CRITIQUE ON BEST PRACTICES IN
INTERNATIONAL INSOLVENCY CASES

Myron Trepper
A SOUND APPROACH TO THE
PROCESS OF RESTRUCTURING

Hugh Ray
REACHING A SATISFACTORY RESOLUTION
AS QUICKLY AS POSSIBLE
Alan Gover
SEEKING OUT THE TRUE BOTTOM LINE

Gerald C. Bender
HELPING THE CLIENT
ACHIEVE THEIR GOALS

Robin Phelan
JUGGLING, PSYCHIATRY, RELIGION,
DIPLOMACY, CLAIRVOYANCE, ACTING,
AND OTHER USEFUL DISCIPLINES
ENDEMIC TO RESTRUCTURINGS

Richard L. Wasserman
A STEP-BY-STEP LOOK AT CHAPTER 11
 Guiding Clients Down
a Winding Road

Bonnie Glantz Fatell

Chair, Business Restructuring and Bankruptcy Group
Blank Rome LLP
 Inside the Minds

The Role of the Attorney and Other Financial Advisors

Companies that experience financial challenges that impede their ability to

operate profitably often turn to restructuring experts for advice. These
experts may include attorneys, financial advisors, turnaround specialists, and
investment bankers.

The role of the attorney specializing in corporate reorganization is to act as

the quarterback bringing legal talent and expertise to the game and drawing
upon the knowledge and skills of the company’s management as well as its
outside advisors. The attorney will work closely with the client to identify
the factors causing the financial distress and then develop a strategy
through which these issues may be addressed. The strategy may include a
sale of assets or a corporate restructuring—both operationally and
financially—to achieve financial stability and reposition the business to
become profitable once again.

When initially meeting with clients, the attorney must first identify and
analyze the critical issues the company is facing, whether due to forces
outside the company’s control (such as a change in the industry or
marketplace, domestic or foreign competition, or rising costs for
commodities or raw materials) or internal drivers (such as too much debt,
an increase in labor and health care costs, operational inefficiencies, or
mismanagement). The attorney must then determine what specific
causation may be linked to the factors that are forcing the company into
financial distress by looking specifically at the capital structure of the
company, the operations and business plan, and even the qualifications and
performance of management at all levels.

Working with the client, the attorney will develop a strategy for addressing
the problems as they have been identified. At this point, it may be possible
to restructure the company’s debts through negotiating with the major
lenders, implementing operational changes, selling some aspects of the
business, or, if no viable reorganization plan is likely to succeed, it may be
necessary to sell the entire company. This may be accomplished in an out-
of-court workout or through a Chapter 11 reorganization proceeding. In
any case, the process remains the same: The attorney works with the client
 Guiding Clients Down a Winding Road

and its financial advisors to determine the origin of the company’s financial
difficulties and then develops and implements a strategy for addressing
these issues.

A critical aspect of this process is selecting the best professionals to aid in

the restructuring. Often, management may be resistant to bringing in
“experts” and ceding control over any aspect of the business. One of the
challenges counsel may face at the early stage is persuading the client that it
should hire and then head the advice of turnaround specialists, whether
they are financial advisors, attorneys, or investment bankers. Certainly,
hiring experts will add another layer of expense at a time when the company
feels stretched. While outside professionals will be costly, if the right people
are selected, it will be money well spent. Management needs to appreciate
that while they may understand the industry and the operation of the
business, they are not trained or experienced at restructuring or
rehabilitating a business. Too often, a company will resist hiring
restructuring professionals or accepting their advice until its decline is so far
gone that its equity is eroded, its business is in a downward spiral, and its
options for recovery become limited.

The key to a successful restructuring is to identify issues and challenges

before they become insurmountable problems. A company should
appreciate that bringing in outside advisors early in the process will enable
the company to develop and implement strategies in an orderly fashion,
thereby creating opportunities for the company to consider various options
in its reorganization. By avoiding the inevitable, companies often find
themselves looking down the barrel of a gun and are then forced to file for
bankruptcy without sufficient time for pre-bankruptcy planning. More often
than not, those cases result in an asset sale rather than a restructuring.

How the Need for Reorganization Arises

There are any number of reasons a company finds itself in financial distress.
For example, a company may expand too rapidly and fail to properly plan in
advance to manage the expansion in such a way as to ensure long-term
success. Consider a retail company that grows from fifty to 500 stores in a
short period of time. It may find itself unable to control costs and maintain
 Inside the Minds

quality on such a large scale, resulting in a decline in revenues and

unexpected increased expenses and overhead.

In other instances, a company may acquire another business without first

establishing a protocol for integrating the two companies or may find it is
impeded in its integration efforts by variables it failed to consider. The
result is a redundancy in the types and numbers of employees found at
different levels of each company, unnecessary and duplicative expenses, and
operational inefficiencies.

An additional factor commonly leading to the need to reorganize is the

inability of a company to change as technology or the marketplace
demands. In today’s competitive global market, a company must be
attentive to change and be able to move quickly to accommodate new
trends as the customer demands. Ultimately, it is imperative that a company
be willing to build on its most profitable areas and phase out those
businesses or product lines that have proven unsuccessful over time.
Recognizing the need for change and implementing it at the right time are
key.

Getting to Know the Client: The Importance of the Initial Interview

The attorney’s goals for the initial meeting should be to develop a rapport
with the client and start to build a foundation of mutual trust and respect,
gather factual information and an understanding of the business, and most
importantly, listen to the client—to what is said and, as importantly, to what
is not said.

Advising on the Responsibilities of Management

The officers and directors should be advised in the early stages of the
representation of the changing fiduciary duties as a result of the company’s
financial problems. Specifically, when a company is in financial distress and
unable to pay its debts on a timely basis, the company may be in what is
commonly referred to as the “zone of insolvency.” As a result, the fiduciary
duty of the officers and directors may shift from a duty solely to protect the
interest of the shareholders to a duty also to consider what is in the best
 Guiding Clients Down a Winding Road

interest of its creditors. This is an emerging area of the law, and officers and
directors should be mindful that when in the zone of insolvency, a
company cannot recklessly incur debt and increase credit from its trade if it
appears there is no ability to pay these debts as they come due without
risking that the officers and directors may be found to have breached their
fiduciary duty. During this time, the company should make it a point of
adhering to its policies and procedures and avoiding showing special favor
to insiders. Should the company ultimately file for Chapter 11, the creditors
committee, or perhaps a trustee if one is appointed, will look very closely at
the insider transactions during the period prior to the Chapter 11
proceeding.

Assessing the Factors Leading to the Need for Restructuring

In the initial meetings, the attorney should have the client articulate its goals
—reduce debt, restructure around the core business, asset sale, orderly
liquidation, or address some other problems. If the company wants to
restructure its core business, an analysis must be undertaken to identify the
drivers that are impeding the success of the company. For example:

• Overleveraged: Can the debt be modified or refinanced on more

favorable terms, converted to equity, or reduced through asset sales
or infusion of new capital?
• Diversification into other businesses that have become a drain on
the company’s resources and are not profitable: Consider selling
divisions, orderly liquidation, or consolidation into core business.
• Changing market: Undertake market study and reposition company
through discontinuing unprofitable lines, a new approach to sales
and marketing, or the introduction of new, higher-margin products.
• Operational inefficiencies: Examine costs of labor, raw materials,
overhead; consider cost-saving measures, outsourcing, new sources
of inventory; identify above-market contracts; evaluate ability to
renegotiate supply contracts or costly leases.
• Poor or unmotivated management: A hard look must be taken at
the officers, senior executives, and board members. The company
must undertake a self-evaluation and arm itself with the best talent
 Inside the Minds

in all aspects of the business. Often, a fresh approach may take the
company in a new direction.

Having examined these and other factors, the company, with its advisors,
must determine if its goals are attainable—bearing in mind that
restructuring is a fluid process and goals may change as the process evolves.

Informing the Client and Managing Expectations in a Restructuring

Providing the client with an overview of a corporate restructuring process,

in or out of bankruptcy, is an important agenda item for the initial meeting.
The company should understand how the process works, the various
players that may be involved, the role of the court, the timeline, and the
likely costs.

If Chapter 11 is the best option, the company must be advised in advance

as to its role as a “debtor in possession.” While in some respects the
company will conduct its business as it had previously, there are many
aspects that will change. Anything not “in the ordinary course of business”
will need court approval. This may include selling assets, incurring
substantial capital expenses, settling litigation, entering into new material
contracts, awarding bonuses to employees, and obtaining financing. In
addition, it is critical that the company is advised not to pay debts that are
due and owing as of the date the company files for Chapter 11. These
obligations may be paid only pursuant to the Chapter 11 plan of
reorganization or, in limited circumstances, if authorized by a bankruptcy
court order. To ensure compliance with the bankruptcy laws, it is important
that someone at the company (often general counsel) serve as the point
person to work with bankruptcy counsel to establish procedures to ensure
that the company operates within the parameters of the Chapter 11 process.

Finally, it is important at the initial meeting that the attorney and the client
discuss any critical deadlines the company faces in the upcoming months
that will have an impact on the business restructuring strategy. For example,
is there a payment obligation the company is unable to meet, and what will
be the consequences of not making the payment? How much time will the
company have after the missed deadline before the creditor is able to
 Guiding Clients Down a Winding Road

exercise its remedies? Is the company obligated to complete performance

under a material contract? Are there any impediments to fulfilling its
obligations, and what are the consequences? Is there a deadline in ongoing
litigation such as a foreclosure sale that must be averted in order to preserve
value for the company? Answers to these questions may be determinants as
to the company’s strategy and the time within which it must act.

Current Issues in Bankruptcy Law and the Need for Pre-Bankruptcy

Planning

On October 17, 2005, the Bankruptcy Abuse Prevention and Consumer

Protection Act of 2005 became effective. The new Bankruptcy Act includes
significant changes that will affect the commercial side of the Chapter 11
process. A company in need of rehabilitation or restructuring will be under
tighter time constraints to address critical issues and will potentially face
increased costs that will make it more expensive to reorganize under
Chapter 11. For example, a debtor has the exclusive right to develop and
file its plan of reorganization provided it is filed within a specified time
frame. While previously the company could readily obtain extensions of this
exclusive period, the new Bankruptcy Act imposes an absolute deadline of
eighteen months from filing the Chapter 11 petition. After that date, any
creditor may file a plan and the debtor loses exclusive control of the
reorganization. For example, a creditor whose only goal is to recover on its
claim and has no interest in the continued operation of the company may
file a plan that proposes a sale of the company. In most cases, eighteen
months should be sufficient, but in light of the shorter time frame, a
company should be advised to engage advisors and undertake pre-
bankruptcy planning so it has a business plan and strategy for reorganizing
through Chapter 11 in advance of filing the petition.

For companies with significant commercial real estate leases, the time
within which the debtor must assume or reject its leases also is abbreviated.
After a maximum of 210 days, the debtor must assume or reject its leases
unless the landlord agrees to an extension. Under the Bankruptcy Act, the
landlord has increased leverage in these negotiations since the debtor now is
faced with a choice of assuming a lease prematurely, before it has fully
developed its business plan and strategy to exit Chapter 11, or reject the
 Inside the Minds

lease, a potentially valuable asset. Either choice may have significant

consequences. Rejection of leases may force the debtor into a liquidation,
whereas premature assumption and then later rejecting the lease will
increase the administrative expenses (the landlord will have an
administrative claim for two years of rent) that will make emergence from
Chapter 11 more costly. For a retail company with hundreds of leases, the
necessity to make this decision early in the case could prove particularly
problematic.

On the expense side, the new Bankruptcy Act created additional obligations
the debtor must satisfy in Chapter 11. For example, debtors must now
provide deposits to their utilities or some other form of assurance of
continued payments, and unsecured trade claims for goods sold to the
company within twenty days prior to the petition date are treated as
administrative claims that must be paid before emergence, as are employee
claims up to $10,000 per employee for wages that are unpaid within 180
days prior to the filing for Chapter 11. Under Chapter 11, it is necessary for
a company to pay all of its administrative claims in full in order to obtain
approval of its plan of reorganization. In certain cases, a company faced
with these and other administrative expenses could have difficulty funding
operations under Chapter 11 or obtaining financing to support its plan of
reorganization and exit from Chapter 11.

The changes in the new Bankruptcy Act also make it more difficult for a
company to provide incentives to its senior management and key employees
to ride through the Chapter 11 with the company and not seek employment
elsewhere. Over the past several years, it has become routine for a debtor to
propose a key employee retention program that frequently provided
payments or bonuses—retention bonuses—to employees at specific
intervals, performance bonuses when certain benchmarks in the Chapter 11
are met (i.e., a sale or confirmed plan of reorganization), and a severance
plan in the event the employee is terminated during the Chapter 11. As a
result of the corporate abuse in recent years, the new Bankruptcy Act has
clamped down on these plans and permits such bonuses only if the debtor
can demonstrate that the employee has another job offer and that the
bonus plan does not exceed certain limitations on amounts.
 Guiding Clients Down a Winding Road

It remains to be seen whether the changes in the bankruptcy law will hinder
or help a company seeking relief under Chapter 11. One thing is clear: As a
result of the new Bankruptcy Act, it will be necessary for companies to
approach the reorganization process with a great deal more preparation
than had been necessary in the past. Because of the changes, it is more
likely that companies may sell assets through Chapter 11 rather than
restructure, and that any restructuring challenges will be heightened because
of the time limitations and additional administrative expenses and other
new and untested changes.

Conclusion

Recognizing when a company is in financial distress and in need of outside

professional assistance is never easy. Often, the officers and board of
directors will attempt to right the ship themselves and may not appreciate
the challenges they face in identifying the critical drivers causing the
financial and operational difficulties and developing the optimum strategies
to address the problems. The best advice is to bring in talented, experienced
consultants early in the process and be open to change. Often, a company
can avert bankruptcy or liquidation if it takes appropriate steps to remedy
the problems in a timely manner.

Bonnie Glautz Fatell is the practice group leader of Blank Rome’s business restructuring
and bankruptcy group, and for over twenty-five years has concentrated her practice on
bankruptcy reorganizations and related litigation and out-of-court workouts. She
represents parties in all aspects of bankruptcy including creditors committees, debtors,
institutional lenders, trade creditors, landlords, plan of reorganization proponents,
equipment lessors, and asset purchasers. Ms. Fatell also focuses her practice on banking
and commercial lending matters including loan restructuring, debtor-in-possession
financing, inter-creditor relationships, and lender liability prevention and defense. Ms.
Fatell is the co-editor of Collier’s Commercial Bankruptcy Forms Manual, Third
Edition and a frequent speaker and lecturer on bankruptcy and insolvency matters. She
is a fellow in the American College of Bankruptcy, listed in Chambers and Partners
(USA) in Pennsylvania and Delaware among America’s leading bankruptcy lawyers,
and listed in Best Lawyers in America, 2006 edition.

Ms. Fatell can be reached at fatell@blankrome.com.

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