Bankruptcy is expensive. The professional fees can be overbearing even for the largest companies. It also is very public. It causes tremendous devaluation of a debtor’s business. Customers tend to flee when they hear of it.
Then there is the potential loss of control. Among other things, the debtor is accountable to an official creditors’ committee, a bankruptcy court, and the U.S. Department of Justice (a bankruptcy overseer and administrator). For a small to medium-size business, bankruptcy can be uneconomical, inefficient, and risky. And the success rate leaves much to be desired.
A composition is an out-of-court arrangement and is much more private. It is a form of “financial restructuring” that is informal. There is no statutory law. In a composition, the debtor negotiates a settlement of its unsecured liabilities with its vendors, landlords, and other creditors to provide the debtor with necessary relief.
There is very little paperwork involved — no applications, motions, or other pleadings. Compared with an in-court proceeding, a composition agreement is much less costly. However, a composition can be very challenging because it requires the consent of substantially all major creditors.
Developing a successful creditor composition requires accomplished negotiating and oral communication skills, with the ultimate goal of achieving a compromise or reduction of creditors’ claims to enable the debtor to get back on its feet. The success of an out-of-court arrangement depends greatly on an understanding of the psychology of creditors and on anticipating their actions and reactions.
Handling negotiations with creditors sounds straightforward, but it is easier said than done. While the ultimate goal is to get all creditors to accept a compromise, numerous one-off negotiations usually occur. These discussions can be particularly exhausting and time-consuming. Also, certain creditors, particularly the larger ones with more clout, may ask for their own “special deal” — to be treated better than other creditors.
While the ultimate goal is to get all creditors to accept a compromise, numerous one-off negotiations usually occur. These discussions can be particularly exhausting and time-consuming.
These creditors promise to keep their deal a secret, but that never happens. It is usually best in composition negotiations that the debtor treat all creditors equally, without exception. If one creditor discloses special treatment, it may result in additional creditors seeking special treatment, which can often make it impossible to get the composition done.
Typically, the top 20 unsecured creditors hold approximately 80% of a debtor’s unsecured trade debt. Therefore, it may be most cost-efficient to seek a compromise only from the largest creditors. This tactic also reduces the publicity. The debtor should determine the dollar threshold for creditor claims it seeks to compromise. Creditor claims below this dollar threshold will fall into what is referred to as the “administrative convenience class.” These creditors continue to be paid in full, albeit at a slightly slower rate than in the past.
Who Represents the Company?
One of the most important questions in composition negotiations is who should be the face of the company. If a debtor’s executive is the lead company-side representative, the executive may be asked questions that they are not best suited to answer. While a senior executive (such as CFO, CEO, or COO) should be present at meetings (whether videoconference or live) and on calls during the compromise process, creditors should be advised to communicate only with debtor’s counsel, a financial adviser, or a chief restructuring officer (if one is hired).
The debtor team may also incorporate a single employee (who also should be a senior executive) to respond to individual creditor inquiries before and after creditor meetings or conference calls. Incoming questions should not be answered on an ad hoc basis by a debtor’s employees other than the one person assigned explicitly to the task. This controls the dialogue and avoids conflicting or inconsistent messaging. The debtor’s senior executive tasked with responding to creditor inquiries should have a list of frequently asked questions and stick to a script vetted by counsel.
Providing Financial Information
Before the debtor provides information to creditors regarding its financial affairs, it should require each creditor to execute a confidentiality agreement or nondisclosure agreement (NDA). NDAs should be short and in plain English. Otherwise, the creditor is likely to withhold their signature and ask to refer it to their counsel.
However, sharing financial information, even when subject to an NDA, will never be totally secure. There is always a risk that such information will be leaked or misinterpreted. Leaks can damage relationships with customers and vendors, and competitors may use sensitive information to undercut customer accounts. Keep the financial presentation free of excessive detail, and never distribute highly confidential information in print.
Preparing for the Initial Presentation
Before the initial creditor meeting or videoconference call (see, “Meeting Choices,” at the end of this article), the senior management representative should reach out to each top-20 creditor who has been invited to attend to give a preview of the presentation and to take the creditor’s temperature regarding a proposed compromise. The goal is to get a sense of the following: Is the creditor hostile or supportive? Is the creditor anxious to retain the debtor’s business? What is on the creditor’s mind? Will the creditor recommend a compromise to other creditors? What, if anything, is bothering the creditor? If the debtor correctly anticipates creditors’ questions, there should be no surprises during the meeting.
If a creditor’s sales representative attends the meeting, any reduction in that creditor’s claim may be coming out of their commission. If a credit manager attends the meeting, the debtor’s situation may be causing the credit manager embarrassment. Be cognizant of who the creditor’s representative is. If there is a sense that a creditor may want to grandstand during the meeting, attempt to address any issues with that creditor individually beforehand to avoid a public airing that could adversely sway creditor sentiment.
The debtor should advise each creditor about the situation and that paying creditors in full on standard terms may be a problem. The debtor should not discuss a liquidation analysis or possible recoveries.
When the debtor leaves the meeting and allows creditors to talk among themselves, it is critical for there to be one or more creditors in the room who support the company and a creditor composition to sell the compromise to other creditors.
The debtor, therefore, should identify and seek out a friendly creditor. A friendly creditor has more credibility than does the debtor’s representative. Invite that friendly creditor to rally the other creditors to form an ad hoc creditors’ committee. Try to get the creditors to speak through one voice. Feel free to share the names of some friendly local attorneys with the friendly creditor. Ask the friendly creditor to remind everyone that it is crucial to retain a customer to make back any losses and that getting revenge is worth less than getting repaid.
A debtor should not aim to achieve too much in its pre-meeting communications with individual creditors. The debtor should advise each creditor about the situation and that paying creditors in full on standard terms may be a problem. The debtor should not discuss a liquidation analysis or possible recoveries.
The purpose of the pre-meeting call is for the debtor to advise creditors that it would like to make a presentation reflecting that the debtor has solid business operations but is experiencing some cash flow problems and that the purpose of the upcoming meetings is to talk about a compromise that is fair to all parties. If the debtor is asked whether it intends to seek a discount, the proper response is, “The company is seeking to avoid that, but we are studying the issue now and will get back to you.”
The initial presentation should show the liquidation value of assets and the net proceeds likely to be available to unsecured creditors in a liquidation scenario or pursuant to an in-court Chapter 11 restructuring under the Bankruptcy Code after payment of secured, priority, and administrative claims. Deny any desire or intent to commence a Chapter 11 case if questioned. These are the hypothetical recoveries that creditors might receive in comparison to the debtor’s proposed settlement under the composition.
The presentation should also include relatively high-level cash flow and income projections, assuming that the composition is accepted and implemented. The goal is to demonstrate that the creditors can do better in an out-of-court composition agreement and make back any short-term losses by continuing to do business with a viable debtor.
Creditors, of course, prefer to be paid in full, and in certain instances, a debtor can make that proposal, albeit over an extended period and without interest. The length of any proposed amortization schedule is key. A “bullet” or “balloon” payment (lump-sum payment made for the entirety of the outstanding claim before the maturity date) at an earlier date before maturity is OK, if feasible.
Plus, once creditors accept being paid their claims on different terms or over a more extended period than initially agreed to, creditors are more likely to forgive the balance due at the end of the amortization period if the debtor broaches the issue at a later date when it has significant new business to send the creditor.
When Attorneys Get Involved
If an attorney for a creditor calls the company in advance of the meeting or conference call, the company should take the call and feel out whether the attorney is friendly or hostile. The attorney may be on a different page than their client, though. The attorney’s client may be more concerned about retaining future business and not alienating the debtor from issuing future purchase orders. In contrast, the attorney may be interested in a new engagement and in being perceived as very aggressive.
A debtor should not hesitate to ask a creditor if their attorney’s aggressive posture is reflective of their relationship with the debtor. If the creditor’s attorney is friendly, a debtor may wish to prepare that attorney for the upcoming creditors’ meeting to see if the attorney can help convince other creditors of the utility of pursuing the proposed compromise or settlement path.
It is not uncommon for attorneys to appear at a creditors’ meeting or on a conference call on behalf of their client and to grandstand in an effort to be selected as counsel to an unofficial or ad hoc creditors’ committee. If this occurs, a debtor should not engage with the grandstanding attorney and maintain its composure. The debtor should continue with its presentation and defer such questions to a later point in the meeting with a response such as, “I’m sure that we can provide you with information that satisfies your inquiry.”
The Big Question
Everyone’s first question will be, “What are you offering, and how bad will it be?” The debtor’s answers should be that they know that they have a problem, they are analyzing what relief they need, and they believe that they have a viable business by means of which they hope to be able to repay creditors in full, but that they are still working through the numbers. The purpose of calling the initial meeting is just to ask creditors for a short reprieve to sort things out.
In the meantime, the debtor will continue doing business with everyone on a cash basis so that no one gets in debt any deeper. The purpose of the first meeting is just to sprinkle cold water. Do not try to accomplish too much at the initial meeting. Do not ask for too long a reprieve at the first meeting. You will get more time anyway if creditors see that the debtor is cooperative (i.e., sharing information and negotiating in good faith).
You will meet or confer with representatives of the ad hoc creditors’ committee or its professional advisers. You will share financial information and projections, including a liquidation analysis. Most likely, it will reflect that your settlement proposal is much better than the alternative of shutting the debtor down. Plus, keeping the debtor in business enables vendors to make back their losses. But let the creditors reach that conclusion on their own. They will ask for more. You will come up from your initial offer. This will happen a few times.
An out-of-court composition can be an effective, efficient, and relatively inexpensive means of restructuring burdensome debt. But, all of that goes away absent strict control over the process. Control over the process means constant strategizing, staying close to creditors and anticipating their moves, never letting them become out of control, and letting them feel that they have extracted the most out of the debtor. In other words, letting them feel that they have won!
Choosing where and how creditors will meet requires some thought.
The debtor must consider where and how to meet with creditors. Options are a conference call, a videoconference, a professional adviser’s office, a debtor’s office, or a hotel conference room near an airport. The answer depends on the largest creditors’ geographic location, the then-current situation with the COVID19 pandemic, and whether creditors might be willing to travel. If the claims are large enough, creditors will likely be willing to travel.
Face-to-face meetings (or, if the situation does not allow those, videoconferencing) allow creditors to meet each other, compare notes, and figure out a strategy of cooperation. Conversely, a face-to-face meeting also allows a hostile creditor with an ax to grind to spread misinformation or negativity to other creditors and to destroy any chance of a successful composition. Accordingly, the debtor’s managers must carefully assess the company’s relationship with its largest creditors (and their representatives) before gathering for an in-person meeting, whether physically in the same room or through a videoconference platform (such as Zoom, GoToMeeting, or WebEx).
In-person meetings at a debtor’s place of business are discouraged, as they may scare employees and raise unnecessary questions, triggering an unhelpful rumor mill. Likewise, discussions at a lawyer’s office may make vendors and other creditors uncomfortable, resulting in creditors bringing their attorneys, who often will make unreasonable demands.
The room should be physically arranged (i.e., no tables) to facilitate listening rather than writing notes. A debtor should not hand out a presentation in writing, as doing so risks confidential information finding its way into the public, including into the hands of competitors. Presentations by PowerPoint or a similar program are preferable. Attending creditors can take their own notes. The debtor should make its presentation to creditors uninterrupted, take questions, and then adjourn the meeting.
A conference call is an option when face-to-face meetings are not feasible or when a debtor seeks to avoid creditors meeting each other. Just as in a face-to-face meeting, highly confidential materials should not be distributed. The debtor should make its presentation to creditors uninterrupted, with all other parties on listen-only mode. Creditors should be invited to email or text their questions to the presentation leader. However, the debtor should not risk a disgruntled creditor interrupting the presentation with a question that seeks to derail the debtor’s constructive efforts to bring about consensus. If done by conference call, a webinar is effective for the presentation.
Another meeting option growing in popularity is an online videoconference. This may be a more personal meeting option, and it combines elements of both an in-person meeting and phone conference calls. A suggested approach to a videoconference is to conduct it like a telephone conference call but allow for a greater ability to interact and see creditor representative reactions.
Kenneth A. Rosen is a Partner and Chair Emeritus, Bankruptcy & Restructuring Department, Lowenstein Sandler LLP.
The views expressed herein are those of the author only and are not necessarily the views of Lowenstein Sandler or of any attorneys at the firm.