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Strategic Deals Law Blog

Insight & Commentary on Distressed Company Legal Issues and other Complex Business Law Topics

11 U.S.C § 1145 “Rights Offering”: Paving The Way To A Successful Chapter 11 Reorganization

Posted in Business Restructuring & Bankruptcy, Deal Strategy

Since at least the early 1990’s, securities rights offerings have been used as a vehicle for some companies to exit Chapter 11 bankruptcy.  When the legal circumstances are right, they are a legal tool whose utilization can lead to a “win-win” result that cannot otherwise be achieved through other capital or lending financing sources.

The increased use of rights offerings as part of Chapter 11 business reorganization is largely driven by the more active engagement of sophisticated and “non-traditional” financing entities in the Chapter 11 process.  The benefits of this increased participation spread across the body of parties-in-interest in businesses with complex financial structures.

An Overview Of The Law

Title 11 of the United States Code (the “Bankruptcy Code”), Section 1145 provides a narrow and unique exemption to the registration requirements of the Securities Act of 1933 (the “33 Act”).  Essentially, Section 1145 requires new securities to be exchanged for claims as part of a Chapter 11 plan of reorganization.  The 33 Act is set forth in Title 15 of the United States Code, Section 77a, et. seq. (15 U.S.C. §77a- – 77mm).  As general background, the most well-known and common types of offering exemptions relied upon by business issuers are referred to as “Reg D” offerings.  Specifically, Reg. D is a set of regulatory rules enacted by the Securities and Exchange Commission in accordance with the authority it was granted by the 33 Act.

The Chapter 11 Case Of Eastman Kodak

Through Bankruptcy Code Section 1145, securities issued pursuant to a Chapter 11 plan enjoy their own statutory exemption, in contrast to regulatory exemptions to securities issuance registration requirements.  The use of Bankruptcy Code Section 1145 recently became part of the strategy utilized by Eastman Kodak to successfully confirm a Chapter 11 plan of reorganization in its bankruptcy case.

“Not This Time … Maybe Next Time?”

A Successful Strategy

As demonstrated by the Eastman Kodak Chapter 11 plan of reorganization, confirmed at trial by the United States Bankruptcy Court, Southern District of New York on August 20, 2013, utilization of the unique rights offering provisions under Bankruptcy Code Section 1145 allowed two mutually beneficial outcomes to occur in Kodak’s Chapter 11 case, which would not have occurred but for the Bankruptcy Code’s provisions that facilitate the offer, issuance, and resale of securities without registration with the Securities and Exchange Commission.  These two outcomes were:

  1. Holders of (a) general unsecured claims and (a) retiree claims pursuant to a previously agreed upon settlement, were offered the right to purchase up to thirty-four (34) million shares of the reorganized Kodak’s new common stock at $11.94 per share under a rights offering.
  2. Under this rights offering, up to six (6) million of such shares would be offered to unsecured creditors pursuant to Bankruptcy Code Section 1145.

While not offered under Bankruptcy Code Section 1145, the remaining shares (along with any “unsubscribed” shares offered but not subscribed to under the Section 1145 exemption) are to be offered to general unsecured claim holders and retiree claim holders who are also “accredited investors” or “qualified institutional buyers.”  Such qualifications are necessary in order for the rights offering to qualify under certain other non-bankruptcy securities registration exemptions that were used in conjunction with the Section 1145 offering.

Use Rights Offerings To Maximize Chapter 11 Prospects

While it is too early to tell in the Kodak case, rights offerings can also provide the opportunity for stakeholders to convert their interest into investments that may be at discount to the market perceived value of the reorganized company upon exiting bankruptcy.  Also, consummation of a successful rights offering can provide a much-needed signal to the larger market that belief in the success of the Chapter 11 plan and reorganized company exists.

Weil Gotshal’s Layoffs: An “Unthinkable … and Unavoidable” Bellwether

Posted in Business Restructuring & Bankruptcy

At the Top Of The Legal Game … Now What?

As a legal professional, the take-away from this morning’s news about the venerable Weil Gotshal acknowledging the “new normal” is:

  • Being at the top of the legal game does not equate into being immunized to the radical changes occurring in the business of law.

Like the climber in the picture to the right, while it may look great ahead, does not the picture sure change if there is a rapidly approaching massive snow storm behind him?

While I have long been convinced that the legal profession is undergoing radical change akin to what happened to the United States steel industry in the 1970s, I have to admit that I was hit off guard when I woke up this morning to the headline from @law360 that “More BigLaw Layoffs Expected After Massive Weil Cuts.”

Reality Check Behind the Headline – a Bellwether Event and a Ripple Effect

Behind the headline lies a profound reality check that will surely have a ripple effect across the legal profession from top to bottom – the elite New York based law firm Weil Gotshal has instituted both:

  1. Rather significant layoffs of support staff and lower level attorneys, and
  2. Implemented downward “meaningful compensation” adjustments for dozens of partners (out of approximately 300 partners at the firm).

The economics that drove such decision themself are not surprising.  Instead, what stands out to me is that it took so long and took what I consider a bellwether in the legal profession to cause such an immediate shockwave …. and which undoubtedly is just the start of a long-lasting ripple effect.

Why the Legal Profession Is Parallel to the 1970s Midwest Steel Industry

In college I was an economics major and always was intrigued by what drives industry-level economic change.  So for the past few years I could not help but often think about the parallels between what happened to the United States steel industry in the 1970s and what is occurring now at the highest levels of the legal profession.  Weil Gotshal’s announcement today drove home ominous parallels.

So after a short internet search, I came across a 2012 Pittsburgh Post-Gazette article entitled “For Pittsburgh A Future Not Reliant On Steel Was Unthinkable … And Unavoidable.”  In this article, the author astutely states:

The story of Pittsburgh’s transformation over the last 30 years does not start with the economic miasma of the early 1980s.  It starts with — or, rather, evolved from — the many decades of business and political decisions that preceded the steel industry’s collapse.

So why has Pittsburgh been forced to change so much since the 1980s? Answering that requires first asking this: Why did Pittsburgh’s economy refuse to diversify for so many years, before the worst had come — and after it had been predicted?

The parallels between the legal profession and the Pittsburgh steel industry are almost eerie and go far beyond industries that both merely experienced some sort of transformation.  Today, I cannot help but think the following:

  • The announcement by Weil Gotshal is both “unthinkable …. and unavoidable” and also “starts with — or, rather, evolve[s] from — the many decades of business … decisions that preceded” the announcement.

Like the steel industry, large law firm management (consisting almost entirely of attorneys) steadfastly held off taking pro-active steps to adjust their business model “before the worst had come — and after it had been predicted.”  As a result, the legal profession is now being forced to change very fast – with the pressures of change only accelerating more and more each day in my opinion.

“Yes Houston, The Law Firm Business Model Has a Problem”

One of the first questions that has to be raised within the legal profession is: what is the role of professional management (not “if” there is a role).

Over a year ago in a Wall Street Journal piece entitled “The Law Firm Business Model Is Dying,” Clifford Winston and Robert W. Crandall observed that among many structural problems:

Law firms are aware of the value that professional business managers can add to their operations. But regulations that prohibit the ownership of law firms by nonlawyers prevent those firms from fully realizing the value of managerial skills and oversight that professional management could bring.

Mr. Winston and Mr. Crandall diagnosis is surely correct.  I have long believed that in stark contrast to all other billion dollar industries, the lack of true “professional management” leading most if not all major law firms is finally catching up to the legal profession as a whole with the impact as great as the iceberg above.  For far too long, market dynamics allowed the ways of the old to be converted into essentially money “printing presses” for large law firms.  But like most things that are too good to last forever, economic forces within which the “business of law” operates has now caught up to even the Weil Gotshal’s of the world.

Now What?

Based on my experience working with both healthy and distressed businesses where I have observed and previously discussed the impact of good management and consequences of bad management, I only hope my profession finally takes a long overdue hard look at the role professional management can and should play in the legal industry. The news from Weil Gotshal, which contains some of the best and brightest in the legal business, is the loudest wake-up call so far.  But for now and until then, I suggest reading “Why Partner Layoffs Won’t Save US Law Firms” by my ever-favorite @johngrimley written just six months ago that provides a more broad based discussion of the crossroads and choices law firms face.

How Do You Define Organizational Leadership: Excellent? Ethical? Enduring?

Posted in Deal Strategy

The best executive is the one who has sense enough to pick good men to do what he wants done, and self-restraint enough to keep from meddling with them while they do it.”

-Theodore Roosevelt

If you were asked in a blind survey to name the three characteristics to best describe your business organization, what percentage of surveyees would include the following three traits:

  1. Excellent;
  2. Ethical;
  3. Enduring?

Would you?

I have been working on this post for four weeks now, but ended up holding off until I finished reading the book discussed below (which I highly recommend and is surely worthy of a full book review).

Strengthening Business Organization Leadership Skills: Not Your “Father’s Oldsmobile” Conference

As background, I recently returned from attending the Turnaround Management Association’s all-new education symposium held in Chicago which focused on strengthening and reinforcing business organization leadership skills.  Attendees included business turnaround professionals of many stripes, and came from as far away as Finland.

Unlike those “conferences” that leaves most attendees with few new and valuable “take aways” at its conclusion, this program delivered something innovative and valuable.  Senior executives and top experts who have distinguished themselves as effective organization leaders:

a)      Illuminated in detail their respective leadership philosophies and historical “lessons learned,”

b)      Led insightful interactive discussions on leadership topics, and

c)       Laid out the tools that can be used to distinguish oneself as a professional leader.

I surely left with a much stronger “tool box” of leadership principles.  To paraphrase a colleague, “it was nice to take a step back from discussing high-level finance and legal topics specific to the turnaround industry and explore the ‘nuts and bolts’ behind the people that can be the difference between a successful business organization and failure.”

How Do You Define “Leadership”?

The symposium challenged the attendees to critically think about the meaning ascribed to the word “leadership.”

In the past few years, business schools have been re-examining how they define leadership.  Here are a few ways they are defining or characterizing “leadership”:

  • [T]he ability to inspire others to strive and enable them to accomplish great things” – Dartmouth’s Tuck School of Business;
  • Trustworthiness,” “Respect for Others,” “Change Leadership,” “Developing Others” -among other things, from the unique “Leadership Behavior Grid” that is now part of Stanford Business School’s applicants’ recommendation form.

Just as I was challenged at the symposium to consider the following question, how do you define “leadership” when it comes to your particular professional field?  My answer comes a little later, but first the following.

The Importance of Virtuous + Innovative Leadership

I strongly believe that ever-changing economic dynamics, driven by the inevitable impact of globalization as well as the economic disruptions of the past six to seven years, means that the financial viability of any organization requires leaders equipped to cope effectively with the complexity of today’s business environment.  This is true whether a Fortune 500 Company, a law firm, or a local small business.

Just last month, Billionaire business investor Ronald Perelman donated $100 million to Columbia Business School to develop a “Center for Business Innovation” that is aimed at strengthening innovations and programs for future business leaders.  As Mr. Perelman stated in Bloomberg:

The business landscape is changing rapidly and dramatically, and as such the principles that define strong business leadership — such as an entrepreneurial mindset and solving complex challenges — are more important now than ever before …

Of special interest to me, law schools have a long, long way to go in the leadership development arena.  Just a few months ago the first book of its kind was published on the topic “Law and Leadership: Integrating Leadership Studies into the Law School Curriculum.”

“Building Excellent Ethical & Enduring Organizations”

One session that I found exceptionally insightful was a dialogue lead by @BobVanourek, who explained the organizational leadership principles set forth in his book “Triple Crown Leadership: Building Excellent, Ethical, and Enduring Organizations” and discussed how they also apply to turnaround and crisis situations.

Mr. Vanourek skillfully walked through his five leadership practices (with all citations from the book):

  1. Head and Heart” – most businesses only focus on Head (knowledge; skills; experience; education) and miss the boat on Heart (character; emotional intelligence; cultural fit; passion).  Of interest to me is that apparently Google looks at the “bottom” of a resume first.  Mr. Vanourek wonderfully quotes Nelson Mandela: “A good head and a good heart are always a formidable combination.”
  2. The Colors” – this is a business’ “Purpose; Values; Vision.”  To be effective, an organization’s “colors” must go beyond business school jargon and truly reflect how an organization connects with its employees and vendors to further a commonly understood cause.  As explained in the book: Purpose “grounds” an organization and its leaders, values “guide” an organization and its leaders, and vision “inspires” an organization and its leaders.
  3. Steel & Velvet” – this one I found, in retrospect, to be the one that has challenged me the most when I have been in a leadership position.  “Steel & Velvet” goes to leaders needing to know when and where to invoke the “hard edge” by decisively exercising authority to achieve excellent results, all within ethical boundaries, and the “soft edge” by employing a relational style that inspires colleagues to step-up and unleash themselves as co-difference makers within the organization.  Vanourek emphasized: people stop listening if a leader constantly operates on the “Steel” side, which is a critical point to remember in a business reorganization or reconfiguration as individuals usually need to step-up in ways like never before.
  4. Stewards” – this leadership practice goes to the heart of leadership being driven by the business’ shared values and vision.  Stewards are most successful when every person knows that he or she is empowered by the organization’s Colors and “high-performance culture of character” to pursue and achieve exceptional results.  The goal is to reduce the risk of depending on just one “heroic leader,” which can be stifling to an organization’s Colors.
  5. Alignment” – finally, leaders need to ensure that all team members understand what their role is and what the expected results from such role are, something my own recent professional experience surely validated.  Absent that, chaos and organizational under-performance will undoubtedly occur.

Final Thoughts

All businesses need stay ahead of the rapid changes impacting across marketplaces. In both those areas I am actively involved – law firms and business turnarounds, no matter how strong one’s educational or professional pedigree is, I am now more firmly convinced than ever that it is the “leadership difference” that will drive enterprises to future success.

The Market Is Ripe For a New Style of Outsourced General Counsels

Posted in Alternative Fee Structures, Deal Strategy, Future of the Legal Profession, Law Practice Management

While it may change, at present, I believe that the legal services market does not offer a turn-to sector where optimal outsourced general counsel services are readily available to a business community increasingly scrutinizing their current law firm relationships and eyeing new ways in which their business’ legal needs can be met.

Summary of My Previous Lead-In Post

This piece is an extension of my stream of reasoning set forth in last month’s post “The Rise And Impact Of Empowered Chief Legal Officers.”  In that piece, I laid out a major paradigm shift occurring in how businesses meet their legal needs as a result of an accelerating transformation of the seller-consumer relationship and dynamics between:

(a)    On one hand, law firms, and

(b)   On the other hand, businesses that have made the smart and forward-looking business decision of installing sophisticated and empowered in-house General Counsels/Chief Legal Officers and legal departments.

An Opportune Time for Offering the Legal Services Market a New Style of Outsourced General Counsel Services 

A great opportunity exists for professional legal service providers with expertise of a general counsel and statesmanship to expand into, redefine, and deliver a new and innovative package of external general counsel legal services to all sizes of businesses.  This fresh opportunity has arisen from the same pressures of change driving the rise of empowered in-house legal departments.

The opportunity centers around providing:

  1. Client-tailored menus of structured fees, for a
  2. Defined scope of work.

Such an external general counsel package of legal services is the best course of action when a company determines that such option is more cost effective and more prudent to meet the business’ ongoing legal service needs than (a) hiring a full-time general counsel or, alternatively, (b) continuing to rely exclusively on traditional law firms.  While the “outsourced general counsel” concept is not entirely new, what is new in today’s rapidly evolving legal market is a thirst for the following:

(i) skilled “general counsel” types of the lawyer-business “ally” mindset, who are in step with the “trusted advisor” philosophy, going hand-in-hand with
(ii) alternative fee structure options.

The question thus becomes: is there a turn-to professional legal service business sector that offers the total package set forth above to chose from?  My answer: not yet.

Message to Businesses: Some Law Firms “Get” What You Get, Most Don’t (…Yet)

In my opinion, Stephen Poor, the Managing Partner of Seyfarth Shaw, captured it perfectly in a New York Times “Deal Book” piece last year titled “Re-Engineering the Business of Law,” where Mr. Poor states that:

 “True long-term success requires businesses to improve continually and re-imagine how they operate in the face of changing competition and market forces.”

Mr. Shaw hits business performance reality on the head with the above statement.  However, Mr. Shaw then goes on to equally capture, in my opinion, how such business performance reality is still not in the vernacular of law firm economics as it is with other businesses when he states:

“Yet this innovative urge, which drives so much of the rest of the American economy, is largely absent from large law firms….

Instead, the measures become balancing rate growth versus discounted fees, lawyer productivity measured in tenths of hours, recruiting the partner with a book of business from one firm to another and similar yardsticks.”

Many of us have “been there, done that” and are no longer doing it for various reasons.  But times are changing … some for the better, some by returning to old ways.

The Law Firm Rate Bubble – Is Recent History Repeating Itself In Lieu of Structural Change?

In my opinion, there was a billing rate “bubble” in the 2000’s that like most bubbles was the by-product of loose credit-activity, which outpaced economic fundamentals.  Yet, billing rates have yet to properly adjust like a lot of the economy (in comparison, think of housing?).  This is not an “anti-law firm” rant — I believe it is simple economics.  But we are starting to see a billing rate uptick again in many legal sectors.

A year ago @lvanderpool Lisa van der Pool wrote a very telling article from an indicator standpoint titled “Lawyer Inflation: With Economy Mending, Many Firms Return To Raising Rates.”  Ms. van der Pool wisely cited Mr. James Westra, who diagnosed the structural disease far too many law firms face:

“The fact is that a lot of firms masked static productivity with rate increases, which is how they kept increasing profits. That became much more difficult to do starting in 2008, …

Over the last year, as the economy has started to recover, the firms that felt they can do it, have started to raise rates pretty significantly…”

The above words should not be taken lightly as Mr. Westra’s vantage point speaks for itself:

  • Foremost to the business crowd, he is currently managing director and Chief Legal Officer of the private equity firm Advent International Corp.;
  • Foremost to the legal crowd, he is the former Managing Partner of Weil, Gotshal & Manges LLP’s Boston office.

Three Factors Creating the Opportunity

With all of the above in mind, I believe there are three primary factors that are driving the market opportunity to deliver a new style of outsourced general counsel professional services:

  1. Businesses Legal Budgets.  Due to the challenging global economic climate over the past decade, many profitable small and medium sized businesses who have traditionally farmed out all of their professional legal service needs to outside law firms can no longer fit their legal needs into their legal budget.
  2. Internal Business Management Philosophies.  At the same time, static-minded number crunchers often argue that businesses should not turn to hiring a full time in-house legal counsel (setting aside for now that today is exactly the right time to make such a hire).  This is because such analysis is driven by those most comfortable with the “cost” side, which comes at the expense of the efficiency side of the question.
  3. Continued Predominance of the Old Way Law Firms Operate.  In these changing economic times, unlike any other business that are subject to nearly everyday forces of supply-demand as stated by Mr. Westra above (or as I like to put it for attorneys, “cost-value” accountability), when it comes to the most sellers of professional legal services, they are lagging far behind in adjusting their business practices.  While the old seller-consumer dynamics still predominately drive most major law firm business (i.e. compensation) models, and therefore business development efforts, I believe the clock is ticking on that approach.  This is because such an approach is not a viable long-term business plan for keeping existing clients and gaining new clients.  Unfortunately, addressing the paradigm shift is not a priority for most (but not all) law firms as it will require a significant internal culture transformation on many levels, a concept touched on by @Johngrimley in his piece “Why The Billable Hour Is Not The Issue.”

But the paradigm shift ultimately will become a focus for those law firms that have the long-term view for their firms.

My Recommendation– Take Steps to Avoid a “Hobson’s Choice”

Many businesses feel they face a truly “Hobson’s Choice” between (a) their ongoing need for consistent, high-level professional legal services, and (b) the financial reality that they can no longer internally justify the cost of their historical outside counsel’s hourly rates.  While unfortunate in the short run, forward looking businesses without an in-house legal counsel should seek out legal professionals:

  1. With expertise and demeanor that an external general counsel should possess, which includes the mindset of being a “trusted advisor” (which may not always be legal professionals who have served in-house as a general counsel),
  2. Who can meet both of the elements of the “Hobson’s Choice” set forth above,

and do so through:

  1. Client-tailored menus of structured fees, for a
  2. Defined scope of work.

Professional Excellence and a Balanced-Life Can Co-Exist

Posted in Uncategorized

“What you see and hear depends a good deal on where you are standing”

-C.S. Lewis, The Magician’s Nephew

This post might seem a little “off topic” from the declared focus of this blog — “Insight & Commentary On Complex Business &Financial Law Topics.”  But I believe no matter how much “insight” we download as professionals, if we become too overwhelmed in life, both our professional excellence and personal lives will suffer.

So the proposition I put forward here is that professional excellence does not have to be sacrificed on the altar of the very amorphous concept of “work-life” balance.  Further, for those professionals that want to make being a “super professional” a priority in life, they can do so while also having a “balanced life.”  But that involves identifying priorities and making difficult choices as no one can have it all (indeed, the acceptance in professional circles over the past few decades that we can have it all is what has caused all the imbalance that exists — usually unknowingly — in many professional’s lives).

Before proceeding, I want to make clear I believe that there are truly different strokes for different folks.  Therefore, there is nothing wrong with those that choose to make their professional career the primary focus of their life …. as long as it does not come at the expense of others who never signed up for that.

Launching Point

The launching point for the discussion below is that all professionals must step back and start with the question: what is truly meant by the commonly used phrase “work-life balance”?

As the eminent Jack Welch stated a few years ago:

There’s no such thing as work-life balance. There are work-life choices, and you make them, and they have consequences.”

I agree (with it equally applying to both men and women professionals)

In pondering this post over the last 24 hours, I came across numerous spot-on pieces written from personal experience who discuss the need to make choices, such as:

Then, as you will learn below, last fall @rashkenas Ron Ashkenas wrote a thoughtful article “Forget Work-Life Balance: It’s Time for Work-Life Blend” where he touched on many truths that I revisited first-hand just yesterday and which propelled me to write this piece:

“The reality for many of us these days is that our professional lives bleed into our personal lives. The boundaries are increasingly permeable and movable. We check our emails in the evenings and weekends. We delay or miss family events because we can’t leave the office. And when we do, we take our communications devices with us so that we can stay connected to work.”

I assume most of you reading this have “been there, done that.”  However, just becauseit is a commonly accepted practice to let our professional lives bleed into our personal lives does not make it right.  I think what often happens is that many professionals convince themselves for the sake of survival in an overly “marginless” world that letting our professional and personal lives bleed together is OK.  Yes, there are times and places where that will occur.  But it should be the exception – it is not a fait accompli.

My Personal Mea Culpa

So all of the above leads up to the following: yesterday, May 23, 2013, was my son’s yearly “Cardinal Field Day” at St. John’s Episcopal School, which is a day of fun-focused track and field events in a carnival atmosphere.  The school is split up between yellow, blue and red teams.  Parents and other adult family members are not only welcome, but encouraged to come and enjoy the spirited atmosphere.  As with years past and most of his school events, I made sure to attend.  But this year’s Cardinal Field Day was different for all the right reasons.

Last year, I was 100% physically present at Cardinal Field Day but sadly, in retrospect, spent most of the time trying to “balance” watching my son participate from just far enough away that the noise coming from the field would not be heard on the concurrent multi-party conference call I was participating on via my cell phone.  At the time that seemed like a perfect equilibrium since my son was definitely more interested in hanging out with his friends just far enough away from “Dad”.  But later that night it was emotionally divulged to me by him of how he interpreted things, specifically that to him “all I did was talk on the phone.”  The message was loud and clear: I might have been physically present, but I was not really “there” as he wanted me to be.

My first reaction, as if pulling from some “Better Something Than Nothing” handbook for lawyers, was a “IRAC”, legalist and presumably logically response to my son: “most dads do not attend Cardinal Field Day; … I was there watching you all the time.”  In my mind, the easy justification for that response was “work like this pays for you to attend St. Johns.”  However, that response was truly an “exercise in missing the point,” even if factually accurate.

What mattered was that my son had hit on the foundational point raised in a very enlightening post by @Ju_Summerhayes entitled “The Minimalist Lawyer”, which is that “[e]verthing has its place.”  For my son, my cell phone did not have a place during those 90 minutes of Cardinal Field Day.

That experience caused me to revisit the difficult question: even though I was a name partner at a small law firm I help found and thus controlled where I was for my conference call, was my perceived “equilibrium” really a work-life balance?  I thought it was and in most respects I feel that I have identified the right priorities and made the right choices with respect to balancing the professional excellence I seek to deliver with the personal life that I cherish.  But like so many things in life, and what is especially true for attorneys like me who spent most of their formative years in “Big Firm” environments (which can still haunt us even long after we left the halls of “Big Firm” life), is staying on top of:

  • what is meant by “everything has its place” for me and my family, each day as well as in the long run, and
  • once that is figured out, how do we put that into practice with respect to my professional life (as well as my wife’s professional life) and our family and personal lives?

Undoubtedly, these questions are very dynamic, perpetually changing moment to moment.  Fortunately, this year at Cardinal Field Day I 100% “got it” by putting away the cell-phone other than to take a few pictures of my son and post them to Facebook, like the one below. …. And I still was able to complete my legal work at the standard of “professional excellence” I set for myself.

Management: Look in the Mirror Before Filing For Chapter 11

Posted in Business Restructuring & Bankruptcy, Deal Strategy

“However beautiful the strategy, you should occasionally look at the results.”

- Winston Churchill

One of my favorite business topics is how to avoid the far too common “execution gap” between strategy and results.  Effectiveness is the ultimate test of any given course of action.  But before even getting to the execution stage, businesses need to get the plan of action right as the first step.  This includes avoiding being overly concerned with the most immediate task at hand, while not understanding the whole situation and future landscape.

One of those situations arises when management of financially distressed companies are preparing the company to commence a Chapter 11 bankruptcy.  Specifically, over the years of advising financially distressed companies, I regularly found that although undertaking the necessary technical steps to file for Chapter 11, management of such companies rarely thought of facing the prospect of being stripped of their management authority once the Chapter 11 case commenced.  Then, when they do once in Chapter 11 bankruptcy, as discussed below it is often too late or, at best, the legal options are much more limited.

This far to common failure of management preparing for Chapter 11 to appropriately evaluate how they are going to be perceived once the Chapter 11 case is commenced and consider pre-petition strategic options available puts the success of the Chapter 11 at unnecessary risk.  That is because after the Chapter 11 is commenced, a motion to appoint a Chapter 11 trustee may be made, in which case the Chapter 11 debtor will be at a significant legal disadvantage if a Chief Restructuring Officer (CRO) would have been a better preemptive option in lieu of a Chapter 11 trustee.

Why It Matters When & How a Chapter 11 Trustee is Appointed

Bankruptcy Code §1104(a) provides a meaningful sword for interested parties to displace the management that got the debtor in its financial predicament after a Chapter 11 is commenced through the appointment of a Chapter 11 trustee.  The Chapter 11 trustee becomes the sole fiduciary and assumes control and management of the Chapter 11 entity, including authority t exercising such day-to-day operational control of the business.

The following are the statutory delineated grounds for the appointment of a Chapter 11 Trustee arising from management’s handling of the debtor’s business affairs (whether pre-petition or after the Chapter 11 case is commenced):

  • fraud,
  • dishonesty,
  • incompetence,
  • gross mismanagement, or
  • “similar cause….” that the Bankruptcy Court determines to exist.

Following the revisions to the Bankruptcy Code in 2005 as part of the “Bankruptcy Abuse Prevention and Consumer Protection Act” (“BAPCPA”), the Office of the United States Trustee, or “UST” (who is typically, but not always, the party that brings a Chapter 11 motion) is now required to move for the appointment of a Chapter 11 trustee under the following circumstances:

. . . if there are reasonable grounds to suspect current members of the governing body of the debtor, the debtor’s chief executive or chief financial officer, or members of the governing body who selected the debtor’s chief executive or chief financial officer, participated in actual fraud, dishonesty or criminal conduct in the management of the debtor or the debtor’s public financial reporting.

11 U.S.C. §1104(e).

This is because I believe it is critical for the management of any distressed business facing the realistic prospect of allegations of any of the above to strongly consider consensually relinquishing meaningful management control by appointing CRO prior to filing for Chapter 11 (or the Board to affirmatively cause the same to happen if management resists).  I was prompted to write this article after a colleague read a prior article I wrote about the value of CROs and their evolution and asked about how different legal scenarios impacted the ability to appoint a CRO.

Why Pre-Petition Management & Boards Should Care About the Prospect of a Chapter 11 Trustee

Pre-Petition Management and Boards should care about the prospect of a post-petition Chapter 11 Trustee because there is a significant line of Bankruptcy Court cases that I believe provide a legally justifiable path and option – the appointment of a pre-petition CRO — that significantly increases the ability to outflank those that may later seek the appointment of a post-petition Chapter 11 trustee (or use the threat of such a motion for unrelated leverage purposes).  For most (but not all) businesses in Chapter 11, I am in agreement that a Chief Restructuring Officer is a better alternative to a Chapter 11 trustee.

Since the enactment of BAPCPA, several courts have addressed the broader question of whether a Chapter 11 trustee can or should be appointed if a CRO already has been installed to control the management affairs of the Chapter 11 debtor, including the appointment of a CRO pre-petition.

Key Case: In re 1031 Tax Group LLC

Of noteworthy importance as a potential roadmap for distressed businesses and their advisors is In re 1031 Tax Group LLC, 374 B.R. 78 (Bankr. S.D.N.Y. 2007), with the highlights of this case being:

  1. A few days before a Chapter 11 was commenced, the pre-petition management appointed a CRO but remained in place as management (which is often the case).
  2. Immediately after the Chapter 11 was commenced, Chapter 11 debtor requested that the Bankruptcy Court approve an “irrevocable delegation” agreement that was entered into pre-petition, which unequivocally surrendered management authority, including the ability of the Board to terminate the CRO.
  3. The Bankruptcy Court approved the appointment of the CRO and terms of the “irrevocable delegation” agreement.
  4. The United States Trustee then moved for the appointment of a Chapter 11 trustee to displace the CRO and all of the pre-petition management.
  5. The request for the appointment of a Chapter 11 trustee was denied.
  6. Interesting enough, the Bankruptcy Court found that the pre-petition management’s tactic of installing a CRO and approval of the “irrevocable delegation” agreement were “unquestionably done, at least in part, to avoid the appointment of a chapter 11 trustee.”
  7. However, and I believe correctly so, the Bankruptcy Court did not believe “cause” existed under Section 1104(a)(1) because the changes made “resulted in the Debtors installing new current management, free from any taint associated with . . . prior management.”

Take Away from In re 1031 Tax Group

  • If the post-petition Chapter 11 debtor can make a sufficient factual showing to the Bankruptcy Court that the pre-petition appointed Chief Restructuring Officer is sufficiently independent of the pre-petition appointing management and has the necessary legal authority and autonomy to control the Chapter 11 debtor’s affairs going forward, then the CRO will be viewed as being in effect new management and not be tainted by prior management.

The above is true even if the pre-petition appointing management engaged in fraud or gross mismanagement.

Thus, the path outlined provides a path for a pre-petition distressed business to “immunize” itself as the future Chapter 11 debtor against the post-petition appointment of a Chapter 11 trustee (provided the CRO acts accordingly and the prior “tainted” management does not influence the decision making process of the CRO).

Critical Legal Distinction

A critical note is that a very different legal dynamic arises if a Chapter 11 debtor seeks to appoint a CRO post-petition.  This is because, in contrast to the UST lacking the legal authority to directly challenge and void the pre-petition corporate governance decision of a distressed business prior to it filing for Chapter 11, once a Chapter 11 is commenced and the business entity is operating under the confines of the Bankruptcy Code and Court, the UST will always take the position that the Bankruptcy Code only provides for the displacement of the Chapter 11’s management by the appointment of a Chapter 11 trustee and does not authorize a “debtor-in-possession” (or any party for that matter) to seek the appointment of a CRO.  There is must more case law for such a situation, which I will likely discuss in a separate post.

Strategic Considerations in Bankruptcy Code Section 363 Transactions

Posted in Business Restructuring & Bankruptcy, Deal Strategy

The multifaceted tactical and strategic considerations that come into play when a financially distressed company pursues the sale of substantially all of its assets by means of a sale pursuant to Chapter 11, Section 363  was the subject of a presentation I gave this morning to my Provisors’ “Mergers and Acquisitions” professional networking group.  I was kindly introduced to this group a few months ago, and then nominated for membership, by a terrific professional colleague and group member Jim Davidson of the always professional  and sophisticated financial advisory services firm Avant Advisory Group.

The presentation was entitled “Strategic Considerations in Bankruptcy Code Section 363 Transactions – It’s More than Law and Process”, which may be best exemplified by the following image for a practitioner way over its head if not fully in-tune with the M&A and Chapter 11 bankruptcy cross-over arena in which 363 sales occur:

As a quick primer, Section 363 of the Bankruptcy Code provides the means for a Chapter 11 debtor to sell substantially all of its assets “free and clear” of third party interests to an acquirer if certain legal requirements are met.

While Chapter 11 of the Bankruptcy Code was originally designed to provide an orderly legal process for distressed operating entities to reorganize their businesses and exit bankruptcy as a going concern, most distressed companies with value-add assets now simply file for Chapter 11 bankruptcy for the specific purpose of selling all or substantially all of their assets by utilizing the M&A advantages afforded by Chapter 11’s Section 363.  The practical reality is that distressed companies now commonly team up pre-bankruptcy with an acquirer of their choosing, enter into an Asset Purchase Agreement, file Chapter 11 and then seek to utilize Section 363 to consummate the M&A transition.  The driving assumption is the perceived speed, efficiency, and legal benefits obtained through Court approval of the transaction via Section 363.

Thus, I was not surprised this morning before heading off to the Provisors meeting when I read a leading bankruptcy news headline story by Aviva Gat of the Deal Pipeline that a noteworthy operating business — Oreck Corporation — had filed Chapter 11 and publicly announced the intention of selling substantially all of its assets via the Chapter 11 process.  Moreover, Oreck’s bankruptcy court filings stated: “If a deal is not reached, … it is possible that a liquidation and wind down of the Debtors may ensue.”

My Presentation and Interactive Discussion

By design, my presentation and subsequent interactive cross-talk among the group members did not focus on the legal and economic policy question of whether or not the trend towards using Chapter 11’s Section 363 as a M&A tool is superior to the more traditional Chapter 11 reorganization process.  Instead, the focus was on:

  1. The need for a unique intersection of Chapter 11 bankruptcy expertise and traditional M&A expertise to best serve any major parties legal interests, which is because each expertise are fully implicated when financially distressed companies choose to pursue consummation of a distressed M&A transaction by means of Section 363 of the Bankruptcy, and
  2. The strategic “tools” that professional advisors, both legal and financial, need to be aware of and — most important from a strategy perspective — need to be instinctively attuned to in a 363 sale situation in order to utilize such tools for the benefit of their client.

Specifically, the following “variables” were discussed:

  • Statutory Provisions Governing 363 Sales: private market acquirers needs to understand that rightly or wrongly, the statutory framework and judges case law as it applies to the deal-specific situation need to be considered before become actively involved in a 363 sale situation.
  • Key Benefit of a 363 Sale – the “Gold Standard” Afforded by the Bankruptcy Court Order: Knowledgeable sophisticated acquirers place a premium on obtaining the Order approving a 363 Sale that provides for the acquisition of the acquired assets free and clear of any current or future liens, interests, claims or encumbrances, which by its nature is a Federal Court order that has the full force and effect in any jurisdiction of the United States, whether at the Federal, state or local level.
  • Deal Strategy and Deal Fundamentals: Section 363 provides the opportunity for distressed sellers to offer legal protections and inducements to acquirers, and flexibility in structuring and timing the sale (subject to the degree of leverage held by secured creditors), but such decisions need to be made after consideration of how such decisions will be made by the Bankruptcy Court and other significant parties-in-interest.
  • The Players: While the pre-bankruptcy filing “business judgment” of the distressed company to enter into the terms of a pre-filing Asset Purchase Agreement will be given considerable deference in the absence of clear evidence of collusion or fraud, by submission of the company to the Bankruptcy Court process, all 363 sales become subject to judicial oversight and thus the company’s decision making does not operate in a vacuum when it comes to major transactions pursued under Chapter 11.  It should never be lost on interested parties that the post-bankruptcy filing entity is considered a distinct legal entity from the pre-petition company, even though for all practical purposes insofar as management, corporate governance and business operations are concerned, the post-petition company operates as the same unless as previously discussed and recommended a truly independent Chief Restructuring Officer is installed.  Plus, in middle market and larger Chapter 11 cases, an official committee of unsecured creditors will undoubtedly be appointed, who play an active (although not always productive) role in how the final terms and conditions of a 363 sale evovle and finally take shape.  This includes:
    • How the 363 sale is marketed publicly and privately,
    • The terms and conditions of the bidding procedures, and
    • The terms and conditions of the final transaction documents.
  • The Court Approved Sale Process.  Last, but surely not least, parties should never loose sight that all 363 sales are a function of the judicial process and judicial oversight as ll 363 sales must be approved by the Bankruptcy Court after notice and opportunity for all interested parties to be heard.  In each situation, this dynamic can be strategically good vs bad, depending on the goals and motivations of the specific client.  But is a reality that should never be ignored by the tactically smart party.   At the end of the day, the Bankruptcy Court is the first and most important gatekeeper for approving the often amorphous but always present concept of the “highest and best” offer, which is not necessarily the highest in terms of dollars.

Presentation Take-Aways

As part of the presentation, I examined publicly filed “exemplars” from Section 363 deals I ran as lead counsel, including the following documents I made available via Dropbox:

  1. 363 Sale Asset Purchase Agreement approved by the Bankruptcy Court (http://bit.ly/10a1Hvv), and
  2. 363 Sale Court Order entered by the Bankruptcy Court (http://bit.ly/ZOqupe)

Whether a Section 363 sale is the best path a distressed company should pursue always depends first on the specific facts of each case that determine the leverage of each major party-in-interest.  I strongly believe a 363 sale is a value-enhancing tool for identifying “good” companies and “dead” going concerns.  A value-enhancing professional practitioner, whether on the legal or financial side, will not only be able to access and decipher the unique business factors implicated by the 363 sale process, but will have the ability to strategically advise and guide its client in a manner in the best interest of such client.

All told, a 363 sale never happens in an identical “vacuum” to any previous 363 sale, thus tactical and strategic decisions can be the difference between a “good deal” and a “winners curse” deal for the acquirer and the bankruptcy estate if the deal is later unraveled by any appellate court.

Facilitating the Liquidation of “Bad” Companies and the Reorganization of “Good” Companies [Part 2]: Evolution of the Role of the Chief Restructuring Officer

Posted in Business Restructuring & Bankruptcy

I pick up today on the theme started in an earlier post “How the Chapter 11 Bankruptcy Process Can Better Facilitate the Liquidation of ‘Bad’ Companies and the Reorganization of ‘Good’ Companies” and discuss the evolution of the role of “Chief Restructuring Officers” in the business workout and Chapter 11 arena.

The title “Chief Restructuring Officer”, or CRO, may not be a long-standing title when compared to other historical professionals in the business turnaround field.  Indeed, the roles and duties that the modern CRO assume have been around in many aspects for as long as there have been businesses to restructure.  However, the scope of authority and role of a modern CRO has evolved significantly from its turnaround consultant predecessors.  Today, for any business facing operational or “balance sheet” challenges, the CRO has become a mainstay fixture in the strategic arsenal that businesses (and secured lenders via leverage) have at their ready disposal in a business turnaround situation.

The Turning Point: The Recession of the Early 2000s

Over a decade ago during the last restructuring apex, the role of a CRO in business turnarounds experienced a foundational change:

  • Prior to the early 2000s, crisis and turnaround management professionals typically served as independent consultants who reported directly to, and served at the mercy, of the troubled company’s “C-level” officers or board of directors.
  •  Beginning in the 2000s, crisis and turnaround management professionals started to become employed directly by corporate entities as chief restructuring officers (CROs).

The turn from relying primarily on turnaround consultants and the rise of the use of CROs developed within the Delaware Bankruptcy Courts and then proliferated in other bankruptcy courts across the Country.

It has been argued, and correctly so, that acceptance of CRO’s is a function of:

  1. The frequent reluctance of entrenched upper-management or the CEO (even if conflicted) to delegate the necessary authority to turnaround consultants, thereby leaving such financial advisors in the ineffective position of being at the discretion of upper management and/or the board of directors when it came to differences of opinion.
  2. This is turn resulted in turnaround consultants being viewed both internally and more importantly, by external parties-in-interests, as not being able to achieve the desired turnaround results because they lacked the necessary operating control and authority of over the financial and operational decisions of the company.

Thus, the philosophy behind the greatly increased scope of a CRO’s role and authority, in contrast to the historical turnaround consultant, derives from two foundational notions:

  • CRO’s need to have the necessary authority to direct the course and direction of a restructuring, and
  • CRO’s need to have greater independence over existing management, so that they can be more objective in the hard decisions that have to be made.

In a 2004 American Bankruptcy Law Journal article titled “Does Chapter 11 Reorganization Remain a Viable Option for Distressed Businesses for the Twenty-First Century?”, the eminent Harvey Miller of Weil Gotshal described the CRO as follows:

The CRO is vested with executive decision making powers and direct access to the debtor’s governing body.  Direct access to the CRO is given to the creditor constituency responsible for the CRO’s appointment. The CRO has the authority to meet privately with the creditor constituency and otherwise deal with that creditor constituency as to the administration and formulation of a reorganization plan. From the perspective of some observers, the CRO is almost a de facto trustee.

CRO’s are thus viewed as having the ability to effectuate a more impartial and effective restructuring.  This is believed to be true whether in a Chapter 11 proceeding or an out-of-court workout.

Why the Evolution and Acceptance of the CRO Role?

Commentators have debated what drove in a relatively short period of time the evolution CROs to becoming a commonly accepted role-player, if not necessary party, for business turnarounds.  Many have argued that the primary cause or factor is a now customary insistence of major secured lenders for a CRO to be installed as a condition to that lender consensually working with the distressed business or Chapter 11 debtor.  Whether such insistence arises from an altruistic desire of secured lenders to put into place a mechanism to bridge differences between a debtor and its creditors or a purely self-interested means to unfairly control a distressed situation (or somewhere in between) is question beyond the scope of this piece.

Thus, without exploring the legalistic question of causality and the relation between the set of leading factors (causes) and the CRO phenomenon (effect) and recognizing the CRO phenomenon has been affected by a variety of factors, I believe the most direct factors in the evolution and acceptance of the modern CRO’s role in place of turnaround consultants was driven by the concurrent emergence of:

  • Much more complex financial and capital markets, as well as increasingly challenging operating markets for business, and
  • More sophisticated and aggressive lenders (rightly or wrongly).

As a result, the need arose for a more advanced and specialized skill set based on an integrated understanding of managerial, financial, operational and corporate governance expertise for distressed situations.  The old way of relying on existing management and boards of directors, assisted by traditional turnaround consultants, no longer sufficed.  Modern CROs filled that void.

Whatever the precise genesis of the evolution of the modern CRO, they are now a mainstay in the business turnaround arena and they continue to have a significant, and I believe overall positive impact, on the ability for the system to sort out “good” companies and “bad” companies.

NEWS INSIGHT: Public Hearing by the American Bankruptcy Institute’s Commission to Study the Reform of Chapter 11

Posted in Alternatives to Bankruptcy, Business Restructuring & Bankruptcy, Deal Strategy

This past Friday, April 19, 2013, the highly anticipated public hearing of the American Bankruptcy Institute’s (ABI) Commission to Study the Reform of Chapter 11 occurred at the ABI’s 31st Annual Spring Meeting in Washington D.C.    The Commission consists of Chapter 11 experts from across the Country, and includes my bankruptcy professor and law school mentor Ken Klee of UCLA School of Law and the law firm Klee, Tuchin, Bogdanoff & Stern.

The Commission’s mission is stated as follows:

In light of the expansion of the use of secured credit, the growth of distressed-debt markets and other externalities that have affected the effectiveness of the current Bankruptcy Code, the commission will study and propose reforms to chapter 11 and related statutory provisions that will better balance the goals of effectuating the effective reorganization of business debtors—with the attendant preservation and expansion of jobs—and the maximization and realization of asset values for all creditors and stakeholders.

The April 19th hearing covered a spectrum of issues enmeshed in all business Chapter 11 cases, but had a particular focus on so-called “middle market” Chapter 11 cases – the predominate type of business bankruptcy case in Southern California.

I have long been a proponent of meaningful reform to the Chapter 11 process, but it must be targeted at making the Chapter 11 process both more efficient and more true to its purpose – that is, preserving the value of a business as a reorganized going concern where that path preserves substantially more value than the value realized from the sale or liquidation of the business’ assets, and concurrently and promptly filtering out the rest.

I read through most of the witness testimony, which is available on the Commission’s website, and found all the testimony compelling and in many instances on-the-mark when it came to diagnosing the problems.

Dan Dooley, the CEO of the national turnaround firm MorrisAnderson, http://www.morrisanderson.com/team/profile/daniel-f.-dooley aptly hit on the most telling structural drawback of the current Chapter 11 system, which I characterize as follows:

It is very difficult for middle market companies to use the Chapter 11 process to turnaround a business and exit Chapter 11 as a reorganized going-concern entity. 

As Mr. Dooley stated:

Chapter 11 is now viewed as too slow and too costly for the majority of middle market companies to do anything other than sell its going concern assets in a 363 sale or to simply liquidate the company.  Both of these outcomes are often pursued almost exclusively for the sole benefit of the secured lender.”

Mr. Dooley’s characterizations as to the current state of Chapter 11 cannot be dismissed, as some may, as coming from a biased professional vantage point.  Whether the current state of the Chapter 11 system is good or bad from a commercial system perspective, what Mr. Dooley describes is accurate.

Where I diverge, at least in part, from some of the experts goes to the harder question: what are the best solutions?  I continue to believe that our economic system benefits from a Chapter 11 mechanism as long as it provides a clear and fair-to-all path for “good” companies to consummate a turnaround and exit as a reorganized and healthy going concern entity.   There are many great success stories out there, not just the horror stories that tend to grab the headlines.  Furthermore, Chapter 11 can serve other purposes that just the reorganization and exit of going concerns.  Indeed, Chapter 11 has increasingly become a new niche forum for consummating an M&A deal by means of a 363 sale.  As I have previously discussed, I believe there is great value in having this option available because if properly navigated, 363 sales can be strategically utilized as a tool to meet multiple parties’ respective goals while also being in the best interest of the bankruptcy estate.

Nonetheless, the slow speed of Chapter 11 and increased control secured creditors have over the direction of a Chapter 11 case is likely driving companies that would have otherwise been better off reorganizing as a going concern being instead forced to sell-off their assets in Chapter 11.  I think the degree to which this is occurring is open to debate, but it surely occurs and thus needs to be addressed.  That is a tall-task for the Commission but one I am glad they are trying to tackle.

UPCOMING EVENT: Strengthening Professional Leadership Skills the Focus of Upcoming All-New TMA Program

Posted in Deal Strategy

Strengthening and reinforcing leadership skills among business turnaround professional service providers will be the focus of an all-new education symposium by the Turnaround Management Association (TMA), aptly entitled “Leadership For Today, Tomorrow, and Beyond“, set to take place at TMA Headquarters in Chicago May 14-16.

Curriculum Focus

The curriculum will focus on leadership decision-making themes, including “how to” and the importance of:

  • Building strong teams;
  • Creating quality client goal-focused work product;
  • Managing well in the midst a crisis;
  • Marketing and communicating in an interconnected world;
  • Transcending situational discord to protect your client’s interests;
  • Negotiating to maximize outcomes; and
  • Dominating your niche specialty.

Who Will Be There

The event will bring together experts in leadership from a broad range of sectors and include senior level financial services and legal professionals with a specialty in bankruptcy and restructuring, ranging from smaller firms such as my fellow 2013 TMA Western Regional Conference Co-Chair Andrew Toft to large firms such as turnaround and business services firm Alvarez & Marsal and the international law firm Greenberg Traurig LLP.

After The Event

I will be attending the TMA Senate program and am looking forward to forging new relationships and enhancing my individual and firm leadership skills.  I plan to follow-up with a write-up of my “take-aways” from the program, especially how they help me apply my professional skills in creating winning scenarios for the clients I service facing business restructuring matters.