Successful Wind-Down and Exit Management

The steps we take focus on the following:

• Analyze how to extract value from cash flow, operations, and assets.
• Maximize recovery potential by developing the optimal exit plan and choosing the best mechanism for implementing it.
• Minimize the likelihood of future liabilities by using the Bankruptcy Code as a roadmap.
• Identify the right potential buyers.
• Minimize potential legal exposure.

Implementing these steps within a framework of good faith, fair dealing, transparency, and commercial reasonableness reduces the likelihood of additional claims being filed and provides a game plan that will bring integrity to the process and maximum value to stakeholders, while minimizing legal exposure.

Extract Value

The first phase, which typically takes one to two weeks, should be to analyze how the maximum value of the company can be realized. Given the cash burn, negative earnings, operational problems, and arguable lack of enterprise value, one often initially hears, 'Shut it down immediately.' But the best option is not always apparent at the outset. Determining how best to maximize recovery and to minimize future claims requires an analysis of many factors, including cash required to operate, status of raw material supply, asset types and conditions, and level of cooperation among stakeholders. Of course, there is no breathing room to perform such an analysis if there is no cash to operate. So, simultaneously, the goal is to stabilize operations and to minimize cash burn to provide the time needed to pursue higher-yield outcomes.

While operations are stabilized, a liquidation analysis should be prepared that shows which option, given current conditions, will most likely maximize recovery in the shortest time and with the least cost. This analysis should consider all factors that influence recovery and expense, including an in-depth review of the collectability of Accounts Receivable on an invoice-by-invoice basis, considering potential offsets and counterclaims that may arise when 'the music stops.' Inventory should be analyzed to uncover any excess raw materials that could be sold to competitors and/or vendors. Work-in-Progress (WIP) should be matched against backlog to determine if it makes economic sense to complete. Discounted finished goods should be offered to existing customers while simultaneously offered to salvage markets. Fixed assets should be identified and shown to used equipment dealers and brokers to estimate recovery values.

As part of this phase, key employees whose presence would be beneficial to the wind-down and exit process may be identified. These people know the business, and it would cost the company more if they left. The wind-down specialist and counsel need to collaborate and balance the need to persuade employees to stay with potential creditor reaction and legal requirements.

The result of the analysis phase should be an exit plan, an accompanying budget, and a cash-flow projection. The budget will serve as the roadmap, setting the baseline recovery expectation and highlighting areas where improvement beyond that baseline may be achieved.

Maximize Recovery Potential

Armed with the analysis described above, parties should now be in a position to determine whether there is an underlying business that can be salvaged in some form. Sometimes, there is no chance for salvation ' for example, there is no order backlog; minimal, if any, saleable inventory; no proprietary intellectual property; obsolete equipment; environmentally challenged real estate; and/or an absolute lack of cash to operate. In those situations, disposing of assets piecemeal is the only alternative.

When the business is still viable in some form, and recovery values are similar for a straight liquidation and a sale of assets as a package, what determines the best course? Both scenarios will likely require some operating cash. Even in the liquidation scenario, there are still costs, such as personnel to show the assets, maintenance, insurance, utilities, and security. Sometimes, the time horizon to recovery will dictate. Sometimes, ongoing exposure beyond cash will govern. Sometimes, the market for the products will suggest a clear alternative. The answer is often to pursue both paths. In other words, create a plan that will prepare for the worst (liquidation), while allowing for the best (a sale to a strategic buyer).

Without starting the wind-down process and beginning to generate cash, there will be nothing to sell because the secured lender will likely foreclose. But as long as the budget is met, weekly variances are positive, and there is running room to improve operations, finding a strategic buyer may be possible. Maintaining credibility with all constituencies by showing progress is critical.

It is highly likely that the company has already been shopped to some degree, but an acceptable offer has not materialized. It is difficult at the outset to convince stakeholders to put additional money at risk and to buy time without a well thought out, rational, and achievable strategy that will provide incremental recovery commensurate with the additional risk. But with a well-conceived liquidation plan, coupled with a strict budget, one can enable discussions with potential suitors at the same time the company is being wound down.

Convincing the constituencies that the process of recovery is underway, and that the organization is not holding out for a white knight, is critical. It may seem highly contradictory (especially to management), but only by starting the liquidation process will there be an opportunity for a better outcome.

Minimize Future Liabilities

The other side of the equation to maximizing value involves minimizing costs and future claims. The two key considerations in this part of the process are the mechanics (in or out of bankruptcy court) and the integrity of the process.

Many factors play into the decision on mechanics, including the level of trust and cooperation among the owners, the management, the secured lender, and other creditors (including whether any creditors are likely to take precipitous actions against the company or its assets); the unsecured creditor constituency's size and variety; the presence of employee issues; the potential acquirer's desire for a court order providing for free and clear title to the assets versus its desire to avoid a competitive bidding process typical of bankruptcy sales; and the need for protection and comfort of the company's officers and directors. Generally speaking, court-supervised processes are better suited for cases involving larger and more complex capital structures and/or creditor constituencies, WARN Act or other material employee liabilities, numerous landlord or other claims that would be subject to bankruptcy caps, numerous 'non-assignable' contracts that require court sanction to be transferred to a buyer, possible valuable avoidance actions that would be created and/or pursued most effectively in bankruptcy, and the likelihood that the officers and directors will be second-guessed.

While not always viable, an out-of-court wind down has two important advantages: increased speed and lower cost. A successful out-of-court wind down is possible when the hostility and claims arising from the process can be managed without court supervision, particularly if it is run as if it were in court, using key elements of the Bankruptcy Code as guidelines, which gives the process credibility. Operating in good faith, with integrity and fairness and open and frequent communication, is vital.

Operating as if in bankruptcy provides a sound framework for action and communication. The point at which the decision is made to wind down the company should be viewed as a quasi-bankruptcy filing date. Two important guidelines are: 1) pay no 'pre-petition' debts; and 2) incur no new debt without a high degree of certainty that it can be repaid.

Adhering to these guidelines can be challenging. Vendors do not like being told their old debts are frozen while being asked to provide continued goods or services. However, creditors tend to cooperate if they believe they are being treated fairly, and other 'squeaky wheels' are not getting greased.

Having the message come from seasoned professionals goes a long way toward building trust among creditors. Informing creditors that the senior secured lender has agreed to fund the wind down and that the budget includes payments to creditors on a go-forward basis is critical to gaining their support. In some cases, it makes sense to form an ad hoc creditors' committee and to implement a formal process for communication. Transparency, like sharing the budget and weekly variances with interested parties, is also important to gaining creditor confidence.

At any time, particularly if creditors have lost trust or confidence in the process due to a lack of open and frequent communication or to the perception that creditors are not being treated fairly and reasonably, the company could be faced with an involuntary bankruptcy filing, so it is in their best interest to be prepared for bankruptcy, even while trying to avoid it.

Attract Buyers

The goal is to find a buyer with four characteristics: appreciation of the opportunity, the ability to integrate the opportunity into its own infrastructure, the financial and managerial resources to make a deal happen, and the ability to move quickly amid uncertainty. While it is not easy to find such a buyer, if one is found, it will normally provide recoveries in excess of what would be obtained in a liquidation.

Within days, potential targets can be identified for pretty much any market, and they should be sent a 'teaser' of no more than 10 pages, designed to promote interest in the company and to commence a dialogue. The due diligence process proceeds as the wind down does, and sometimes it is a race to the finish line.

Matching potential assets for sale with potential buyers is the start. Having a deal means a sale agreement and other related documents are needed, and that requires counsel's assistance. The wind-down specialist can assist in evaluating what terms and conditions are considered 'market'. We undertake much of the operational and preparation work to make filing of motions easier and defensible. As with all sale processes, evaluating the best offer involves balancing cash required, price offered, and speed to close.

Minimize Legal Exposure

Pursuing a wind down has the benefit of minimizing the potential legal exposure of the company's directors and officers. The focus of the board (and management) in the wind-down process, as with all other important company decisions, should be on their fiduciary duties, which in the wind-down context (likely insolvency) extend not only to shareholders, but to the community of company interests, including creditors and employees.

The duty of care requires directors to act with such care as an ordinarily prudent person in a like position would use under similar circumstances. The duty of loyalty requires directors to act in good faith and in the honest belief that actions they support and take are in the best interests of the company, and not the individual, and directors must be disinterested and independent and not usurp corporate opportunities for their own benefit.

There are two key points to consider with respect to the fulfillment of fiduciary duties. First, directors are entitled to the benefit of the 'business judgment rule' 'that is, directors are presumed to have acted on an informed basis, in good faith, and in the honest belief that their actions are in the best interests of the company. That presumption does not apply where there is evidence of fraud, self-dealing, bad faith, or gross negligence. Second, directors are entitled to rely, in good faith, on information and opinions presented by employees and professionals (including wind-down professionals) and by others as to matters that are reasonably believed to be within their area of competence.

The particular constituencies to whom directors owe their fiduciary duties are dependent on the solvency of the company. With a solvent company, fiduciary duties are owed to shareholders only. On the other hand, the directors of a company in the 'zone' or 'vicinity' of insolvency (or actually insolvent) have an extended duty to the community of company interests, including shareholders, creditors, employees, and other interested parties, to maximize then value of the enterprise.

In the context of a wind-down scenario, there should not be much question that the company is insolvent or at least in the zone of insolvency, and it should therefore be assumed that directors have fiduciary duties to a broader group. By way of background, a company can be determined to be insolvent on a balance sheet basis (i.e., liabilities exceed the reasonable fair market value of assets) or as an equitable matter (for example, inability to meet debts as they become due in the ordinary course of business or, in certain circumstances, having unreasonably small capital). The 'zone' or 'vicinity' of insolvency typically includes a period prior to actual insolvency, although there is no established formula. Courts tend to examine the facts and weigh the proximity to, and probability of, insolvency and the risk whether creditors would be paid, in retrospect. Of course, bankruptcy or related proceedings are not required for a court to conclude that a company was insolvent or in the zone at any particular time. Together, the wind-down professionals and legal counsel advise the company's board and management team toward helping them make informed, independent, and good-faith decisions and judgments, with the intention of maximizing the value of the enterprise

Conclusion

When a company is failing to the point where key stakeholders have determined that it should be shut down and liquidated, the path chosen will have a significant impact on the outcome. Many times the obvious choices are not the optimal ones. While ceasing operations immediately can certainly increase short-term cash, it can have severe negative effects on the final recovery.

No decisions should be made without first conducting a comprehensive, yet accelerated, analysis of all areas of recovery and their associated costs. This analysis and related budget will set the baseline, identify areas of upside, and serve as the roadmap throughout the process. The most significant upside will come from identifying strategic players and convincing them that there is an opportunity they should not miss.

The integrity of the process is as important as the result. Conducting the wind-down process as if it were taking place in a bankruptcy provides for a sound and defensible framework. Following the tenets of good faith, fair dealing, adequate notice, commercial reasonableness, and the bankruptcy priority rules will maximize recovery, while minimizing costs and the likelihood of future claims.

Bruce Erickson, CTP, heads Wind-Down Management practice of CRG Partners in Boston. During his 18 years of hands-on experience in asset disposition, workouts, restructuring and liquidation management, he has worked with companies in a broad range of industries both in and out of bankruptcy. He can be reached at 617-482-4242 or [email protected]. Joel Levitin is a partner in the New York Office of Dechert, LLP, where he chairs the international bankruptcy/corporate recovery and insolvency group. He focuses primarily on corporate restructuring and reorganization matters, most often on behalf of troubled or distressed companies and acquirers of such companies. He can be reached at 212-698-3558 or [email protected].

Professionals are often asked to assist in the wind-down and liquidation of a company by the company's legal counsel. The requesting attorney, who may have a history with the company, knows the company is in trouble and may even expect a bankruptcy filing will come relatively soon.

At this point the company's secured lender is unwilling to provide additional support, the company has been unable to attract alternative financing, and the equity sponsor will not continue to fund the company. The company's limited working capital often comes from stretching trade and other creditors to the breaking point. Word of the company's situation has spread to the point where vendors will supply product only on C.O.D. terms or demand a portion of old debt, further exacerbating the cash crunch. Payment of outstanding accounts receivable slows while customers investigate switching suppliers. Uninformed employees assume the worst, and many are paralyzed with fear of losing their jobs; those who can are fleeing. The ability to meet payroll is often in doubt.

In hiring a seasoned exit manager, much of the burden in administering to these concerns is lifted from counsel. Wind-down specialists handle the troubled company's day-to-day operational issues. This ensures the company does not make promises it cannot keep, and does not run afoul of bankruptcy rules, for example, freeing counsel to focus on their core competencies. Against this backdrop, wind-down specialists create and implement an exit strategy that maximizes recovery, while minimizing costs, future liabilities, and personal exposure.

The steps we take focus on the following:

• Analyze how to extract value from cash flow, operations, and assets.
• Maximize recovery potential by developing the optimal exit plan and choosing the best mechanism for implementing it.
• Minimize the likelihood of future liabilities by using the Bankruptcy Code as a roadmap.
• Identify the right potential buyers.
• Minimize potential legal exposure.

Implementing these steps within a framework of good faith, fair dealing, transparency, and commercial reasonableness reduces the likelihood of additional claims being filed and provides a game plan that will bring integrity to the process and maximum value to stakeholders, while minimizing legal exposure.

Extract Value

The first phase, which typically takes one to two weeks, should be to analyze how the maximum value of the company can be realized. Given the cash burn, negative earnings, operational problems, and arguable lack of enterprise value, one often initially hears, 'Shut it down immediately.' But the best option is not always apparent at the outset. Determining how best to maximize recovery and to minimize future claims requires an analysis of many factors, including cash required to operate, status of raw material supply, asset types and conditions, and level of cooperation among stakeholders. Of course, there is no breathing room to perform such an analysis if there is no cash to operate. So, simultaneously, the goal is to stabilize operations and to minimize cash burn to provide the time needed to pursue higher-yield outcomes.

While operations are stabilized, a liquidation analysis should be prepared that shows which option, given current conditions, will most likely maximize recovery in the shortest time and with the least cost. This analysis should consider all factors that influence recovery and expense, including an in-depth review of the collectability of Accounts Receivable on an invoice-by-invoice basis, considering potential offsets and counterclaims that may arise when 'the music stops.' Inventory should be analyzed to uncover any excess raw materials that could be sold to competitors and/or vendors. Work-in-Progress (WIP) should be matched against backlog to determine if it makes economic sense to complete. Discounted finished goods should be offered to existing customers while simultaneously offered to salvage markets. Fixed assets should be identified and shown to used equipment dealers and brokers to estimate recovery values.

As part of this phase, key employees whose presence would be beneficial to the wind-down and exit process may be identified. These people know the business, and it would cost the company more if they left. The wind-down specialist and counsel need to collaborate and balance the need to persuade employees to stay with potential creditor reaction and legal requirements.

The result of the analysis phase should be an exit plan, an accompanying budget, and a cash-flow projection. The budget will serve as the roadmap, setting the baseline recovery expectation and highlighting areas where improvement beyond that baseline may be achieved.

Maximize Recovery Potential

Armed with the analysis described above, parties should now be in a position to determine whether there is an underlying business that can be salvaged in some form. Sometimes, there is no chance for salvation ' for example, there is no order backlog; minimal, if any, saleable inventory; no proprietary intellectual property; obsolete equipment; environmentally challenged real estate; and/or an absolute lack of cash to operate. In those situations, disposing of assets piecemeal is the only alternative.

When the business is still viable in some form, and recovery values are similar for a straight liquidation and a sale of assets as a package, what determines the best course? Both scenarios will likely require some operating cash. Even in the liquidation scenario, there are still costs, such as personnel to show the assets, maintenance, insurance, utilities, and security. Sometimes, the time horizon to recovery will dictate. Sometimes, ongoing exposure beyond cash will govern. Sometimes, the market for the products will suggest a clear alternative. The answer is often to pursue both paths. In other words, create a plan that will prepare for the worst (liquidation), while allowing for the best (a sale to a strategic buyer).

Without starting the wind-down process and beginning to generate cash, there will be nothing to sell because the secured lender will likely foreclose. But as long as the budget is met, weekly variances are positive, and there is running room to improve operations, finding a strategic buyer may be possible. Maintaining credibility with all constituencies by showing progress is critical.

It is highly likely that the company has already been shopped to some degree, but an acceptable offer has not materialized. It is difficult at the outset to convince stakeholders to put additional money at risk and to buy time without a well thought out, rational, and achievable strategy that will provide incremental recovery commensurate with the additional risk. But with a well-conceived liquidation plan, coupled with a strict budget, one can enable discussions with potential suitors at the same time the company is being wound down.

Convincing the constituencies that the process of recovery is underway, and that the organization is not holding out for a white knight, is critical. It may seem highly contradictory (especially to management), but only by starting the liquidation process will there be an opportunity for a better outcome.

Minimize Future Liabilities

The other side of the equation to maximizing value involves minimizing costs and future claims. The two key considerations in this part of the process are the mechanics (in or out of bankruptcy court) and the integrity of the process.

Many factors play into the decision on mechanics, including the level of trust and cooperation among the owners, the management, the secured lender, and other creditors (including whether any creditors are likely to take precipitous actions against the company or its assets); the unsecured creditor constituency's size and variety; the presence of employee issues; the potential acquirer's desire for a court order providing for free and clear title to the assets versus its desire to avoid a competitive bidding process typical of bankruptcy sales; and the need for protection and comfort of the company's officers and directors. Generally speaking, court-supervised processes are better suited for cases involving larger and more complex capital structures and/or creditor constituencies, WARN Act or other material employee liabilities, numerous landlord or other claims that would be subject to bankruptcy caps, numerous 'non-assignable' contracts that require court sanction to be transferred to a buyer, possible valuable avoidance actions that would be created and/or pursued most effectively in bankruptcy, and the likelihood that the officers and directors will be second-guessed.

While not always viable, an out-of-court wind down has two important advantages: increased speed and lower cost. A successful out-of-court wind down is possible when the hostility and claims arising from the process can be managed without court supervision, particularly if it is run as if it were in court, using key elements of the Bankruptcy Code as guidelines, which gives the process credibility. Operating in good faith, with integrity and fairness and open and frequent communication, is vital.

Operating as if in bankruptcy provides a sound framework for action and communication. The point at which the decision is made to wind down the company should be viewed as a quasi-bankruptcy filing date. Two important guidelines are: 1) pay no 'pre-petition' debts; and 2) incur no new debt without a high degree of certainty that it can be repaid.

Adhering to these guidelines can be challenging. Vendors do not like being told their old debts are frozen while being asked to provide continued goods or services. However, creditors tend to cooperate if they believe they are being treated fairly, and other 'squeaky wheels' are not getting greased.

Having the message come from seasoned professionals goes a long way toward building trust among creditors. Informing creditors that the senior secured lender has agreed to fund the wind down and that the budget includes payments to creditors on a go-forward basis is critical to gaining their support. In some cases, it makes sense to form an ad hoc creditors' committee and to implement a formal process for communication. Transparency, like sharing the budget and weekly variances with interested parties, is also important to gaining creditor confidence.

At any time, particularly if creditors have lost trust or confidence in the process due to a lack of open and frequent communication or to the perception that creditors are not being treated fairly and reasonably, the company could be faced with an involuntary bankruptcy filing, so it is in their best interest to be prepared for bankruptcy, even while trying to avoid it.

Attract Buyers

The goal is to find a buyer with four characteristics: appreciation of the opportunity, the ability to integrate the opportunity into its own infrastructure, the financial and managerial resources to make a deal happen, and the ability to move quickly amid uncertainty. While it is not easy to find such a buyer, if one is found, it will normally provide recoveries in excess of what would be obtained in a liquidation.

Within days, potential targets can be identified for pretty much any market, and they should be sent a 'teaser' of no more than 10 pages, designed to promote interest in the company and to commence a dialogue. The due diligence process proceeds as the wind down does, and sometimes it is a race to the finish line.

Matching potential assets for sale with potential buyers is the start. Having a deal means a sale agreement and other related documents are needed, and that requires counsel's assistance. The wind-down specialist can assist in evaluating what terms and conditions are considered 'market'. We undertake much of the operational and preparation work to make filing of motions easier and defensible. As with all sale processes, evaluating the best offer involves balancing cash required, price offered, and speed to close.

Minimize Legal Exposure

Pursuing a wind down has the benefit of minimizing the potential legal exposure of the company's directors and officers. The focus of the board (and management) in the wind-down process, as with all other important company decisions, should be on their fiduciary duties, which in the wind-down context (likely insolvency) extend not only to shareholders, but to the community of company interests, including creditors and employees.

The duty of care requires directors to act with such care as an ordinarily prudent person in a like position would use under similar circumstances. The duty of loyalty requires directors to act in good faith and in the honest belief that actions they support and take are in the best interests of the company, and not the individual, and directors must be disinterested and independent and not usurp corporate opportunities for their own benefit.

There are two key points to consider with respect to the fulfillment of fiduciary duties. First, directors are entitled to the benefit of the 'business judgment rule' 'that is, directors are presumed to have acted on an informed basis, in good faith, and in the honest belief that their actions are in the best interests of the company. That presumption does not apply where there is evidence of fraud, self-dealing, bad faith, or gross negligence. Second, directors are entitled to rely, in good faith, on information and opinions presented by employees and professionals (including wind-down professionals) and by others as to matters that are reasonably believed to be within their area of competence.

The particular constituencies to whom directors owe their fiduciary duties are dependent on the solvency of the company. With a solvent company, fiduciary duties are owed to shareholders only. On the other hand, the directors of a company in the 'zone' or 'vicinity' of insolvency (or actually insolvent) have an extended duty to the community of company interests, including shareholders, creditors, employees, and other interested parties, to maximize then value of the enterprise.

In the context of a wind-down scenario, there should not be much question that the company is insolvent or at least in the zone of insolvency, and it should therefore be assumed that directors have fiduciary duties to a broader group. By way of background, a company can be determined to be insolvent on a balance sheet basis (i.e., liabilities exceed the reasonable fair market value of assets) or as an equitable matter (for example, inability to meet debts as they become due in the ordinary course of business or, in certain circumstances, having unreasonably small capital). The 'zone' or 'vicinity' of insolvency typically includes a period prior to actual insolvency, although there is no established formula. Courts tend to examine the facts and weigh the proximity to, and probability of, insolvency and the risk whether creditors would be paid, in retrospect. Of course, bankruptcy or related proceedings are not required for a court to conclude that a company was insolvent or in the zone at any particular time. Together, the wind-down professionals and legal counsel advise the company's board and management team toward helping them make informed, independent, and good-faith decisions and judgments, with the intention of maximizing the value of the enterprise

Conclusion

When a company is failing to the point where key stakeholders have determined that it should be shut down and liquidated, the path chosen will have a significant impact on the outcome. Many times the obvious choices are not the optimal ones. While ceasing operations immediately can certainly increase short-term cash, it can have severe negative effects on the final recovery.

No decisions should be made without first conducting a comprehensive, yet accelerated, analysis of all areas of recovery and their associated costs. This analysis and related budget will set the baseline, identify areas of upside, and serve as the roadmap throughout the process. The most significant upside will come from identifying strategic players and convincing them that there is an opportunity they should not miss.

The integrity of the process is as important as the result. Conducting the wind-down process as if it were taking place in a bankruptcy provides for a sound and defensible framework. Following the tenets of good faith, fair dealing, adequate notice, commercial reasonableness, and the bankruptcy priority rules will maximize recovery, while minimizing costs and the likelihood of future claims.

Bruce Erickson, CTP, heads Wind-Down Management practice of CRG Partners in Boston. During his 18 years of hands-on experience in asset disposition, workouts, restructuring and liquidation management, he has worked with companies in a broad range of industries both in and out of bankruptcy. He can be reached at 617-482-4242 or [email protected]. Joel Levitin is a partner in the New York Office of Dechert, LLP, where he chairs the international bankruptcy/corporate recovery and insolvency group. He focuses primarily on corporate restructuring and reorganization matters, most often on behalf of troubled or distressed companies and acquirers of such companies. He can be reached at 212-698-3558 or [email protected].