October 2010

Distressed Debt & the Chief Restructuring Officer – Understanding the Philosophy, Psychology and Politics (Part 1 of 2)

In Part I of this article, Ken Naglewski of Seabiscuit Partners examines classical turnaround theory and practice in relation to the realities of organizational dynamics and the behavioral aspects of the players in a distressed debt situation. The author opines on the necessity of a CRO assessing the political realities of each situation and developing a political style and game plan that has the best chance to be successful in a particular situation. In Part II of this article, the author reinforces the importance of dealing with political realities of distressed debt situations, provides some examples from real situations and potential strategies for dealing with different situations.

Classical Turnaround Theory

In classical turnaround theory, an organization is turned around by analyzing the numbers, identifying corrective actions, preparing a business plan or “playbook” and bolstering the management team. In a way it sounds all too easy. Political reality sets in when the CRO needs to deal with the differing agendas and different perceptions of the reality of the situation.

Armed with expertise in the form of 13-week cash-flow analysis, rationalization of the cost/profit profile, business unit segmentation and other tools in the CRO’s tool kit; the objective and dispassionate CRO arrives on the scene and moves forward with gusto in preparing the plan to maximize the value of the situation, garner the capital necessary to implement the plan and most likely provide the leadership to get the job done.

Unfortunately for the CRO, knowing what to do is generally the easy part. Getting all constituencies to buy in to a general consensus of what needs to be done and how quickly it needs to be done is fraught with political minefields. Moving from the vision of the plan toward effective implementation is what separates the women and the men from the girls and the boys. Anyone who has ever attempted a robust turnaround of a distressed business soon learns there is a big difference between turnaround theory and reality.

Impact of Organization Dynamics

The emotions in a distressed debt/turnaround situation run deep, and the political dynamics can be exasperating at best and destructive at worst. Expertise in a variety of functional disciplines is important, but understanding the political realities of the situation and developing a political platform to initiate and execute corrective actions is of paramount importance.

Veteran, savvy turnaround advisors are generally more or less equally adept at understanding the nuances and tricks of the trade of implementing turnaround theory. While most veteran CROs and turnaround advisors possesses more than fair skills in assessing the political landscape; gut-felt political instincts and skills in successfully melding divergent self-interest into a workable plan are perhaps not as evenly distributed. Key organizational dynamic issues that the CRO needs to consider include:

  • An organization is generally a legal entity separate from the people who populate the organization; yet the organization itself develops a unique culture and personality.
  • Organizations tend to take on the business style of its founders and leaders because values and reward systems reinforce certain ways of thinking and acting. In time, organizations tend to become insular in their thinking.
  • When trouble is on the horizon, organizations tend to circle the wagons and fight back with strategies and tactics that worked in the past.
  • Neither people nor organizations surrender their mental models or view of the business landscape easily; even in the face of realistic evidence to the contrary.

The art of the turnaround involves marshalling the collective energy of the organization and managing diverse personalities, wants, needs and insecurities. The political savvy needed to accomplish this is as important to the success of maximizing value as are developing effective strategies and tactics.

Behavioral Psychology in Distressed Debt Situations

In my senior year in college, a professor of advanced strategy development made a comment that the most difficult component of strategy implementation is people. I had thought the difficult aspects of developing business strategies were in subjects such as complicated economic theories, advanced accounting matters and advanced business statistics. While I don’t remember another single word that professor said, his comment on people stayed with me. Now I believe that most everything else is relatively easy and the professor was right on target; effectively dealing with people, particularly in a distressed situation, is the most difficult factor.

A turnaround/distressed debt situation brings together a group of people with differing agendas, self-interests, personalities and other human traits. Most likely these people have never interacted with each other and now must do so under the umbrella of extreme duress.

According to John Collard of Strategic Management Partners, “Lenders want their invested capital returned. Creditors want to be paid for goods and services. Original investors want and hope for recovery of their capital, while distressed investors want to buy in at 20 cents on the dollar and then turn a profit by trading the credit and others by turning the business around and then selling. Employees want to retain their jobs and benefits. Directors want to avoid risk and litigation.”

On top of this mix of differing interests, lawyers, investment bankers and consulting groups join the party and add to the group dynamics yet another set of interests and personalities. If a Chapter 11 filing comes into play, we add further to this boiling stew of personalities with the addition of the unsecured creditors’ committee and their legal and financial advisors.

The intergroup dynamics are challenging and you need a scorecard and group organization chart to keep track of who’s on first. The CRO might have to deal with some of the following cast of players that have crossed my path:

  • The business owner, who would rather see the company go up in flames (by sabotage if necessary) than witness another person turn around his business — “If I can’t fix it, nobody can”
  • The founding father, who would “rather see the company go down than get in a tiff with my son”
  • The legal and financial advisors to an unsecured creditor’s committee, who shamelessly run up professional fees in a case where there is no chance that the unsecured creditors’ will receive a dime
  • The management teams and company directors, who presided over the downfall of their company while shamelessly increasing their salaries, bonuses and pension plans while the company is burning down.
  • The lender, who does not care if the company is liquidated or sold “as long as I get paid out”
  • The debtor-in-possession commercial lender, who recommended the CRO for the position, asking that the CRO should make sure a covenant is violated. This was a particularly rare, but very egregious event.

Rules of Engagement (Developing a Political Platform)

Thirty or so years ago, there was little in the way of formal writings or teachings on turnarounds. Today, M.B.A. programs at several major universities offer courses on the subject. Now there are two professional designations (Certified Insolvency and Restructuring Advisor, or CIRA, and Certified Turnaround Professional, or CTP). While the course of study of these two programs have provided serious practitioners with a formal way to increase expertise in the finer points of turnaround theory and related technical areas, they offer nothing in the way of material to increase the turnaround professional’s understanding of organizational dynamics or behavioral psychology.

Expertise in these two subjects is equally important. This article does not portend to be a substitute for serious study of the subjects. Nevertheless, the following ten “rules of engagement” provide some basic insights for the turnaround professional or CRO to develop a political platform on which to orchestrate a successful outcome.

  1. When Ego and Insecurity Collide — Check your ego at the door. All psychologically healthy human beings have some ego. And even famous real estate moguls with their own successful television shows exhibit some degree of insecurity. In extreme cases, you might have a person who has an ego that can fill a courtroom and an equal amount of insecurity. Recognize that you also have these normal and human traits and do your best (not always easy) to keep them under control. Importantly, recognize that all of the people with whom you are dealing with in a distressed debt situation (or any other situation for that matter) also have their fair share of these two traits. With these facts firmly in mind, you can establish effective control of a situation. Don’t tread unnecessarily on other people’s ego or thrust a knife into their insecurities.
  2. The Danger of Constructive Criticism — I am thick skinned, so tell me what you think. Unfortunate but true, we human beings do not like criticism. This trait has probably been in our genetic makeup since prehistoric hunter/gatherer times when behavioral criticism on the hunt from tribal leaders or others could lead to banishment from the tribe with the likelihood of death. Hence, when people tell you “I am thick skinned,” be wary. People might ask for constructive criticism, but what they really want is praise. Don’t fall into the trap of making an enemy unnecessarily by telling her or him what they really don’t want to hear. How can you politely tell a person who asked you what you really think about their performance that you actually believe their judgment and decision-making capabilities lack perspective and context? Better to change the subject and tell them what they do well.
  3. Don’t Fight the Culture — Culture eats strategy for breakfast. Trying to change the culture of an organization is like attempting to make an aircraft carrier make a sharp turn; perhaps a laudable goal, but not a realistic scenario. Is culture all that important? Witness the current rash of print media on the “insular culture” of General Motors. Ed Whitacre, the recently departed CEO of GM, lamented publicly on the slow-movement culture of GM. The culture of an organization can change, but not today and not tomorrow. Changing the culture will generally come in small incremental steps. Don’t give up on trying to change the culture if, in fact, it needs changing. But, in the meantime, figure out how to make the culture work for you.
  4. Learn to Admit it When You’re Wrong — Even Ted Williams was out more than he was on base. For the same reason that people don’t like criticism, we humans have a difficult time admitting to being wrong. In some people’s minds they are never wrong and their view of the world is the only one that counts. Unfortunately for these individuals, this annoying behavior trait is recognized quickly by others and not in a flattering way. People who readily admit their mistakes and then follow up with their intended corrective action gain respect, influence and power. General and later President Dwight Eisenhower had a habit of reviewing past decisions and looking for what he could do better next time. Playing a losing hand by hanging on to an obvious falsehood is akin to drawing to an inside straight — something you should never do.
  5. Listen, Listen and Listen! — Are you really listening or just waiting for your turn to talk? CROs tend toward having “A” type personalities with a fair share of ego. Listening to other people drone on for what seems like forever is difficult, but absolutely necessary. Look at it this way, while the other person or group of people are talking, they are giving you keen insights into their personalities, strengths and weaknesses, ego control, insecurities, judgment capabilities and perhaps some useful facts and perspectives on the situation. In many ways, the players in a distressed situation are playing a game of poker, it is to your advantage to let the other players show their hands.
  6. The Fear Factor — His opponents did not necessarily like or dislike President Reagan, but they did fear him. Niccolo Machiavelli concluded that if you cannot be both, it is better to feared than loved. While President Reagan was loved and respected by a great many people, he was able to accomplish much of his agenda because there were certain elements of the loyal opposition that feared he could use his national popularity to unseat them in the next election. In today’s social environment, managing by fear is not considered politically correct. While managing by a winning leadership style of getting the heartfelt enthusiasm and buy in on the turnaround agenda from all constituencies is preferable; each situation is different and there are times when you need to be feared to get accomplish your agenda.
  7. Never Make a Personal Attack — Love all, trust a few, do wrong to none. It is most unfortunate that many media personalities have no shame in ridiculing the physical attributes or intelligence of those whom they disagree with regarding political or social issues. Nothing useful is gained by this tact, and respect from people with character is lost. Where you have control or influence, use it to stop any personal attacks. Garner respect and influence by taking the moral high ground.
  8. Integrity, Integrity, Always Integrity — There is no confidence without integrity. When people know your integrity is above reproach, it is akin to them knowing you are holding a pair of aces in your hand.
  9. Every Hand is a Winner and Every Hand is a Loser. During the course of an engagement, the CRO will have hundreds, perhaps thousands of individual encounters. Think outcome. What do I want from this meeting, this conference call, this hallway conversation or this e-mail? Ask these questions: Who am I dealing with? What are his or her wants and needs? What is their ego threshold? How secure or insecure are they? What do I need from them? What is the best way for me to deal with this individual or individuals to get from them what I need to help make the outcome of this engagement successful?
  10. Perception is Reality — If you don’t accept reality there is nothing you can do to change it. Perhaps the most difficult task in a distressed situation is determining reality and getting people to face reality. Most people, particularly entrepreneurs and C-level executives, tend toward optimism, often extreme optimism, which can often be described as delusional. While the messengers of bad tidings are no longer killed, dismissal is not uncommon. People, and companies, will not put aside their core beliefs (or hopes) or preconceived notions easily. IBM regarded the personal computer as a passing fancy and fought it as a threat to the dominance of the black-box magic of their mainframe computers. Even keen insights backed by rigorous analyses will not necessarily win the day. Each individual perception of reality is their reality and they will make decisions within the parameters of their reality. Unfortunately, there is no easy solution to this dilemma. Do your best to make sure your own reality is based on a solid foundation of facts. You need to be the consummate politician. Do the best you can to understand the reality perceptions of the other people involved in the situation. As influence is gained and a political base is established, the CRO will be able to exert more influence and control to enhance that critical decisions are made within the context of the reality of the situation.


In this troubled time in the American economy, every single job is important and the CRO has a pivotal role in saving companies and saving jobs. To accomplish this objective, the CRO needs to be able to see through the fog of competing self-interest. More than anyone involved in a distressed situation, the CRO is in the best situation to take a broad perspective of the entire situation and chart the best direction. Again, knowing what to do is the easy part, developing the political platform to establish common ground and move all constituencies forward is the challenge.

Part II of this article appears in ABF Journal’s November/December issue.