A recent episode of the ABF Journal Podcast explores a strategy that is increasingly vital for middle-market companies caught in a “bottleneck” of distressed debt. As interest rates remain high and businesses are burdened by layered debt — including the predatory impact of Merchant Cash Advances (MCAs) — traditional turnarounds or costly bankruptcies aren’t always the fastest path to stability.
In a recent article for ABF Journal, “A Workout Without the Mess: When is Article 9 Restructuring the Right Path?“, the team at Second Wind Consultants explored how Article 9 of the Uniform Commercial Code can be used as a “surgical” tool to reset a company’s capital structure.
In this podcast, ABF Journal’s Editor in Chief Rita Garwood interviews Adam Duso, CEO of Second Wind Consultants, who breaks down the mechanics of “prepackaged” out-of-court sales, and Jacen Dinoff, CEO of KCP Advisory and Principal with Cornerstone Business Credit, who provides the turnaround and credit committee perspective.
Transitioning to ABL
Rita Garwood: Adam, the article mentions that Article 9 restructuring can solve the “bottleneck” in bank-to-ABL transitions. For our ABL listeners, how does this process help a new lender step in when the existing collateral doesn’t fully cover the legacy bank’s payoff?
Adam Duso: The way Article 9 works is as an out-of-court process; it allows for a lot of flexibility between the negotiating parties. We work a lot with senior secured lenders, often banks that want to exit credits, but they don’t have sufficient collateral to support 100% takeout on their loan. If we do an Article 9 on that business, we’re able to divorce it of any debt junior to that bank lender and take out the collateralized piece of that loan by bringing in an ABL.
To the extent that the bank is collateralized — say 80% of their deficiency — they’ll get paid down that portion in the Article 9 transaction. The remaining amount can be transferred over into the SPV (Special Purpose Vehicle) created for the transaction, and that portion can be paid out over time. This way, the bank doesn’t have to write off the non-collateralized portion of the debt. They exit the debt on the collateralized piece and get paid out over time on the uncollateralized portion because subordinate debt has been removed and reprioritized.
Garwood: Jacen, from a turnaround perspective, how does the ability to leave behind non-performing contracts and legacy liabilities provide a more credible borrowing base for a new specialty finance provider compared to an organic turnaround?
Jacen Dinoff: The Article 9 process is a powerful tool. For the new lender supporting this financing, they’re getting the “best of what’s left”. They are getting those assets turned over with no liability. If the homework has been done—if the new company acquiring those assets has worked with critical vendors and landlords—it can be almost a turnkey transaction that gets rid of the things you don’t want to deal with. You don’t have to go through a claims process or a protracted execution risk negotiation. From a credit risk profile perspective, you’re getting collateral free and clear under the UCC law statutes.
Deal Mechanics
Garwood: Adam, the article highlights case studies of an HVAC contractor and a diesel distributor where the lender converted deficiency balances into subordinated notes. How do you structure those notes so they’re viewed as “performing” rather than just “hope notes” by the credit committee?
Duso: We do two things. One is working with FA (Financial Advisory) groups that stick on after the transaction. They use historic financials and projections to show what the business could responsibly pay in a sub-debt placement. This ensures these notes perform to the extent they can—whether that involves refinancing the sub-debt at a certain time, moving from interest-only to principal and interest, or creating milestone payments.
By doing an Article 9 sale and stripping excess debt, you create room for responsible coverage ratios with the first position lender. In some cases, this is coupled with a turnaround where performance must increase. While there are times it is truly a “hope note” based on future performance, in most cases, there is interest-only performance or temporary deferral while the company returns to a performing status.
Garwood: Jacen, once the capital structure is reset, how much more operational alpha can you generate for the company now that you aren’t spending all day negotiating with legacy creditors?
Dinoff: Just to tack onto Adam’s point, in Article 9, you’ve really maximized the recovery value for the benefit of the lenders compared to other instruments where many “hands” are out for a piece of that recovery.
Regarding operational alpha: in a crisis, the ability to focus on anything other than the crisis is very hard. We always say we need to stabilize first. I often tell clients: you’ve got great ideas about the future, but it reminds me of trying to hang drapes in a burning apartment building. Until we put that fire out, I can’t tell how good the drapes look. Article 9 stabilizes the “noise traffic” so you can focus on operating activity, efficiencies, and new contracts. It can be a gateway to new business opportunities that were inaccessible in the middle of a crisis.
Counteracting MCAs
Garwood: Adam, you noted that MCA providers often ignore standstill provisions and use UCC 9-406 notices to intercept receivables. How does the Article 9 process effectively “reset” the board?
Duso: An Article 9 is a sale of all assets under the Uniform Commercial Code. We are selling the assets through the senior secured lender, which sells them free and clear of their UCC. Without a valid UCC on the collateral, specifically the receivables, an MCA’s 406 notice is referencing a UCC that is no longer valid. By selling the assets, you remove their validity to send the notice, and the buyer takes those assets free and clear. It puts MCAs in the legal position of unsecured creditors, which undermines their actual notice.
Garwood: Jacen, how often do you find that a business is operationally sound but technically insolvent because of layered capital structures from MCAs?
Dinoff: This happens way too often—constantly in the last few years. Businesses find ways to pile up multiple MCAs, and it’s not always transparent. These create massive problems and starve companies of working capital. I know they’re desperate, but cash doesn’t always solve a problem; sometimes you have to address the creditor directly or look at options like Article 9.
Stakeholder Alignment & PE Considerations
Garwood: For listeners in private equity, Article 9 allows for a prepackaged outcome where the buyer is identified before the sale. How do you ensure this satisfies “commercial reasonableness” while protecting the buyer’s interest?
Duso: “Commercially reasonable” often defines down to “adequate consideration”. We ensure we have appropriate third-party appraisals to show an arm’s length buyer is paying adequate consideration. Other best practices include running a public sale, which is commercially reasonable on its face, or listing the business to show this is the highest and best buyer, which mitigates challenges.
Dinoff: The escalating costs of bankruptcy have led to more investment into understanding Article 9. Lenders and their lawyers are getting smarter about preparing defenses ahead of time, whether through valuation exercises or bringing in an investment banker to market the process. This proves the process provided the highest and best recovery. Usually, challenges are far fewer than what you would deal with in a bankruptcy or a composition plan.
The “New Normal” and Red Flags
Garwood: Do you see Article 9 restructuring becoming the new normal? And what is the one “red flag” that tells a lender it’s time to stop the organic turnaround and start the Article 9 process?
Duso: I certainly think Article 9 will take a larger seat at the table for out-of-court restructurings. We’ve seen high demand from creditors and debtors looking for alternatives outside of court-appointed processes.
The red flag: if you’re tracking performance and it drops below a responsible coverage ratio in the debt stack, that’s when you put it on a watch list. As it gets closer to 1.0, it is time to consider restructuring while the company can still support your debt, even if it can’t support the debt below you. The sooner you get involved, the more value there is to preserve.
Dinoff: I agree. Ever since the bankruptcy code changes in 2005, the market has been forced to look at other vehicles like receivership, ABCs, and Article 9. As for when to stop a turnaround: it’s contingent on the situation. If you find significant additional secured debts that make the debt stack unaffordable—or if there’s truly no way to do it through an organic process — Article 9 is very attractive. It allows for fast cutting of obligations and a turnkey transition without weeks of delay for court appearances and motions.