Surviving the Current
Restructuring to Save the
Dealer and the DealershipBy Forrest B. Lammiman
Article Date: 02-01-2010
Copyright(C) 2010 Associated Equipment Distributors. All Rights Reserved.
Four options are outlined for the dealership in financial distress.
Editor’s note: This article is based on the author’s presentation given at AED’s fall CEO Conference. The next is scheduled for May 19-20 in Oak Brook, Ill.
I don’t know if the current downturn accurately is classified as a “depression” rather than a recession, but Judge Posner of the Seventh Circuit certainly thinks so, as reflected in the title of his recent book on the meltdown of 2008: “A Failure of Capitalism: The Crisis of ’08 and the Descent into Depression.” According to the reviewers, Judge Posner argues that the current downturn is a depression because, unlike other economic downturns since the Great Depression, massive government intervention was necessary to prevent further damage.
Reasonable observers of different persuasions may agree or disagree with that conclusion, but I believe it is difficult not to conclude that this is the most serious economic downturn in this country since the early 1980s and perhaps since the Great Depression of the 1930s. Thus, the issue is survival for many businesses in many industries, including equipment dealerships and the dealers themselves. Set forth below is an outline of four possible bankruptcy, restructuring or insolvency scenarios in the context of the applicable legal principles.
1.) Continuing the Business: Restructuring Out of Court
This is the cheapest and most efficient alternative if it will work. It involves less legal expense, less disruption of a business and more retention of its goodwill with its clients.
However, there is one potential basic problem: Restructuring out of court often may be impossible because of the loss of revenue, lowered profit margins and reduced customer base. Nevertheless, out-of-court restructuring may be possible in some cases by reducing the size of the business, cutting certain lines of business and reducing expenses.
Another consideration is that principals of business may have granted guaranties that cannot be resolved through restructuring out of court. Out-of-court restructuring is a good idea if feasible, but it often will not be feasible in the current business climate.
2.) Reorganizing the Business: Chapter 11 Reorganization Under the Decision-Making Process of the Bankruptcy Court
In a Chapter 11 case, it is possible to, among other things, accomplish the following:
Take advantage of the “automatic stay” imposed under the Bankruptcy Code to keep creditors at bay while the reorganization process goes forward in Bankruptcy Court.
Review outstanding contracts and leases (so-called “executory contracts and unexpired leases”) to determine which should be retained and which should be rejected. For commercial real estate leases, there is a significant cap on damages for lease rejections under the Bankruptcy Code, i.e., lease rejection damages are capped at the greater of one year’s rent or 15 percent of the rent for the remaining term of the lease.
Shed trade debt and other unsecured debt to a significant degree under many circumstances.
Renegotiate terms of secured debt, including possible bifurcation of secured lenders’ claim into secured and unsecured portions where the value of the lender’s collateral has shrunk beneath the outstanding balance of the loan.
Potentially alter payout terms for remaining obligations. Thus, both the cash flow and the balance sheet of the business can be improved.
But there are disadvantages. This alternative is often expensive, particularly if an agreement with the secured lender(s) or other major creditors is not available early in the case or (better) before the commencement of the case. But if Chapter 11 makes sense, the expense is borne by the creditors, not the corporate debtor.
Significant creditor support is usually needed in order to successfully confirm a Chapter 11 plan. In the current lending environment, however, the support of major lenders is often difficult to obtain. In addition, if insiders have significant personal exposure through, for example, personal guaranties, reorganization of the corporate debtor will not necessarily resolve those problems.
3.) Voluntary Winding Down of the Business
This involves reaching settlements with all significant creditors, particularly those where the insiders have given personal guaranties.
The dealer will stay away from Bankruptcy Court under most circumstances, though insiders may have potential liability for preferences received or other repayments received that could bring litigation from the Chapter 7 trustee. Also, insiders lose control in a Chapter 7 case.
In this scenario, collateral is given back to the corporate debtor’s secured lenders in exchange for a release of the corporate debtor and any guarantor. Additionally, make sure that all tax liabilities for which there may be personal responsibility on the part of insiders are paid.
Slowly wind down the residue of the business to get past the 90-day preference period under the Bankruptcy Code (but one year for insiders), for amounts paid or other transfers made on account of “antecedent debt.”
Settlements also may create preference exposure for creditors with whom it is important to settle. Under some circumstances, that may provide another motive for avoiding or delaying any Chapter 7 filing. So it may be important to keep some interim payments going to other unsecured creditors to disincentivize them from filing an involuntary petition against the corporate debtor.
Winding down the business voluntarily may also reduce the risk that transfers from the corporate debtor to insiders or related parties may be subject to attack as avoidable fraudulent transfers. Outside of bankruptcy, only creditors of the corporate debtor may assert fraudulent transfer actions; however, once a bankruptcy case is filed (whether under Chapter 11 or under Chapter 7), the debtor-in-possession or the Chapter 7 trustee is the party with the power to bring fraudulent transfer actions relating to transfers made by the corporate debtor.
Section 548 of the Bankruptcy Code empowers the trustee (or the debtor-in-possession) to bring an action to avoid any transfer of “an interest of the debtor in property” that was made within two years before the date of the filing of the bankruptcy petition. The transfer may be unwound as fraudulent if it was made “with actual intent to hinder, delay or defraud” any creditors.
Alternatively, a transfer may be deemed to be constructively fraudulent (even though not necessarily intentionally so) if (A.) the debtor received less than “reasonably equivalent value” in exchange for the transfer and (B.) the transfer was made at a time when the debtor was insolvent or became insolvent because of the transfer, or was otherwise financially impaired in one of the ways specified in Section 548.
The look-back period for fraudulent transfers under Section 548 of the Bankruptcy Code is two years before the filing of the bankruptcy petition. The trustee has the ability, however, to also use the Uniform Fraudulent Transfer Act as enacted in almost every state (other than New York), to attack transfers made up to four years before the commencement of the bankruptcy case, and even more than four years if the transfer was either concealed or not reasonably discoverable.
4.) Liquidating the Business in Chapter 7
Possible disadvantages of this option include:
You lose control of the wind-down – a Chapter 7 trustee assumes corporate governance and control of all assets.
There is possible liability of insiders or third-parties for preferences or fraudulent transfers, misuse of assets and the like.
The role of Chapter 7 trustee adds an additional layer of administrative expense, without any tangible advantage accruing to the benefit of the owners or other insiders of the business.
The remaining assets of the corporate debtor will be allocated according to the priority scheme set forth in the Bankruptcy Code rather than being marshaled to allow the insiders to exit with a minimum of personal liability or exposure.
The biggest advantage is that the owners and other insiders can walk away from the business that has failed and get on to other things. That is true, however, only if: (A.) the insiders have no personal exposure to the Chapter 7 trustee or the corporate debtor’s creditors; and (B) the insiders have no positive benefit to gain by attempting to keep the business or wind it down on their own.
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