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Keeping Skin in the Game

Joining a bankrupt customer's creditors committee may preserve its viability -- and your assets.
Tim Reason, CFO Magazine
February 1, 2005

The bankruptcy of Pacific Gas and Electric Co. in April 2001 came as no surprise to David Adante. Two months earlier, the CFO of The Davey Tree Expert Co., in Kent, Ohio, which trims brush and trees along utility power lines, had warned investors in an 8-K that the California energy crisis put PG&E — "a significant concentration of revenue" for Davey — at risk.

But Adante was "totally surprised" to get a call that same week from the U.S. Trustee's office, asking him to serve on PG&E's unsecured creditors committee. Except for a few large power suppliers, PG&E's top 20 creditors were all financial firms, not trade creditors like Davey, which had $400 million in revenues last year. In this case, though, not only did the U.S. Trustee ask for a Davey representative, "they asked specifically for the CFO," says Adante.

A CFO is a rare sighting on an unsecured creditors committee, which these days can have precious few trade creditors at all. The result, particularly in larger bankruptcies, is that such creditors risk being overlooked or overrun by the unsecured financial creditors — a trend that is accelerating as the very nature of bankruptcy changes. "Even the good customers [now] go [bankrupt]," says Valerie Venable, corporate credit manager for GE Advanced Materials, citing Dow Chemical Co.'s breast-implant filing and various asbestos cases as examples of otherwise sound companies filing Chapter 11. "It's not just distressed situations; it's companies filing to cap liability."

In the PG&E case, notes Adante, "the utility was not in bankruptcy because it was insolvent; it got into a regulatory crisis, not a financial crisis, and that's not something anybody can anticipate." But, adds Venable, "that's when the creditors committee really has to get in there and make sure we get our fair share. By the time you are done with legal fees, associated bankruptcy financings, and [customer flight], it could make the debtor distressed."

Although large companies tend to rely on credit managers such as Venable to represent them, she says she is more likely to join a committee if it also has a CFO whose industry knowledge can complement her bankruptcy expertise. After all, say experts, if Chapter 11 is truly intended to restructure insolvent companies into going concerns, it needs industry experts to sit alongside the dominant workout groups and debt-holders. "I feel if [trade] creditors don't get involved, the banks and the principals of the company move in the way they feel is most advantageous without input from trade creditors," says Venable. "[But] trade is what keeps these guys going."

A Seat at the Table
In Adante's case, he says, "it didn't take me long to figure out I wanted to be involved." Not only did PG&E owe Davey more than $13 million, he says, but the utility was (and still is) Davey's largest customer, accounting for $51 million — some 15.8 percent — of its 2000 revenues.

Davey attorneys backed Adante's decision, telling him it was a unique opportunity to have a voice in proceedings that could dramatically affect his customer. Although Davey was one of PG&E's largest trade creditors, it was not among the top 20 unsecured creditors, whose claims ranged from a low of $20 million up to $2.2 billion. (Generally, the 7 to 15 committee members are selected from among the 20 largest unsecured creditors, although a spokesperson for the U.S. Trustee says it "often" solicits from a larger group, "depending upon the case.")

Once on the committee, of course, members have a fiduciary duty to act on behalf of all unsecured creditors. But access to information can also help protect their own interests. "Committee members are privy to a lot of inside, confidential information," says Michael Eisenband, senior managing director and head of the creditor-rights practice at New York-based FTI Consulting, which specializes in corporate finance and restructuring. Clearly, it's illegal to trade on such data (reportedly the suspicion behind the recent Securities and Exchange Commission probe of the MCI creditors committee), "but even the judgments you make on your own behalf are based on a lot more information," says attorney Judy O'Neill of the Detroit office of Foley & Lardner.

Likewise, says O'Neill, a vote on the committee greatly magnifies an individual creditor's influence. "If a single creditor were to make waves [in court]," she says, "it would not be viewed [by the judge] with the same strength as a committee."

Not surprisingly, the duty to represent all creditors means that committees don't always make the same choices an individual member would. "It's almost like an out-of-body experience," says Adante. "You can go in and vote for one thing and then have your [own company's] legal counsel file a petition in opposition." Davey never took that tack, he says, but several other companies represented on the committee independently objected to the committee's decisions. Ideally, that's how committee members should behave. But the best interests of all creditors are not always easy to define. Indeed, U.S. Trustees strive for diversity, which frequently means creditors committees are rife with competing interests.

And those competing interests may be quite vocal. For example, "I'm seeing landlords be a lot more aggressive on creditors committees" in the retail industry, observes Jeff Hollander, president and COO of Hollander Home Fashions Corp. in Boca Raton, Florida, who has sat on six creditors committees in the past 10 years. Hollander, who co-chaired the creditors committee of linen retailer Stroud's with Springs Industries CFO Will Bartelmo, notes that manufacturers are concerned about recouping losses already incurred, while landlords try to stem future losses.


In other industries, the committee "dynamic has changed dramatically" with the addition of distressed investors as members, says O'Neill. "If distressed debt players bought for 10 cents on the dollar and could liquidate tomorrow for 15 cents, that's a 50 percent return," notes Eisenband. That's bad news for a supplier, though not necessarily a bad outcome. To be fair, argues Karin Thorburn, a professor at Dartmouth College's Tuck School of Business, "sometimes bankruptcy is a very important tool in this transfer of resources to better uses." Indeed, she says, a trade creditor's interest in keeping its customer alive is as much of a potential conflict as an investor's desire to liquidate.

Accept No Surrogates
Both Thorburn and Eisenband note that when the common goal is to give an insolvent company a new lease on life, distressed investors are skilled at financial restructuring. But, Eisenband adds, that's also another argument in favor of a trade creditor dispatching its top financial talent. "When it comes time to do a plan of reorganization and think about what is the right capital structure," he says, "credit managers don't always understand that. CFOs do because they're responsible for financing in their own company."

Still, say observers, sending anyone from finance is better than the most common surrogate: lawyers. "Businesspeople can come to a business decision," says Jim M. Sczudlo, credit manager at Schlumberger Technology Corp. in Houston. "Many times, I am the chairman and have to continually remind the committee that we represent all unsecured creditors. The attorneys are well aware of the law, but they have been hired by [their client], so they are going to be looking out for that client's interest."

Sending a surrogate can also deprive a company of an important educational experience. "I learned a lot about utilities and how they operate," says Adante, who used the experience to refine Davey's view of which customers to target in the restructuring industry. In the recent multi-million-dollar bankruptcy of San Antonio-based oil-and-gas exploration company EnRe LP, says Sczudlo, the estate hired a former judge to evaluate hundreds of competing creditor "oil and gas" liens against the firm. Sczudlo says he carefully noted "numerous" filing errors and weaknesses in documentation pointed out by the judge. "By serving on a committee, you can strengthen your own company's documentation for the next time."

Gary White, a credit manager at Houston-based Waste Management Inc., thinks every CFO should have the experience at least once, "especially in larger businesses, where CFOs are a bit insulated from it," he says. "So many financial people don't understand the back side of what they do. And the bankruptcy laws are the back side of what they do."

Adante agrees — particularly when it comes to doing it "once." He didn't exactly relish his "three years and six days" on PG&E's creditors committee, he says, although Davey ultimately was paid back in full, plus interest. "As I told our directors, it was a hell of an education," he says. Should Davey be called to serve again, he says, "I would send a treasurer or controller — it would be a great experience for a young up-and-comer with a lot of potential."

Tim Reason is a senior writer at CFO.




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