The affinity for pre-packaged bankruptcies has been modeled by companies across the country since the credit debacle began with large-scale corporate filings by CIT Group, Inc., General Motors Corp., and more recently with MediaNews Group.
According to BankruptcyData.com, the number of prearranged bankruptcies tripled to 30 among public companies in 2009, which supports the headline news of notable pre-pack arrangements completed in record time. The 30 filings, according to Reuters, represent some $124 billion in assets.
The pace and timeframe with which Chapter 11 filings are being processed has become increasingly condensed. In a recent Wall Street Journal article, the very nature of speedy bankruptcies was addressed and begged the question: “have [pre-packaged filings] amounted to short-term fixes of balance sheets without addressing core operational issues.” The short answer is no, but I also believe we must tread lightly on our new found insolvency path.
In the current market, companies across a wide range of industry sectors — from telecom and technology to manufacturing and media — are opting for more expeditious results in the form of 363 sales or pre-packs. Prearranged filing often allows debtors to work out a plan of reorganization with creditors prior to filing — allowing the company to speed through the Chapter 11 process often in under 60 days. While companies are still required to go through the bankruptcy court to implement the plan, the pre-packaged route offers a more streamlined process. A 363 sale, which can offer similar rapid results for the debtor, provides for a free and clear sale of the assets under the section 363 (f) of the Bankruptcy Code.
These fast-track plans have become the preferred methods because they are quicker, cheaper and may help preserve value of the company. As the clock ticks away, companies run a risk for further deflation of assets and in some cases, plummeting assets, by the very nature of the bankruptcy process.
While the benefits are attractive, why the sudden increase? As the banking industry suffers from its losses with assets that are significantly under-collateralized and lending has been reduced to a minimum, secured creditors have become open to alternative options in an effort to reduce additional erosion. At the same time our court systems are overburdened with record numbers of cases and the shorter insolvency cycle has undoubtedly helped push companies to exit court proceedings more efficiently.
As for the quick filing hindering a company’s ability to restructure sufficiently, some would argue ‘yes’ and rally for a return to the conventional process. While there are pros and cons to both sides of the argument, we maintain that the overarching goal of a traditional bankruptcy process is to repair a company’s capital structure. The majority of distressed companies have already begun to address core operational issues in preparation for a Chapter 11 filing and a pre-negotiated filing does not necessarily mean a company is skirting pertinent issues from an operations standpoint. In some cases, a company’s operations remain solid and capital structure is the sole issue.
Those that enter the Chapter 11 process without plans for a complete liquidation, are looking to fix their capital structure, sell assets or find the right strategic partner. With a 363 sale, companies are often selling to a strategic or financial buyer in same space where operational issues will be addressed by the buyer, since their ultimate motivation is the health of the organization and retention of the management as it compliments their existing operation. A 363 sale can also help avoid a Chapter 7 liquidation for companies that have little going concern value as there are investors who may look to pick up a brand, product line, distribution channel or other IP. This process will realize more value than the liquidation process.
If operational issues are part of a necessary overhaul, several core issues — such as excess capacity, consolidation, cash management and business model rationalization — can and should be addressed as early warning signs present themselves, not as a result of an eminent filing. Many companies will engage an advisor to assist with operational restructuring efforts as well as the negotiation of the pre-pack that will have a tremendous impact on the eventual plan of reorganization.
A substantial restructuring effort includes increased reporting requirements and the need to focus on maximizing value for the estate, which becomes an additional diversion for management. As a restructuring effort takes its toll on both management and the company overall, advisors can help manage all interested parties related to the case and provide a considerable amount of assistance to address core operational issues to allow for minimal interruption of operation of the company’s business.
One potential con of the quickie process is the fact that the swift process may leave potential buyers on the sidelines, including those buyers who tend to take a more sophisticated approach to researching and acquiring assets. The new, more rapid method does not bold well for the due diligence process of traditional buyers and, as such, these potential buyers need to be educated on the 363 process so that they can participate fully and thus the value of the transaction is maximized
Extended stays in bankruptcy require a great deal of cash and patience. The longer a debtor remains in bankruptcy, the greater the risk of value erosion. Pre-packs have become increasingly popular as an avenue to leverage existing assets and avoid a drawn out process. In some cases though, pre-packs are extinguished due to objections from lender on how the reorganization will affect their loans. As an alternative, some may be inclined to opt for an asset sale, which has also come into play under the 363 process. While we seem to be pioneering a new path away from the customary reorganization process, the majority of companies will not only need to address their balance sheets, but significant operational issues that will ultimately have a large impact on the long-term health of the organization.
General Capital Partners (GCP) is a Denver-based investment bank and turnaround management firm that serves distressed companies nationwide. Kevin Lombardo is the managing principal for GCP’s Management Services group, which offers financial advisory and restructuring services.