As thousands of companies struggle to survive in the wake of COVID-19’s economic wreckage, there’s a new power player in many C-suites: the chief restructuring officer.
The job is not for the faint of heart. A CRO must push aside all of the internal politics, emotions, and hierarchies to perform the job. It begins with the all-important determination as to whether the company should or should not undertake a reorganization.
That decision is critical because the cost of reorganization—whether inside or outside bankruptcy court—can be substantial. Add up the hefty fees for lawyers, accountants, forensic investigators. and other outside professionals, and it’s easy to understand why many reorganizations don’t succeed. In fact, just one in five distressed companies recover—and that was pre-COVID.
Enter the CRO, who must quickly and accurately determine the company’s strengths and threats as part of answering this critical, overarching question: Can the company be salvaged through reorganization? Unfortunately, many cannot. About one-third of companies will immediately be classified as hopeless. That’s, often because they are overleveraged, short on cash, or run by people who don’t fully understand their business. Or all of the above.
What makes a company salvageable in the eyes of a CRO? Positive cash flow is at the top of the list, but there are other considerations as well. The CRO must examine market competitiveness, new business/means to bring in more cash, and equipment and technology. And don’t forget legacy costs, such as the phone system.
As the CRO for a residential real estate brokerage, I discovered the company was spending $100,000 per month to lease a phone system. Every agent was provided with a personal phone, and the system handled more than 2,000 phone and fax numbers. This large legacy cost made the bankruptcy option more viable because in Chapter 11 the phone contract and other “executory contracts”—such as unexpired real estate leases, equipment leases, and supply agreements—can be rejected.
Of course, there are some lingering costs that need to be addressed, but the creditor to whom you owe the money cannot, under most circumstances, prevent the rejection.
Dealing with those creditors is another job for the CRO. This dance usually begins before a bankruptcy filing, because if the CRO can successfully negotiate the outcome outside of federal court, then Chapter 11 and its accompanying costs and complexities can be avoided. In many instances, a pre-packaged bankruptcy filing can benefit both the company and the creditors. It can rid the company of the legacy cost structure while at the same time providing a sufficient payment to the unsecured creditors. That incents them to support an out-of-court agreement that can be confirmed within a bankruptcy environment.
Once a determination has been made to restructure, the CRO has a new objective: craft a turnaround strategy. He or she will need to sort out what the core business is going forward, what needs to be cut, whether bridge (temporary) financing is prudent and available, and if there are enough organizational resources, among other things. All of this will help the CRO formulate the action plan—which may or may not involve a trip to bankruptcy court.
Once inside bankruptcy court, the CRO must be up on the latest changes in bankruptcy law, including the new Chapter V (officially, Subchapter V – Small Business Debtor Reorganization, of 11 U.S.C. Title 11) that was enhanced as part of the COVID-induced CARES Act. The enhancement raises the eligibility for debtors having indebtedness of less than approximately $7.5 million. Among the many substantial changes:
- Unlike a Chapter 11 case, in Chapter V a creditors’ committee is not formed, and as a result, the debtor’s bankruptcy estate does not bear the costs of the committee’s professionals. This is good for companies because a creditor’s committee has significant power in a Chapter 11 case and is adversarial to the secured creditors, which significantly impairs the reorganization process. Many cases die and get converted to Chapter 7 (liquidation of assets) because of the unsecured creditors’ committee’s demands.
- The “absolute priority” rule does not apply, so a debtor may retain its equity interest even though unsecured creditors do not receive payment in full. This is perhaps the biggest advantage of Chapter V. In a typical Chapter 11, the debtor cannot retain its equity unless (1) creditors vote in favor and (2) the equity security holder “adds value.” This is difficult and in many cases, the “owner” loses its equity and ownership in the business.
- Absent expansion of the trustee’s role, management of the small business remains with the debtor.
- Chapter V gives the small business debtor flexibility to pay administrative claims over the life of the plan rather than in cash on the effective date of the bankruptcy. This has been yet another impediment to successfully reorganizing companies.
For some smaller companies, Chapter V also means they may not need —you guessed it—a CRO. Yet the employment outlook for CROs is still, sadly, rosy. Many companies will struggle as the COVID recession continues and will look to CROs for guidance. For some companies, even restructuring won’t be the answer. Instead, they will cease to exist.
Stephen Klein is Managing Director of Atlanta-based Bennett Thrasher’s bankruptcy & restructuring practice and has previously served as a chief restructuring officer.