Bankruptcy can be expensive - even for a large company - especially when you add the professional fees. It is very public and it devalues the business. Customers will leave. And you lose control: the debtor answers to an official committee of creditors, the bankruptcy court and the U.S. Department of Justice. For a small or mid-size company bankruptcy can be uneconomical, inefficient and risky, and the success rate leaves a lot to be desired.
But there’s an alternative that is strictly out-of-court, informal, completely private, and not even governed by statutory law: the creditor composition. This is an arrangement under which the business comes to terms with its creditors, agrees on a settlement of the unsecured debts owed to vendors, landlords, and so on, and gets relief from its creditors. Success or failure depends on negotiating skill, understanding the psychology of the creditors, and anticipating how they’ll react.
Treat All Creditors Equally
The ideal compromise is one where all the creditors agree, but most of the time you have to negotiate on an individual basis, and that can be exhausting and time-consuming. Larger creditors with clout will ask you to make them an exception and promise to keep the arrangement secret. Don’t fall for it - it never happens. You must treat all creditors equally, with no exceptions, or others will also demand special treatment, and you may quickly find that the deal has become impossible.
Typically, the top 20 unsecured creditors account for 80% of all unsecured trade debt. So it might make most sense, and carry less publicity, to seek a compromise only from the largest ones. Set a dollar threshold, then you can put creditors below that dollar amount into an “administrative convenience class” and they will continue to receive payment in full. They just won’t be paid quite as quickly as they used to.
The Face of the Company
There’s one question every owner should answer during a restructuring: Who will be the face of the company? A senior executive (CEO, CFO, COO) should be present at meetings and on calls, but creditors should be instructed to only talk with company counsel, or a financial advisor or chief restructuring officer if one has been hired. One senior employee should be designated to field individual creditor questions, but no one else should answer questions ad hoc. The designated employee should rely on a FAQ list and a script which has been approved by the company’s legal counsel.
Always insist that your creditors sign a confidentiality agreement or NDA before you share financial information with them. It should be a short, plain-English document; if it’s too complex or long, the creditor will be reluctant to sign and insist on having it checked by their lawyer. Be aware, though: even with an NDA, the information might get leaked or misunderstood. Don’t bury your message in a presentation full of detail; never give out highly confidential information in print.
Before the first meeting of creditors, the senior person who is going to present to the creditors should call each of the top twenty creditors invited to the meeting to familiarize them with what will be presented and see what their temperature is: are they hostile to the company? Are they supportive? What’s on their minds? Will they recommend acceptance of a compromise to the rest of the creditor group? You want to anticipate as many questions as possible; there should be no surprises. You don’t want to accomplish too much on these calls; you also want to avoid discussing liquidation, recoveries, etc.
When the company’s people step out and the creditors talk among themselves, you need at least one creditor that you have on your side so that you can sell the compromise. Find one friendly creditor and they will have more credibility than the debtor’s representative. Ask this friendly creditor to convince the other creditors into forming an ad hoc creditors’ committee to speak with one voice and remind them that staying in business as a customer enables them to recover their losses, and that vengeance is less sweet than repaid debts.
Meeting with Creditors
Where do you hold a meeting with creditors? On a conference call, or video conference; at your advisor’s office; your office; a hotel conference room (a good idea if the hotel is near an airport). An in-person meeting is useful because it lets your creditors compare notes and work together, but it also has the risk of letting a hostile creditor politicize the room. You don’t want to be in your own office (employees may be spooked, and a rumor mill starts there) or in a lawyer’s office (the creditors will bring their own lawyers). On a conference call, leave the creditors on “listen-only” and ask them to email or text questions.
The presentation needs to cover the liquidation value of your assets and what an unsecured creditor can expect to net in either a liquidation or in a Chapter 11 proceeding, after secured, priority and administrative claims are satisfied. Also include high-level projections of your cash flow and income, assuming the composition goes through. The goal is to convince the creditors that they are better off getting paid outside of the courtroom, and that they can make up for any short-term losses by dealing with a company that is viable in the long run.
Expect everyone’s first question to be, “What do you think you’re going to offer, and how bad is it?” Here’s what I advise you to say: “We know we have a problem, and we’re working out what kind of relief we need, but we believe the business is viable and we want to repay in full. We’re still working out the numbers.” Your first request to your creditors is just a short reprieve. (In the meantime, continue doing business with everyone on a cash basis so nobody gets any deeper into debt.) Don’t ask for too long a reprieve; you’ll get more if you cooperate and negotiate in good faith.
Creditors generally want to be paid in full. Sometimes the debtor can offer to do that, but over an extended period and without interest. But once the creditor is comfortable with the longer schedule, then later, when the debtor has significant new business to send them, it makes sense to ask the creditor to forgive the remaining balance.
Next, you’ll meet with the ad hoc committee of creditors (or their advisors) and present projections and a liquidation analysis that shows that, in all likelihood, your offer exceeds what the creditors would receive by shutting down. Let them draw that conclusion. They will ask for more, and you’ll move up from your first offer, several times. A composition can be effective, efficient and relatively cheap, but it is critical that you exert strict control over the process: keep tight strategy, stay close to the creditors, anticipate their behavior, and let them believe they have won.
