Many business leaders are grappling with questions about how to continue seeking growth while protecting against downside risks. In recent months, the latter seems to be getting greater attention.
While no one knows for sure whether we are headed for a deep downturn and the next major restructuring wave, there are things businesses can and should consider doing at this time to address the potential impact of conducting business in a financially distressed climate.
Where We’ve Been and Where We May be Headed
When the COVID-19 pandemic took root, many believed we were in for another wave of Chapter 11 bankruptcy cases. There were quite a few filings in 2020, particularly among retail and energy companies, but nothing like what we saw at the height of the financial crisis from 2008-2011. However, as rapidly as the wave formed, it receded in 2021.
Factors such as abundant federal stimulus money, historically low interest rates, a growing economy, and lender forbearance all contributed to a relative dearth of Chapter 11 bankruptcy filings last year.
Recent data suggests filings are on an upward trend. According to the American Bankruptcy Institute, commercial Chapter 11 filings increased 76% in September 2022 relative to September 2021. And Subchapter V small business filings increased 79% in September 2022 compared with September 2021.
So what should we expect moving forward? Given the economic and geopolitical challenges that have dominated the headlines for most of 2022, indications point to increasing amounts of financial distress for both consumers and businesses.
There's a lot of buzz in the restructuring world, and we will continue to see more companies being forced to reorganize or wind down moving forward. If that happens, it will likely be due to some combination of factors like persistent inflation, the war in Ukraine, high energy prices, lenders being less willing to forbear, continuing supply chain challenges, the wind-down of Federal Reserve’s quantitative easing program, and growing amounts of consumer debt, among other factors.
Robust government spending along with easy availability of credit enabled many businesses to stay afloat, but as liquidity is pulled out of the economy, it’s almost certain that more will sink — some into bankruptcy.
Proactive Steps to Protect a Business
During 20-plus years of corporate restructuring experience, I’ve witnessed the differences in outcomes experienced by companies that take bold, aggressive steps to ensure their survival during a downturn and those that don’t. Here are some of the issues your company should focus on to help ensure it can weather whatever storm may be coming.
1. Increase liquidity. Companies will need sufficient cash to survive, which means tapping credit lines before liquidity dries up and divesting non-core assets to raise capital while there is still a robust transactional market. One well-known example of a company taking action to increase liquidity was in 2008, when Ford put up all of its assets as collateral to raise funds, which unlike GM and Chrysler, enabled it to stay out of bankruptcy.
2. Protect your supply chain. If the economy loses steam, plan for more parts and services suppliers to fail, or at a minimum experience disruptions, moving forward. Assess and identify critical parts and services, particularly those that come from a single-source supplier, and make contingency plans to ensure the continuity of your supply chain.
3. Review the financial health of customers. In every economic downturn, one of the ways companies try to conserve cash is by delaying payments beyond contract terms. Thirty days becomes 60, and so on. Accordingly, pay close attention and audit the financial health of your customers. Be diligent about enforcing payment terms. If possible, amend payment terms to cash on delivery, and obtain a personal guarantee or security interest.
4. Err on the side of caution. Negotiate, draft contracts, and approach new business dealings in a way that anticipates insolvency issues. Work with counsel to build protective provisions in contracts that may help limit your exposure in a bankruptcy. Also, be diligent about enforcing your rights and exercising remedies if, for example, a counterparty to a contract breaches its obligations. Time is of the essence.
5. Stop collection efforts if a customer files for bankruptcy. Your business can’t keep chasing money it is due if a customer files for bankruptcy. You may be able to maximize your recoveries through an administrative claim or by exercising reclamation rights, but hit the brakes and consult with an experienced restructuring attorney if an automatic stay is in place.
6. If your business is experiencing distress, know your options. Bankruptcy is not the only option, and often not the best one for a business that needs to reorganize or wind down its business. There are other options, such as a receivership, assignment for the benefit of creditors, or state law wind down, that provide many of the benefits of bankruptcy without some of the drawbacks, including a great deal of scrutiny.
There’s little to lose from taking these steps to protect your company, even if a restructuring wave doesn’t materialize. Failing to act, however, can lead to big problems if one does. On a risk-adjusted basis, it only makes sense to get ready for the possibility of more financial distress.
David G. Dragich, founder of The Dragich Law Firm, represents businesses in all aspects of complex corporate reorganizations, bankruptcy, insolvency, and distressed asset acquisitions and dispositions.