October 2009
The Metropolitan Corporate Counsel
Page 11
Financial and Economic Crisis – Service Providers
Corporate Restructuring: Pitfalls And Opportunities
The Editor interviews Charles Goldstein
and Guy Davis, managing directors in the
Litigation, Restructuring and Investigative Services Solution Group of Protiviti
Inc. Protiviti (www.protiviti.com) is a
global business consulting and internal
audit firm composed of experts specializing in risk, advisory and transaction services. The firm, which is a wholly owned
subsidiary of Robert Half International,
helps solve problems in finance and transactions, operations, technology, litigation,
governance, risk, and compliance.
Editor: Two years of tight markets and
even tighter credit have put corporate
downsizing, liquidity problems and
even bankruptcy in the news. Can
restructuring give business executives
real control over their companies’ trajectories?
Goldstein Restructuring can be the best
option – and sometimes, the only viable
one – for a company that has taken too
many hits from an extended downturn.
Still, it helps to remember that even in the
best of times, a company has to work with
the resources it has and the market as it
exists. In tight economies, it is even more
important to be proactive, to constantly
monitor not just your company’s performance, but also the health of your competitors, clients and customers, and vendors and lenders. You should have a
recovery strategy ready before you actually need one because it’s twice as tough
to come up with alternatives when you are
in the midst of a crisis.
Davis: That’s right. A company also
misses opportunities when it waits too
long to implement substantive change.
That’s why it’s so important to monitor
the internal and external corporate environment closely. Let me emphasize that
this means more than tracking changes; it
means an ongoing, active reassessment of
business plans and relationships that
guides corporate responses to risks and
opportunities.
Editor: Given the state of the economy,
I expect that corporate risk aversion is
at an all-time high. Doesn’t that keep
business executives on their toes?
Goldstein: Risk aversion tends to make
people very cautious and reluctant to act.
However, that is exactly the wrong
approach for this economy, where failure
to act can be the greatest risk of all. It’s no
secret that the marketplace is unfriendly to
weakened businesses. Corporate decisionmakers are expected to recognize when
their companies are nearing what is called
“the zone of insolvency.” Corporate legal
departments and outside counsel must be
on top of this issue because there are substantial legal ramifications. The company
must act swiftly to protect both itself and
its creditors from further erosion. Executives who delay restructuring or continue
to pile up debt may end up being personally liable to corporate creditors and
shareholders – especially if the company
ends up in the bankruptcy courts.
Editor: Are there specific warning signs
that business executives should be look-
reworking agreements so that the terms
are more feasible for the company and its
clients.
Charles
Goldstein
Guy
Davis
ing for so they can avoid both insolvency and liability?
Goldstein: Loan defaults are obvious
indicators, as are operating losses, especially when they continue beyond traditionally slow seasons. But a company
needs to look beyond itself, too. If your
business depends on a key supplier or
vendor, you are tied rather tightly to its
health – so watch it carefully. Similarly,
when key clients or customers begin to
reduce their orders, make frequent lastminute changes to standing orders or fall
behind on their payments, be prepared to
restructure your business relationships
and rethink your projections. Whenever
these red flags start popping up in the
internal data of any business, we encourage corporate decision-makers to consider
restructuring. Delay can be fatal.
Editor: Restructuring business relationships sounds different from the
downsizing and outsourcing we usually
think about when businesses restructure. Which way is better?
Goldstein: The two strategies are not
mutually exclusive. Reworking contracts
and revising joint venture and partnership
agreements can be crucial to maintaining
a positive cash flow and a healthy business. Many companies also need to simultaneously adopt an aggressive “shrink to
profitability” strategy that eliminates
unprofitable product lines, speculative
investments and excess overhead by
focusing on core competencies.
Davis: Don’t forget that restructuring is
not limited to downsizing or cutbacks. In
some circumstances, it can include growth
strategies, such as vertical or horizontal
integration. For instance, if a supplier of
key components is struggling, you may
want to consider acquiring part or all of
the business to ensure that your company
gets the supplies it needs. This approach
has been less popular during the past 24
months because of the tight credit markets. However, as the economy improves,
M&A activity will pick up as strong companies reactivate this strategy and acquire
weaker firms that survived the storm.
Editor: These suggestions seem to
assume that a company has enough
capital or credit to make rather large
payments or investments. How realistic
is that?
Davis: The current downturn may affect
everyone, but some businesses are wellplaced to find opportunities. On a pragmatic level, companies need to be more
self-reliant than ever. The easy lines of
credit just aren’t there now, so companies
should consider alternatives. Sometimes
that means investing in a vendor or
Goldstein: That brings us back to restructuring relationships. Sometimes, recognizing economies of scale can help both
the vendor and purchaser. It might be
more cost-effective, for example, to
change monthly deliveries to weekly or
quarterly deliveries. Or, to centralize or
decentralize deliveries, depending on
what works best. These steps can reduce
costs without the need for large upfront
cash expenditures. Any business, large or
small, can benefit from such strategies.
Editor: You’ve already described some
of the risks that economically stressed
companies and their executives face,
but you also mentioned opportunities.
Tell us about those.
Davis: Restructuring itself is an opportunity to avoid the collapse or liquidation of
the company. The risk of failure exists
before a decision to restructure is made.
Furthermore, I believe it’s important to
distinguish between restructuring and
reorganization. Restructuring involves a
significant modification to a company’s
balance sheet (debt levels and capitalization), which is frequently accomplished
through the Chapter 11 process. Reorganization focuses more on a revision of company operations, including product lines,
services, relationships and personnel.
Reorganization is also a key part of the
typical Chapter 11 process. Whether a
company needs restructuring or reorganization, a proactive approach is always better. Don’t wait until it’s too late.
Editor: Many people would say that it’s
already “too late” if a company has to
file a Chapter 11 case.
Goldstein: Chapter 11 is actually
intended to offer distressed businesses a
chance to reorganize and recover before
it’s over for good. Some problems are
simply too large or complicated to deal
with outside of the bankruptcy courts. For
instance, mass tort litigation or class
actions can chew up a company’s time and
cash. The Chapter 11 process puts a stop
to those litigation matters so the company
can focus on its business.
Editor: Do companies get a better deal
in the bankruptcy courts than in the
open market?
Davis: Troubled companies can get a
breather and a fresh start because the
bankruptcy court provides an organized
forum to resolve disputes and reorganize
the business. Bidders for corporate assets
will certainly get a more transparent
“deal” in the bankruptcy courts. One great
advantage for buyers is the increased
availability of detailed books and records
that can be scrutinized by all parties,
including creditors. That last part is very
important: creditors play an essential role
in Chapter 11 reorganizations, acting as
watchdogs to keep away frivolous offers –
and to get the best deal! Business rivals
often turn out to be the most competitive
bidders.
Editor: I thought that companies filed
Chapter 11 cases to reorganize and
keep doing business, not to sell themselves. Am I missing something?
Goldstein: Reorganization is the goal of
Chapter 11, but reorganization can involve
the sale of the entire business, or its underperforming divisions or burdensome
“assets,” including long-term leases. A
sale of the business is typically viewed as
a successful Chapter 11 because the business enterprise has been preserved, albeit
under new ownership. For larger companies, it is often possible to use Chapter 11
to reorganize specific divisions rather than
the entire corporation. The sad truth, however, is that not every reorganization case
succeeds. When failure occurs, the business is usually liquidated through a Chapter 7 proceeding.
Editor: What’s the most common reason that a restructuring or corporate
reorganization fails?
Davis: Both out-of-court restructurings
and Chapter 11 reorganizations are most
likely to fail when corporate executives
are too slow in recognizing and responding to red flags that should alert them early
on to the need for corporate restructuring.
The most successful Chapter 11 cases
have a well-planned exit strategy before
the case is filed. These companies have
moved before their creditors have whittled
down their credit lines, capital and credibility.
Editor: Are those red flags you mentioned earlier difficult to see, or do people simply ignore them?
Goldstein: Corporate executives often
have a can-do, accentuate-the-positive
attitude that has succeeded for them and
their companies for years. So, there may
be a tendency to simply discount or dismiss bad news until it becomes unfixable.
Also, when people are surrounded by a
group of inside experts, managers and
advisors who have all been looking at the
same data and problems for a long time,
they may develop a “group think” mentality that is unrealistic or highly biased. It’s
hard to step beyond one’s own experience.
That’s where a fresh, knowledgeable,
objective eye can really help.
Editor: This sounds like a Catch-22. If a
company can’t see its blind spots, how
does it recognize when it is backing into
one?
Davis: There are some patterns to watch
for, although they may have fuzzy borders. One signal is recurring discussions
about problems without a clear action plan
or resolution at the end of the discussion.
Another is constant modification of
action-plan trigger events that simply prolongs the status quo and prevents any
action, regardless of planning, from being
implemented.
Goldstein: It boils down to this: If a company appears to be in trouble, it probably
needed help some time ago. And if it looks
like a company will need help down the
road, it probably should reach for that help
now.
Please email the interviewees at charles.goldstein@protiviti.com or guy.davis@protiviti.com with questions about this interview.