Want to Save Your Property?

No one can dispute that we are in a down economy and the light at the end of the tunnel is a distance away. However, many are standing in the tunnel on the railroad tracks and unfortunately, the light at the end of the tunnel is moving toward them ' and it is definitely a train. So, what do you do when the train is bearing down on you at 70 m.p.h.? You have a few choices. You can:

• Give up and get crushed;
• Lie down on the tracks and hope the train passes over you;
• Jump out of the way to the left;
• Jump out of the way to the right; or
• Yell for Superman and hope he comes to the rescue.

The same can be said for your financially troubled business.

Is Bankruptcy the Answer?

Many business owners who are faced with a matured bank loan or multiple debts that are long past due immediately think that bankruptcy is the only way out. This could not be further from the truth. While bankruptcy may work for some businesses, it does not make sense for most. Certainly there are cases where bankruptcy is the answer; however, those instances are few and far between. When clients come to my office thinking about filing for bankruptcy, I usually end up talking them out of it in favor of other strategies.

There are many downsides to filing bankruptcy. The biggest disadvantage is that bankruptcy is generally more expensive than non-bankruptcy alternatives. In addition, a debtor is subject to the scrutiny of more parties, as a U.S. Trustee, a committee of unsecured creditors and a judge must review every move that the debtor makes while in bankruptcy. Further, every payment made to an insider during the year leading up to the filing is subject to disgorgement. While each case is different, these factors often tip the scales against a bankruptcy filing.

A Hypothetical Case

To illustrate this point, consider one fact pattern and run it through some of the alternative strategies. A company called Big Shopping Center Failure, LLC (BSCF) is having difficulty. Its former big box anchor tenant has itself filed for bankruptcy and has rejected its lease, leaving the shopping center 50% leased. BSCF's lender, America's Bank (Bank), has just learned of the lease rejection and has sent a demand letter to BSCF and all of the guarantors of the loan. The guarantors have personally guaranteed all of BSCF's debt to the Bank.

As with all cases, before determining a strategy, it is imperative to determine the direction in which you want the case to go. In other words, in this case, do the owners of BSCF believe this is a project worth saving? If not, perhaps this is the time to stand on the tracks and let the business get run over by the Bank. If, on the other hand, the owners believe the project is worth saving, then it is time to jump left or jump right. BSCF's owners must be realistic in this determination. In this case, assume BSCF's owners have determined the project is worth saving.

Forbearance/Composition Agreement

BSCF's owners have a few irons in the fire for new tenants. Additionally, the guarantors have assets that the Bank can reach should they ever get sued, and they certainly do not want that to happen. Thus, approaching the Bank to discuss some kind of forbearance agreement is one alternative strategy to bankruptcy. For the most part, banks do not want to own property ' that is not their business. Nor do they want to foreclose and manage properties. Consequently, if BSCF can show the Bank that it is the most knowledgeable party with respect to the property in question, that it knows the tenant market better than anyone the Bank could hire, and that it would make the most economical sense for the Bank to continue to let BSCF manage the property, there is a very good likelihood that the Bank will give BSCF a period of time to try to turn things around.

The plan proposed by BSCF, though, must be sound. It must submit a bare-bones budget to show that the property can operate with no ' or minimal ' help from the Bank. Additionally, the Bank, like most banks today, is primarily concerned about keeping interest current (when interest is not current, after a certain period of time, the Bank must increase reporting and set aside reserves, which means less money that the Bank can put to use). Accordingly, BSCF will have to demonstrate that interest can be kept current. Perhaps it means accruing interest at the current note rate, but actually paying a lesser amount so that at the new maturity, more interest would then be due. Or perhaps it means a rate reduction now, with increases over time. There are many ways to propose something that the Bank might find palatable; however, BSCF must also be reasonable. The Bank will not just reduce its rate below market because BSCF has asked it to (in fact, Bank guidelines suggest that when a loan is riskier, the interest rate should actually be raised). Guarantors must reduce any salary or management fees, and perhaps throw some of their own money into the operation. Banks love to see owners contribute equity.

Finally, the plan could propose to turn over the property to the Bank at the end of the forbearance period, should BSCF not turn things around. This would save the Bank the time and money of foreclosing.

A forbearance might also require a compromise with unsecured creditors. Sometimes this is referred to as a composition agreement. In our example, BSCF would invite all of its creditors to a meeting or solicit their agreement via mail. The solicitation is a letter that explains the situation and proposes to treat all creditors of the same level equally. In our example, this means that all unsecured creditors would receive the same percentage payment. This is the equivalent of a bankruptcy plan without the bankruptcy. The disadvantage here is that this type of plan is difficult to achieve when there are large numbers of creditors and only works if everyone signs on.

Purchase the Loan for Discount

Another strategy to consider is the short payoff, or purchase of the Bank's note and mortgage at a discount. For the most part, banks understand the value of their real estate collateral. They also understand that when property values are less than loan balances, there is no way for them to recover the loan amount from the real estate alone. In this scenario, the Bank would have to recover the land through foreclosure, sell the land, sue the guarantors for the loan balance, obtain a judgment against the guarantors, and hope they have assets left by the time the judgment is obtained, to satisfy the judgment. Since litigation can take years to complete, banks often would rather be paid a lesser amount today, than risk the fees and time necessary to pursue litigation, knowing that the guarantors may not have assets remaining at the end. Therefore, if the guarantors have the resources or can get financing elsewhere, albeit for less than the full loan balance, they should offer the bank a short payoff. The worst that can happen is the Bank refuses.

It is important to note that even though it seems as though this would be a great time for banks to sell their loans at deep, deep discounts, many are holding firm and not caving to the pressure of a depressed economy, especially when the guarantors have assets. Banks will settle on a short payoff or sale, but the price must be reasonable given all of the facts.

Do Nothing

Believe it or not, doing nothing can also be an effective strategy. While I would always encourage BSCF to keep the lines of communication open with the Bank, it may be that the Bank is just not willing to negotiate on terms that BSCF finds acceptable. Or it may be that the Bank is not going to take any action notwithstanding the threat of doing so. Thus, doing nothing can also work, and it does not cost a lot of money; however, doing nothing does not buy BSCF any of the certainty that it may be seeking. The Bank can strike at any time, and BSCF's owners will likely lose a lot of sleep waiting for the other shoe to drop. This strategy usually does not pay off.

Explore Other Options for the Property

Sometimes the best strategy is to see if there is a better use for the project or an alternative source of financing. Many developers have sought zoning changes to increase density, changed the use from for-sale to rental, or sought out New Markets Tax Credits, Historic Tax Credits or TIF financing to make projects work. It is almost never too late to try.

Conclusion

The points above illustrate that bankruptcy may be the right move in certain situations: 1) if you have a war chest of funds and a cooperative secured lender; 2) if you have multiple locations in various states that need liquidation; or 3) if there are major money-losing contracts that can be rejected mid-stream. In most cases, however, hopping on the train to one of the alternatives is usually the better bet.

William S. Schwartz is a partner in the Banking & Finance Service Group of Levenfeld Pearlstein LLC in Chicago, and concentrates his practice on representing lenders and borrowers in financial services, litigation (including bankruptcy) and workouts. His lending and borrower work focuses on middle-market financing through asset-based and real estate-related loans, including financing through the New Markets Tax Credit Program

No one can dispute that we are in a down economy and the light at the end of the tunnel is a distance away. However, many are standing in the tunnel on the railroad tracks and unfortunately, the light at the end of the tunnel is moving toward them ' and it is definitely a train. So, what do you do when the train is bearing down on you at 70 m.p.h.? You have a few choices. You can:

• Give up and get crushed;
• Lie down on the tracks and hope the train passes over you;
• Jump out of the way to the left;
• Jump out of the way to the right; or
• Yell for Superman and hope he comes to the rescue.

The same can be said for your financially troubled business.

Is Bankruptcy the Answer?

Many business owners who are faced with a matured bank loan or multiple debts that are long past due immediately think that bankruptcy is the only way out. This could not be further from the truth. While bankruptcy may work for some businesses, it does not make sense for most. Certainly there are cases where bankruptcy is the answer; however, those instances are few and far between. When clients come to my office thinking about filing for bankruptcy, I usually end up talking them out of it in favor of other strategies.

There are many downsides to filing bankruptcy. The biggest disadvantage is that bankruptcy is generally more expensive than non-bankruptcy alternatives. In addition, a debtor is subject to the scrutiny of more parties, as a U.S. Trustee, a committee of unsecured creditors and a judge must review every move that the debtor makes while in bankruptcy. Further, every payment made to an insider during the year leading up to the filing is subject to disgorgement. While each case is different, these factors often tip the scales against a bankruptcy filing.

A Hypothetical Case

To illustrate this point, consider one fact pattern and run it through some of the alternative strategies. A company called Big Shopping Center Failure, LLC (BSCF) is having difficulty. Its former big box anchor tenant has itself filed for bankruptcy and has rejected its lease, leaving the shopping center 50% leased. BSCF's lender, America's Bank (Bank), has just learned of the lease rejection and has sent a demand letter to BSCF and all of the guarantors of the loan. The guarantors have personally guaranteed all of BSCF's debt to the Bank.

As with all cases, before determining a strategy, it is imperative to determine the direction in which you want the case to go. In other words, in this case, do the owners of BSCF believe this is a project worth saving? If not, perhaps this is the time to stand on the tracks and let the business get run over by the Bank. If, on the other hand, the owners believe the project is worth saving, then it is time to jump left or jump right. BSCF's owners must be realistic in this determination. In this case, assume BSCF's owners have determined the project is worth saving.

Forbearance/Composition Agreement

BSCF's owners have a few irons in the fire for new tenants. Additionally, the guarantors have assets that the Bank can reach should they ever get sued, and they certainly do not want that to happen. Thus, approaching the Bank to discuss some kind of forbearance agreement is one alternative strategy to bankruptcy. For the most part, banks do not want to own property ' that is not their business. Nor do they want to foreclose and manage properties. Consequently, if BSCF can show the Bank that it is the most knowledgeable party with respect to the property in question, that it knows the tenant market better than anyone the Bank could hire, and that it would make the most economical sense for the Bank to continue to let BSCF manage the property, there is a very good likelihood that the Bank will give BSCF a period of time to try to turn things around.

The plan proposed by BSCF, though, must be sound. It must submit a bare-bones budget to show that the property can operate with no ' or minimal ' help from the Bank. Additionally, the Bank, like most banks today, is primarily concerned about keeping interest current (when interest is not current, after a certain period of time, the Bank must increase reporting and set aside reserves, which means less money that the Bank can put to use). Accordingly, BSCF will have to demonstrate that interest can be kept current. Perhaps it means accruing interest at the current note rate, but actually paying a lesser amount so that at the new maturity, more interest would then be due. Or perhaps it means a rate reduction now, with increases over time. There are many ways to propose something that the Bank might find palatable; however, BSCF must also be reasonable. The Bank will not just reduce its rate below market because BSCF has asked it to (in fact, Bank guidelines suggest that when a loan is riskier, the interest rate should actually be raised). Guarantors must reduce any salary or management fees, and perhaps throw some of their own money into the operation. Banks love to see owners contribute equity.

Finally, the plan could propose to turn over the property to the Bank at the end of the forbearance period, should BSCF not turn things around. This would save the Bank the time and money of foreclosing.

A forbearance might also require a compromise with unsecured creditors. Sometimes this is referred to as a composition agreement. In our example, BSCF would invite all of its creditors to a meeting or solicit their agreement via mail. The solicitation is a letter that explains the situation and proposes to treat all creditors of the same level equally. In our example, this means that all unsecured creditors would receive the same percentage payment. This is the equivalent of a bankruptcy plan without the bankruptcy. The disadvantage here is that this type of plan is difficult to achieve when there are large numbers of creditors and only works if everyone signs on.

Purchase the Loan for Discount

Another strategy to consider is the short payoff, or purchase of the Bank's note and mortgage at a discount. For the most part, banks understand the value of their real estate collateral. They also understand that when property values are less than loan balances, there is no way for them to recover the loan amount from the real estate alone. In this scenario, the Bank would have to recover the land through foreclosure, sell the land, sue the guarantors for the loan balance, obtain a judgment against the guarantors, and hope they have assets left by the time the judgment is obtained, to satisfy the judgment. Since litigation can take years to complete, banks often would rather be paid a lesser amount today, than risk the fees and time necessary to pursue litigation, knowing that the guarantors may not have assets remaining at the end. Therefore, if the guarantors have the resources or can get financing elsewhere, albeit for less than the full loan balance, they should offer the bank a short payoff. The worst that can happen is the Bank refuses.

It is important to note that even though it seems as though this would be a great time for banks to sell their loans at deep, deep discounts, many are holding firm and not caving to the pressure of a depressed economy, especially when the guarantors have assets. Banks will settle on a short payoff or sale, but the price must be reasonable given all of the facts.

Do Nothing

Believe it or not, doing nothing can also be an effective strategy. While I would always encourage BSCF to keep the lines of communication open with the Bank, it may be that the Bank is just not willing to negotiate on terms that BSCF finds acceptable. Or it may be that the Bank is not going to take any action notwithstanding the threat of doing so. Thus, doing nothing can also work, and it does not cost a lot of money; however, doing nothing does not buy BSCF any of the certainty that it may be seeking. The Bank can strike at any time, and BSCF's owners will likely lose a lot of sleep waiting for the other shoe to drop. This strategy usually does not pay off.

Explore Other Options for the Property

Sometimes the best strategy is to see if there is a better use for the project or an alternative source of financing. Many developers have sought zoning changes to increase density, changed the use from for-sale to rental, or sought out New Markets Tax Credits, Historic Tax Credits or TIF financing to make projects work. It is almost never too late to try.

Conclusion

The points above illustrate that bankruptcy may be the right move in certain situations: 1) if you have a war chest of funds and a cooperative secured lender; 2) if you have multiple locations in various states that need liquidation; or 3) if there are major money-losing contracts that can be rejected mid-stream. In most cases, however, hopping on the train to one of the alternatives is usually the better bet.

William S. Schwartz is a partner in the Banking & Finance Service Group of Levenfeld Pearlstein LLC in Chicago, and concentrates his practice on representing lenders and borrowers in financial services, litigation (including bankruptcy) and workouts. His lending and borrower work focuses on middle-market financing through asset-based and real estate-related loans, including financing through the New Markets Tax Credit Program