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Turning Off The Lights: Safely Shutting Down An Insolvent Subsidiary

By Jonathan P. Friedland and Ryan Blaine Bennett
September 17, 2004

It is not uncommon for a holding company (or private equity fund) to have at least one operating subsidiary (or portfolio company) that is underperforming relative to the other companies it owns. Sometimes problems can be fixed and fortunes reversed. Other times, however, the subsidiary/portfolio company continues to struggle and may eventually become truly distressed and even insolvent. At some point, the strategic decision will be made to discontinue the operating subsidiary's business. When this occurs, strategy must be quickly developed and executed to minimize any ongoing losses and to maximize the recovery for the subsidiary's stakeholders.

Any business strategy should be approached with an informed understanding of the overall legal landscape, as well as the specific risks and potential rewards associated with each of the parent's available options. Likewise, the parent must understand its position in the decision-making process relative to those of the insolvent subsidiary's other obligees ' its creditors.

For example, a troubled company will likely need cash infusions to continue operating. And, because potential lenders are not likely to be lining up to extend financing in such a situation, the parent is probably going to be faced with having to decide whether continuing to fund the subsidiary is worthwhile, or just a case of throwing good money after bad. In this context, of course, making a secured loan is preferable to making an unsecured one. Even a secured loan, however, can later be “recharacterized” by a bankruptcy court and treated as if it was a capital contribution (and thus moving any recovery on account of the loan to the end of the line).

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