Ready for Prime Time … Receiverships Grow in Scope and Popularity
The legal restrictions and market perception surrounding a bankruptcy can make a turnaround a difficult affair, especially in the current economy. Receivers were once appointed mostly to handle distressed real estate deals, but Chris Tierney of Hays Financial Consulting argues that experienced receivers have the leeway and the acumen to turnaround almost any business.
In today’s challenging business environment, distressed companies face a diminishing number of increasingly unappealing options. Finding a traditional loan remains difficult, if not impossible, especially for small- and medium-sized businesses. M&A activity continues to be stagnant. Private equity is still skittish. Even strategic buyers — which snapped up many companies or their assets over the last two years — are too busy digesting their acquisitions to consider coming back for more.
With no white knights in sight, lenders to these companies have less and less expectation that anyone will assume or payout their loan at par. The options that remain would be hard to stomach in any economy:
- Partial (or complete) liquidation? The economy is already forcing lenders to sell inventory, equipment and real estate at a discount. If the business is in a distressed sector, such as construction, then prepare for a fire sale.
- Chapter 11 restructuring? Appealing in theory, but alas, true reorganizations are becoming rare. Attempting a turnaround in the tighter timeframe now mandated by the code is often impossible for small and middle-market companies. As a result, the Chapter 11 filing is starting to become the first step toward liquidation.
- Out-of-court workouts? Even out-of-court workouts have become difficult, with companies stuck between impatient lenders and serious business headwinds.
For lenders seeking ways to deal with bad loans on their books, it’s time to start looking at non-traditional options — and quickly. One such option is the business receivership. Once largely the province of commercial real estate, receiverships are increasingly common as lenders realize they can be employed for nearly any business.
Any lender can petition for a court-appointed receiver if they believe that their collateral is at grave risk. If a judge agrees, the receiver can immediately take legal possession of the business and/or assets and assume day-to-day management. The receiver usually takes control of all assets, books and records, operations, etc. allowing for a quick review of the company’s financial affairs and the smoothest path to stability.
A receivership is often the result of a dispute between lender and borrower over how to resolve a default situation, and some managers will fight the appointment of a receiver. Good communication is the best avenue to obtain a consensual agreement on the value of bringing an experienced receiver into the picture.
For an operating entity, a receivership has traditionally been used as a powerful tool when a lender suspected fraud. A receiver is typically vested with the power to investigate wrongdoing, sue to recapture fraudulently transferred assets, and issue subpoenas to investigate potential illegal acts.
But a receiver appointment is also useful when a lender believes that time and new management can turn a business around, protect existing value from eroding, or manage an orderly wind-down and sale of the company. In fact, in these circumstances, receivership has considerable advantages over a Chapter 11 filing:
During a bankruptcy, most companies are run by either current management or a trustee. Current management in many cases is often the problem due to lack of experience running a distressed company or the inability or lack of desire to make tough decisions. Trustees more often than not are attorneys who have a good grasp of the code but may lack real business acumen in what it takes to turn around and run a business. Experienced business receivers, by contrast, have extensive management and related situational experience specifically with companies facing severe difficulties brought about by market conditions, poor management or fraud.
The law governing the majority of receiverships is usually based on the state where the business is located and is generally much more flexible than those found in federal bankruptcy statutes. This often provides the experienced receiver with more flexibility in running the business. Experience indicates that receiverships tend to be less expensive than a traditional bankruptcy — there are no committees hiring their own advisors, reporting requirements are more streamlined, and the focus is on creating business solutions rather than legal ones so there is less inherent need for legal representation. All of this allows an experienced receiver to spend less time attending hearings and legal meetings and more time engineering a successful turnaround or wind-down.
Lack of Publicity
Bankruptcies are very public events that can spur rapid value erosion. Like a bankruptcy, a receivership involves a hearing and public documents. But receiverships tend to play out much more discreetly and are not as closely followed as bankruptcies. With generally no set legal timeframe for completion or equitability requirement, an experienced receiver has the time to negotiate unique individual deals with effected parties in ways that may be more advantageous to the business and its survival and therefore the value of the underlying estate.
Receivership also has the potential to shield the lender from legal liability, since the receiver is an officer of the court, not an agent of the lender. This benefit is especially important for real estate loans, because a lender that takes direct control of a property through default can become liable for a host of issues, from environmental problems to security. Real estate or business owners facing a looming or existing default sometimes fail to pay property or other taxes, ignore routine upkeep, or use rent payments to prop up other properties. A receiver ensures that cash is used for its intended purpose.
Bankruptcies will always have their place. They may be more appropriate for a rapid liquidation. And if there is a qualified buyer, a bankruptcy can be useful for handling junior creditors, clearing liens, obtaining waivers on environmental issues and the like. The protections afforded by bankruptcy are certainly powerful. But as a lender compares receivership versus bankruptcy, they should check the receivership law in their state. In some states, for example, receivers may sell an asset free and clear of all liens. Other states permit something akin to the automatic stay, during which creditors may not sue the business until the receiver has a chance to get their hands around the situation. Finally, if the receivership doesn’t lead to the hoped-for turnaround, then a company can still file for bankruptcy later.
As the weak economy continues to drag on, we expect to see more troubled deals in the next two to three years than we have in the last five to seven. Some lenders are entering workouts with unrealistic expectations as to the speed of a resolution and the size of their recovery. Others are just kicking the can down the road, hewing to an unspoken policy of “lend and pretend” while borrowers dig themselves into an ever-deeper hole. By the time the lender turns off the spigot and forces the borrower to bring in the requisite expertise, there’s often no alternative but to wind down the company.
There are plenty of companies out there that just need management with experience in operating during troubled times, and with the willingness to make the tough decisions necessary to buy the extra time needed to wait out the economic storm. Lenders that recognize the potential of these temporarily underperforming borrowers will stand the best chance of full repayment down the road if they take speedy, decisive action to prompt a turnaround. And that’s why more and more lenders are turning to experienced receivers to help them through these troubled times.
Chris Tierney is managing director of Atlanta-based Hays Financial Consulting, a nationally recognized provider in working with distressed and insolvent businesses. Tierney has more than 21 years of experience providing financial, operational and strategic advice for companies both in and out of bankruptcy. For more information, please visit www.HaysConsulting.net.