Bankruptcy is never easy for lenders! – Article


The annual number of bankruptcies peaked at 60,837 in 2009, but financial and bankruptcy experts expect the level of bankruptcy filings to explode well beyond that peak over the next 12 to 24 months. In the first six months of 2020, there were 3,604 corporate bankruptcy filings, a 26% increase from 2,855 filings in the first six months of 2019 (Epiq/AACER). Chapter 11 bankruptcy filings in June year-over-year increased 43% between 2019 and 2020. The June increase is expected to be the start of a wave of corporate bankruptcy filings, as the economic impact of the COVID-19 virus manifests in lost businesses.

This expected increase in bankruptcy filings means that lenders will be challenged to manage an increasing number of borrower relationships throughout the bankruptcy planning process and during bankruptcy.

Lenders, borrowers and their advisors will need to focus on two key elements:

  • Funding issues, including DIP budgets or cash collateral budgets
  • The end game, which will usually include a sales process.

This means that lenders will need to be prepared to review and analyze DIP and cash collateral budgets, and monitor business performance through a sale process in the event of bankruptcy.

Analyze the budget of a borrower linked to bankruptcy

Analyzing a budget for a bankruptcy process is more complicated than analyzing a budget in the normal course of operations. Some of the key things to consider include:

First day motions:

o Cash Management Process: This motion addresses the debtor’s ability to continue using existing cash management processes or allows the debtor to modify its cash management processes. This request may also relate to the payment of checks or disbursements that are outstanding on the date of filing.
o Joint Administration or Substantial Consolidation: For related entities, in some districts, this motion addresses reporting requirements for each entity or whether entities may be combined into a single entity for procedural or substantive purposes, including for cash flows. cash flow and monthly operating reporting requirements.
o Payroll and payroll-related items, including benefits: This motion discusses paying employees for pre-recording payroll-related expenses and strategies to address benefits such as vacation pay, reimbursement of employee expenses, employees and other employee-related matters.
o Adequate Utility Insurance: This motion identifies the amount of Adequate Insurance payments that should be made to utilities to ensure the uninterrupted receipt of services. Depending on the jurisdiction, this can take between two weeks and six months of use and may require deposits.
o Critical Vendor Designation: This motion seeks to pay vendors that are necessary to maintain operations or preserve substantial value, and contemplates the payment of pre-petition claims during the early stages of bankruptcy. This seller-critical approach essentially puts these sellers ahead of the secured lender and other creditors.
o Assumption of any lease or obligation: This motion could identify contracts that are immediately assumed. Typically, the company waits as long as possible to seek this type of relief to avoid paying healing costs and preserve cash and options. There are limited circumstances where vendor critical processing may not be available and contract support may be desirable.
o Rejection of any Lease or Obligation: This motion could identify contracts that are immediately rejected and could result in cost savings by avoiding ongoing costs under the contract.
o Insurance assumptions: This motion relates to insurance premiums that must be paid or funded.
o Hiring Professionals: These motions are specific to each professional and show hourly rates and payment practices throughout the file. These requests also disclose all down payments made, including those that may not have been previously disclosed to the lender.

DIP financing or cash collateral: These queries relate to whether the borrower will receive financing from their lender (debtor in possession or DIP financing) or whether they will be able to survive on the money collected (Cash Collateral). Depending on the specifics of the situation, borrowers and lenders may disagree on the approach or the conditions to be attached to the financing. Because of this tension, a detailed analysis of weekly cash flow and a 13-week cash flow is an essential deliverable in any potential bankruptcy situation. A lender’s advisors will be able to review cash budgets under various cash funding and collateral options, and against day one movements, to provide a detailed overview of the company’s liquidity and liquidity needs before and during a bankruptcy.

Each of the items listed in the day one queries and approach to using the money has an impact on the dollars spent during the pre-bankruptcy period and immediately after. In addition, forecasts should address:

Working capital management:

o Accounts receivable:

  • The possibility and likelihood of receipt delays and cash flow sensitivity should be considered.
  • Future sales: Depending on the type of business, filing for bankruptcy can impact future sales at different times during the budget period.

o Inventory:

  • Borrowers may wish to identify critical vendors who would help pay off pre-application debts with funds raised or funded during bankruptcy.
  • Suppliers may require COD payments to continue providing goods or services.
  • Selling obsolete or slow-moving inventory at a discount could be a source of cash flow.

o Accounts Payable:

  • It is essential to establish tracking procedures to identify accounts payable as pre-petition and post-petition obligations. Lenders need to ensure that the borrower is prepared from an accounting standpoint and from a personnel standpoint. If a borrower is not careful with this follow-up, post-petition collections could be used to pay pre-petition amounts in violation of bankruptcy laws and the rights of secured creditors.

At a minimum, secured creditors must require the following:

√ Weekly receipts and disbursements, including a carryforward of book and bank balances.
√ Weekly statement of security, including any statement previously provided to the lender.
√ Monthly reporting previously provided to the lender.

Analyze considerations for a sales process

Secured creditors are often asked to fund transactions leading to a filing to ensure that a harassing bidder for the borrower’s assets is identified prior to the filing. While this is often a more comfortable approach for a borrower and their advisors, it may not be the best approach for the lender.

Absent a substantial equity cushion, a lengthy investment banker sale process that results in the identification of a potential buyer is unlikely to be ideal unless collateral values ​​increase. or that there is a significant prospect of substantially higher bids. These are the arguments that the borrower and his advisers will make. However, the costs associated with the lengthy sales process before filing for bankruptcy and the level of communication that takes place with potential buyers are negatives for lenders to consider.

A cash flow analysis for the sale process throughout the pre-bankruptcy period followed by the bankruptcy filing and the sale process MUST be compared to a cash flow with a short planning period followed by a bankruptcy filing and a quick sale process during bankruptcy.

Without a detailed cash flow analysis under the two options, the likely economic impact for the secured creditor under the other approaches cannot be properly assessed.

Although there may be more risk in certain situations, a borrower does not need to have an identified buyer to declare bankruptcy. Despite confidentiality agreements signed by potential buyers, the financial situation of the borrower not generally kept secret during a sales process, and expecting the financial situation to remain confidential is a mistake for the lender. While borrowers often believe they will be able to find a buyer at a higher price before filing for bankruptcy, lenders need to consider the costs of a pre-sale process and the cash burn of operations during this period to assess risk and reward.

With the support of their lender, a borrower can move relatively quickly through a sale process with or without a bidder. In most bankruptcy courts, the post-filing process can take 60-90 days, if there are no unforeseen circumstances and a buyer is found. Another thing to consider is that a pre-deposit sale process could take the same 60-90 days and not result in an acceptable offer. After this failed process, bankruptcy would still be required.

Bankruptcy cases have no certain outcome

Proper bankruptcy planning requires the assessment of cash flows and risks of delays in preparing for and carrying out the bankruptcy process. No borrower or its advisors can guarantee a quick process or accurate results. Lenders and their advisors must be prepared for uncertainty and be able to forecast and monitor cash flows (and all underlying variables) before and after a bankruptcy filing to minimize costly mistakes.

Lenders who are armed with experienced legal and financial advisors to assess cash flow and bankruptcy options will be able to negotiate, structure and implement liquidity and funding solutions most likely to maximize value and collections throughout the bankruptcy process.

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