Rising default rates mean companies are having to hire an expert they never hoped to need: a chief restructuring officer. For struggling companies, chief restructuring officers can bring enormous value. But companies need to be careful when bringing such a person on board. In, particular, crafting a chief restructuring officer’s engagement letter to avoid conflicts down the road — especially with chief financial officers — is paramount.
The CRO’s role must be defined and understood by company leaders. CROs are often hired to allow other executives to focus on the business, but it’s not always possible to separate the CRO from financial, operational, or executive matters. Specificity in the engagement letter is crucial.
For a struggling company, the CRO first brings his or her outsider’s perspective to the company’s 13-week budget. What expenses are essential? Which vendor’s goods and services are critical? Who gets paid and who doesn’t? Does the secured lender (or the board) want the CRO to completely control disbursements? Do they expect the CRO to be the sole arbiter on such things as employee termination, sale or liquidation of business units, and terms of a bank forbearance agreement?
These are issues ripe for confrontation between the CRO and others within the company where lenders only want disbursements that directly or indirectly benefit the lender.
The lender’s role, especially for middle-market companies, shouldn’t be understated. Lenders gently, and sometimes not so gently, recommend CROs to borrowers, and the nominees often appreciate the recommendation — and know the lender might be a repeat customer. For the company hiring the nominee, on the other hand, this is usually is a one-off engagement.
That raises the question: Can CROs truly be disinterested parties? When disputes develop, will the CRO be loyal to the company or to the lender? Still, the CRO-lender relationship can benefit the company, as CROs can get lenders to give companies another chance to fix things. That alone may be worth hiring a lender-suggested CRO — provided the company knows how to deal with inevitable conflicts.
Consider that lenders will at least partly blame a CRO if he or she supports a debtor plan that ultimately fails. But lenders won’t think less of a CRO who recommends liquidation or a prompt sale if the company ultimately succeeds with a turnaround strategy.
During restructuring, the CRO should not be permitted to speak to the lender without notifying the board or senior management. A designee from management should be invited to participate in all lender conference calls and to attend all meetings with the lender. No documents should be sent to the lender by the CRO without approval from management and the borrower’s legal counsel.
Information conveyed to and communications with third parties should be known to management in advance.
The CRO may ask (or require) that it be allowed to take certain actions without management constraints. If management’s autonomy is reduced or restricted, the retention agreement should lay out safeguards. The most significant safeguard is identifying what requires board pre-approval. For a distressed company, an active and well-informed board means more board meetings.
The CRO should get board approval for the number and level of employees that the CRO may terminate, the value of assets that the CRO may sell, the engagement of other professionals, adoption of a budget, settlements of disputes involving dollars above a specified level, adoption of a business plan, and terms of the lender’s forbearance.
Inevitably, debate may erupt in negotiations over CRO restrictions in the engagement letter. The lender will require its approval of the retention agreement and will object to restrictions on its ability to directly communicate with the CRO outside of management’s presence. The real (unstated) issue is the desire of the lender to hear the CRO’s candid assessment of management’s abilities. But, that can be addressed by other means.
Candor by the CRO with its own client cannot be escaped. The CRO will say that restrictions will make it harder to keep the lender at bay, but there is no excuse for the lender to know or hear anything not known by the board. Management should have the opportunity to address the CRO’s views and to debate them before they are conveyed to an adversary.
Kenneth A. Rosen leads the bankruptcy, financial reorganization, and creditors’ rights department at Lowenstein Sandler LLP.
The views expressed herein are those of the author only and are not necessarily those of Lowenstein Sandler LLP or of any attorney at Lowenstein Sandler LLP.