The Rules of Engagement for Navigating Business and Financial Distress

The question is not if but how deeply the global coronavirus (COVID-19) pandemic will disrupt businesses and impact future operations. That answer differs based upon each company’s industry, access to cash and other capital, debt structure, ability to manage expenses, lost revenues, and operational interruption. Certain industries, such as airlines and airline service companies, hotels, restaurants, sports and entertainment, media, and retailers, among others, are suffering immediate adverse effects. Our healthcare resources are being stretched thin. Statewide “shutdowns” only exacerbate the overall operational disruption, even as companies assess whether they fall into exceptions for “necessity” or being “essential.” The current dislocation may last for months. Despite the uncertainty of this crisis, important steps can be taken now to proactively manage risk and liquidity needs. Some businesses will rebound (including through government loans or other steps taken to stabilize an affected industry). But other disruptions may be more permanent, as customers reduce spending or otherwise shift how they consume products and services. And some companies will seek bankruptcy protection, with the issue being when and not whether. Whatever the duration of this crisis, companies should take steps now to enhance their future prospects. This process mandates close coordination with the company’s board (or other managers), whose knowledge and expertise should be quickly tapped.

Rule 1: Remember, No Company Is an Island

As companies assess the steps necessary to minimize the immediate operational dislocation, they must remember that they are not alone. Other stakeholders have a vested interest in the company’s ability to rebound, including lenders, key vendors, landlords and contract counterparties, among others. In assessing immediate steps, companies should (i) develop a list of all major affected stakeholders, (ii) develop a communication plan to fold them into the process and keep them updated as to the company’s needs and strategic thinking for managing the crisis, and (iii) determine what support, financial or otherwise, is available from them. This can include negotiating a “debt service holiday” with lenders to conserve cash for operations; requesting temporary expense reductions (e.g., rent relief or deferrals for retail stores and restaurants); ensuring with the company’s lenders that no “material adverse effect” type clauses in loan documentation will prevent access to available loans; delaying payments to material contract parties; and, unfortunately, furloughing employees or otherwise reducing noncritical employee-related expenses. While other stakeholders will not want to see their own revenues/income cut, any payment relief request will be measured against the potential permanent loss of business/income from companies that cannot survive.

Rule 2: Cash Is King

Liquidity management will be critical over the coming months, especially for companies suffering an immediate loss of revenues. Assess cash options as “now,” “next” and “later.”

• Now: In addition to the deferral of cash outlays described above, Step 1 will be for companies to marshal available cash reserves by considering the drawdown of available credit facilities even if there is no present need for that cash. Note that, if appropriate, companies should consider where that cash will be deposited and whether that depository financial institution has any offset rights under loan agreements that could impede the future use of that cash. Step 2 requires that all immediately upcoming expenses be reviewed and prioritized for payment based upon (i) necessity of preserving the business and (ii) consequences of nonpayment (including personal liability for responsible officers, such as nonpayment of sales taxes and employee withholding taxes, and loss of key business contracts or leases). Develop a plan to implement immediate cost savings, which will evolve.
  
  
• Next: Assess ways to reduce additional expenses and losses over the next 30 to 90 days. These include approaching lenders for (i) additional access to revolvers or other cash advances and (ii) debt service relief (principal amortization, interest or both). In approaching lenders for financial relief, companies should review their debt documents to assess further relief for potential breaches of financial and operational covenants. If the availability is based upon a borrowing base formula, anticipate potential revaluations of collateral value that affect availability (potentially going from excess availability to overadvance based only upon the effects of an updated appraisal). Companies should also assess potential cross defaults with material contracts, especially those that affect long-term business operations. Discussions with lenders may warrant forbearance or waiver agreements, which in turn depend upon “requisite lender” approval rights to modify payment and other loan provisions. Companies should assess whether in multiple lender facilities (or multiple debt facilities) all lenders have the same alignment with the company or certain lenders will be less accommodating. Companies should develop a strategic approach to these potential holdout lenders. Companies should assess the financial and operational health of their lenders and investors to provide support — how thinly stretched are their resources? As noted, other key contract parties should be approached for payment deferrals and relief, including landlords, suppliers and other contract parties to whom material payments are upcoming. Prioritize expenses that must be paid, e.g., taxes and employees, versus those that can be stretched or deferred. Be aware of liabilities for nonpayment. For example, certain states impose personal liability upon the company’s management and/or owners for nonpayment of employee-related expenses. Develop a strategic communication plan and, as discussed below, anticipate that updated cash flows and business plans will be requested to evaluate any payment relief. As part of this, companies should assess whether they have or need a confidentiality agreement to share nonpublic information and should be mindful if they are sharing information that is, itself, subject to a confidentiality restriction with another party. Companies should balance being transparent to the key stakeholders with being thoughtful and deliberate on the messaging of the going-forward strategy.
  
  
• Later: Assuming (hopefully) that the immediate global healthcare crisis peaks in the next 60 to 90 days, the economy will take much longer to recover. Companies need to assess their future access to capital and take steps to address business dislocation. This includes seeking additional secured or unsecured financing from third parties. Additional equity or sponsor funding should be assessed, whether secured (senior, pari or junior), unsecured or equity infusions. Such equity participation may be required in order to obtain any third-party financing. Companies will also need to assess government assistance packages that may become available. This requires understanding the federal, state and local elected officials critical to accessing (as well as shaping the scope of) future stimulus packages. As capital markets stabilize, debt repurchases or exchanges may become available, and the company’s existing loan documents and intercreditor agreements should be reviewed for any restrictions on these options, especially if assessing affiliated company transactions.

Rule 3: Review the Business Plan (and Then Rinse and Repeat)

No one’s existing business plans accounted for a global pandemic and the resulting market crisis. Companies need to begin to revise their short and longer business plans and projections. In addition, 13-week cash flows should be prepared, laying out what expenses can be deferred (as noted above) to preserve liquidity and minimize operational losses. Expect that these cash flows will be required for any discussions with key stakeholders for monetary assistance (whether affirmative funding requests or payment deferrals). Further expect these projections and cash flows to be fluid and updated frequently to adapt to a changing environment. These projections should account for base-case and better-case outcomes, especially fluctuations based upon the changing impacts of COVID-19. Reevaluate all prior operating assumptions and test those based upon evolving data. It would be prudent to assume shifting spending patterns by consumers (beyond simply a move from bricks and mortar to online shopping), although this is difficult to project. Overall demand will be lower in certain industries, especially as consumers take into account the losses in income and savings (including retirement accounts). Decreased demand may not snap back quickly, and business plan assumptions should be conservative. The company’s senior management should also fold the board into the decision-making path forward. This includes board-level briefings and updates on operations, liquidity and financing alternatives, cost reduction efforts, and internal and external communication strategies.

As part of the business plan process, companies should assess the impact on the supply chain and potential domino effect of the company’s vendors being unable to fulfill (timely or otherwise) product orders due to their own financial distress or other reasons. (Companies dependent upon critical vendors may, in turn, need to factor in how to support those vendors or suffer a greater loss on their own operations. Remember, your company may be someone else’s key stakeholder.) The potential impacts on your supply chains could be extensive. Develop a supply chain contingency plan and evaluate alternative suppliers and any increased costs, delays and revenue losses of switching to new suppliers (if even available). This is especially important for supply chains overseas, where factories may be shut down for longer than anticipated, coupled with a backlog or other delays in shipping products. China is starting to recover on production, but other countries in Asia, the Americas and Europe may still be facing disruption.

Rule 4: Have a Plan B

The next term step is to consider whether the company requires a formal restructuring strategy. Various aspects of a business may no longer be viable (or may not return to viability quickly enough). Contracts may become onerous and outdated. Financing may be insufficient or on unworkable terms. A company may require an operational as well as financial restructuring. Potential options may include:

• Termination (or rejection) of burdensome contracts
• Asset sales
• New financing
• Equitization of existing debt

A company may be able to implement some of these actions outside of a formal (court) restructuring with the consent of the affected stakeholders. Others may require resort to Chapter 11 to take advantage of the Bankruptcy Code’s ability to accomplish change without compliance with nonbankruptcy consent rules. Chapter 11 can offer a number of advantages over an out-of-court restructuring (although Chapter 11 also has its detriments). The benefits, among many others, include:

• DIP financing: Lenders (including existing lenders) may be more willing to provide new financing through “DIP loan” bankruptcy financing. The security provided by the bankruptcy court’s order approving the loan, as well as the structure of a court process to enforce future default remedies, often facilitates financing that would otherwise not materialize.
  
  
• Rejection of contracts and leases: The Bankruptcy Code allows for rejection of burdensome (unprofitable) contracts and leases and gives the contract counterparty a “pre-bankruptcy” claim against the estate for rejection. This feature could facilitate the unloading or renegotiation of burdensome contracts and leases and pave a path towards reorganization around a smaller set of go-forward contracts and leases. For example, a retailer (including restaurant operators) may need to close a number of locations that are no longer sustainable. Companies should also consider recent case law changes from the U.S. Supreme Court that provide that rejection of a contract is not a termination or rescission and the nondebtor party may still have certain nonmonetary rights that otherwise arise in the context of a breach (such as the right to continued use of licensed intellectual property despite a trademark rejection by the debtor licensor).
  
  
• Automatic stay: When the debtor enters Chapter 11, all litigation against the debtor is automatically stayed. This protection may be especially needed by companies with overwhelming litigation related to COVID-19 or other enforcement actions by creditors for nonpayment of pre-bankruptcy payables/claims. An automatic stay may be needed to keep a valuable contract from being terminated due to delays in payment.
  
  
• 363 asset sales: Section 363 of the Bankruptcy Code allows for the sale of assets to third parties free and clear of any liens and encumbrances. These “363 sales” are often very attractive to potential buyers and may create an opportunity to sell portions of your business to reorganize around a smaller business segment. Such a sale may also be needed to preserve the going concern business of an otherwise insolvent entity.
  
  
• Opportunity for companies with access to capital: There will likely be a number of bankruptcy filings in the next 12 to 18 months, and many of those will involve asset sales as part of going concern sales or liquidations. This will present acquisition opportunities for companies with the ability and capital to expand.
  
  
• Allowances for nonconsensual outcome: One of the biggest impediments to out-of-court restructurings is the general need for all stakeholders to agree to the desired modifications. Chapter 11 allows for the court to approve a Chapter 11 plan over the objections of creditors. This added flexibility allows the debtors to consider solutions that may not receive support from all stakeholders but are in the best interest of the estate at large.

Companies need also consider that bankruptcy can be disruptive to ongoing operations and costly. At the present time and for the foreseeable future, access to bankruptcy courts is highly constrained, which can delay, if not limit, relief otherwise available. Chapter 11 has always been a balancing act, and is even more so today.

Rule 5: Ask for Help

These are unprecedented times. There are financial, legal and operational advisors that can assist in developing a strategy to survive. Lobbyists and crisis communication managers may also be important parts of the team. These advisors can (i) map out the operational and financial impacts of the current crisis, (ii) assess your legal rights and options, and (iii) develop and manage an effective strategy for communicating with stakeholders. Know whom to approach for the data necessary to understand your options. Each company should look to manage its own narrative. A company cannot reasonably be blamed for the crisis that is affecting it right now, but in the future, when the dust settles, creditors and other stakeholders will look at how the company’s management reacted and the steps taken by them to preserve business value. For that, good governance and preparedness are key. Who knew that “2020 hindsight” would take on such a dire tone in the months (if not years) to come?