Despite a strong first quarter for the American economy in 2019, there have been many troubling signs. The recent inversion of the yield curve, newly announced layoffs and tariffs in the automotive and agriculture sectors, and modest increases in GDP growth indicate that troubled financial times may be around the corner for Alabama. Companies facing financial difficulties are often concerned with how to identify financial stress, when to ask for help, and how to navigate through troubled financial waters.
Identifying the problem
One of the keys to getting ahead of potential financial issues is identifying when you have a problem. Companies should be paying close attention to monthly and quarterly performance metrics. Important questions to consider include: Are you in compliance with your loan covenants? Are you having to stretch payables? Are you having to finance receivables or manipulate them beyond normal limits? Each of these indicators can predict impending problems. Early warning signs also often come from a friendly call from your banker/lender, or maybe a concerned visit from the company CPA.
Take the early warning signs seriously. Companies may be able to avoid a bankruptcy or a substantial restructuring by proactively identifying potential areas of concern and addressing them in a timely fashion. Moreover, sometimes even bad financial news can be an opportunity for growth and retrenching. For example, recognizing that a product line is not profitable and discontinuing it can allow for expanding core activities that generate profit.
Successful companies can face bankruptcy or substantial financial challenges and come out stronger on the back side. Many people in Alabama remember the stories of HealthSouth (now Encompass Health) and its financial struggles. That company has now rebranded, is extremely profitable and is an established leader in the healthcare industry. This is just one example illustrating that a bankruptcy or substantial financial restructuring may not be the end of the line.
Taking the plunge
If a company gets to a point of financial uncertainty, assembling the right team of professionals is important for successful reorganization. As with many aspects of the legal profession, the restructuring world is highly skilled and specialized. Identifying the right professional to assist and guide your company is an important step. In addition to legal advice, financial advisors/accountants and potential investment bankers can help companies resurface in troubled waters of a bankruptcy.
In considering when to file bankruptcy, there is an important legal principle to remember. A once profitable company begins to show that it is insolvent (in other words, that it’s not making its regular payments to creditors or is upside down on its balance sheet) when it enters what is known as the “zone of insolvency.” When companies enter this zone, legal fiduciary obligations shift. Normally companies are beholden to their shareholders and are driven by profit and earnings. When a company enters the zone of insolvency, that legal obligation changes, and company leadership’s priority responsibilities are redirected to creditors. As a result, the interests of creditors have to be placed above that of equity interest holders.
How to Chart a Course
A bankruptcy is a difficult and expensive process, but one that can streamline and modernize a company. An important adage I always tell clients is, “When you have dug a hole the first rule is to stop digging!” Companies that have been losing money can’t continue to simply lose money and think a bankruptcy will solve their problems. Rather, a bankruptcy is an opportunity to put a pause on creditor concerns and focus on the bottom line to realign priorities. Companies should take a bankruptcy filing as an opportunity to reject and abandon practices and product lines that have been losing money and focus on core assets and profitable ventures.
Restructuring professionals, both legal and accounting, can help guide companies through this process. For example, tools exist that allow a company to reject unnecessary leases or burdensome contracts. Bankruptcy professionals can help companies identify those leases and contracts and take steps to mitigate future loss.
The reality of a bankruptcy is that there is simply not enough money to go around, and cash to pay creditors and establishing the ground work for future operations is critical. Spending precious dollars on activities that are not fruitful or assist in the long run success of the company have to be curtailed and eliminated.
In addition to short-term concerns about cash, long-term issues also need to be addressed. Can potential profits be sustained in the long run? Are product lines and business opportunities going to continue to present themselves in the future? Will a company’s reputation be sustainable? Will the marketplace accept products in the future? Every decision a bankrupt company makes must be made with an eye toward the future.
What is a successful bankruptcy?
In a bankruptcy, success is measured in the eye of the beholder. Creditors always want to be paid in full, but often that is impossible. Alternative routes to success include companies who can maintain their workforce and provide vendors an opportunity to continue to sell product to a new entity, or those that sell or restructure themselves so that a hiccup in financial performance can be overcome with a fresh start.
In a bankruptcy, recovery is different for every party and in every circumstance. A bankruptcy, however, should always be entered into knowingly and with a clear path forward charted. This path helps the company navigate its way through a bankruptcy as quickly and efficiently as possible to ensure and maximize creditor recoveries, and to enhance the long-term prospects of the company.
Scott Williams is a partner in Rumberger, Kirk & Caldwell’s Birmingham office, where he represents parties in complex commercial bankruptcy and litigation matters. He can be reached at [email protected].
