Business:

Avoiding bankruptcy: The right advisors can keep a crisis at bay

Tips for reducing expenses and restructuring your finances

Debt holders are taking over the Hooters hotel after owners filed for bankruptcy in 2011 to block a threatened foreclosure by creditors.

By the numbers

  • 18,220: Number of bankruptcies in Nevada in 2005

    30,637: Number of bankruptcies in Nevada in 2010

    26,239: Number of bankruptcies in Nevada in 2011

    310: Number of business bankruptcies in Nevada in 2005

    1,015: Number of business bankruptcies in Nevada in 2010

    1,018: Number of business bankruptcies in Nevada in 2011

    95: Number of Chapter 11 filings during the first three months of 2012

What to do when filing a business bankruptcy

  • • Hire an attorney. Businesses filing for bankruptcy must be represented by a lawyer.

    • Prepare financial statements with an attorney, bookkeeper or accountant. In Chapter 11 bankruptcy cases, monthly operating reports must be filed so it’s important that an appropriate accounting system be in place.

    • Attend an “initial debtor interview” with the office of the United States Trustee, which is part of the U.S. Justice Department and monitors and participates in the bankruptcy process. This is necessary for Chapter 11 cases.

    • Attend a “341 Meeting” with creditors. These are typically scheduled about a month after bankruptcy filing. Creditors can ask the debtor’s representative questions under oath about the company’s finances.

    • Provide for Chapter 7 cases financial records requested by the appointed trustee.

    • Attend required court hearings.

    • Discuss with an attorney “fraudulent transfers,” which involve money inappropriately taken out of a business while it is headed for bankruptcy and while creditors have a claim to finances.

    • Discuss with an attorney whether Chapter 7 bankruptcy makes sense for a business that is closing. Under Chapter 7, a trustee can look for fraudulent transfers going back four years.

    • Discuss with an attorney whether to communicate information about a bankruptcy to customers, suppliers and employees.

    • Discuss with an attorney whether to seek new financing or investors to hold onto a business.

    • In Chapter 11 cases, discuss with an attorney any responsibility as a fiduciary to the bankruptcy estate.

While the Southern Nevada economy appears to be improving, bankruptcies and distressed debt business restructurings are showing no signs of slowing down.

The slight decline in Nevada’s unemployment rate, from 11.7 percent in April to 11.6 percent in May, coupled with the state’s move from No. 1 to No. 3 on the residential foreclosure list, are encouraging signs of a fiscal return. But insiders say that for the most part, businesses that struggled during the recession will continue to do so, at least for the short-term future.

“As far as commercial bankruptcies, I foresee a lot more coming,” said Zach Larson, a bankruptcy attorney at the Las Vegas law firm Marquis Aurbach Coffing. “I think a lot of the businesses that initially weathered the storm have now hit a point where they can no longer weather it.”

“They’ve been through their savings, they’ve liquidated what they can, they’ve gotten rid of the liabilities they can,” Larson said. “Now they’re facing a situation where total sales are still down. If they want to try to keep their business going, and it’s viable to do so through a bankruptcy, that’s where they’re looking to go now.”

VEGAS INC. sat down with Larson and other bankruptcy professionals to talk about strategies businesses can consider to reduce their expenses and restructure their debt.

Expense Reduction 101

Many struggling companies fail to come to grips with their problems early on, while their businesses are still viable.

Dealing decisively with issues when they start can prevent headaches and unnecessary legal expenses later, said Randy Creighton, a Black & LoBello attorney who works on out-of-court debt restructurings and bankruptcies.

“Usually what I see is people’s eyes closed to the debt,” Creighton said. “All they do is they make payments, and they have no idea (of their financial situation) because they’re too afraid to look. All you’re doing is kicking the can down the road. You need to have a come-to-Jesus talk and sit down with yourself, your business partner, your manager, whoever is in charge of the books, and on a piece of paper have all your debt outlined. Really examine it and analyze it so you can see what’s causing you the most harm.”

Businesses, for example, can get on the right path in many cases simply by reducing their operating expenses or negotiating more favorable terms on property or equipment leases.

“Say you’re an operating business and you have food costs and you have been using food service Company A for 15 years, and you know the salesman and you play golf every other weekend. What you don’t see is you’re paying $15,000 per month for food, and if you went to Company B, you could be paying $12,000 per month,” Creighton explained. “I worked with one business owner, and we reduced operating expenses by 15 percent without touching any debt or the lease.”

In the current troubled commercial real estate market, landlords dealing with a glut of empty or under-leased office properties may be agreeable to lease concessions. The difficult reality for landlords is that they’re in a market where office vacancies are elevated in the 24 to 25 percent range. Warehouse and industrial vacancies are running above 15 percent, and retail vacancies are estimated at about 10 percent.

Concessions are often preferable to having a vacant property that an owner will have trouble re-leasing, Creighton said.

“You have to educate and inform the landlord that this space is built for Business A. The guy across the street is paying $2 in rent per square foot, and I’m paying $4.25. I can’t survive at $4.25,” Creighton said. “If we leave here, you’re going to have to lease this place out at $2. Let’s make this reasonable. I’ll pay you $2.50, and I can survive at that point. And if I leave, your new tenant will want to make changes, and you’ll have to pay out of pocket (for improvements).”

But keep in mind: Such negotiations also require a struggling tenant to convince his landlord that he won’t be back in a year or two seeking additional concessions, Creighton said.

Debt reduction outside of bankruptcy

There are many alternatives to putting a business that’s losing money into bankruptcy.

They include shutting the business down and walking away; turning property over to a bank to avoid foreclosure and further personal liability through a deed-in-lieu-of-foreclosure transaction; getting a bank to agree to a short sale in which a property is sold for less than its mortgage, with the bank agreeing not to pursue the deficiency; finding investors to pump money into the business; or selling the business and negotiating a mortgage modification aimed at keeping it operating.

Closing a business and walking away can make sense when an owner hasn’t made a lot of personal guarantees for leases and trade accounts or is willing to deal with the consequences of those guarantees.

“I often tell my clients: ‘Save your money. Don’t pay me, just close your doors,’” Larson said.

When an owner is burdened with hefty personal guarantees, it might make sense for him to close the business without filing for bankruptcy and to file for personal bankruptcy instead. That way, attorneys need to be paid for only one bankruptcy, not two, Larson said.

For example, “if you have construction equipment that has to go back (to the finance company), your deficiency can be $200,000 to $300,000,” Larson said. “So that individual is going to have to file personal bankruptcy most likely.”

As for short sales or deed-in-lieu-of-foreclosure transactions, those are the equivalent of closing and walking away from a business without having any obligations remain related to the real estate.

“The reason you do this is not necessarily for the benefit of the business because when you walk away, you shut down the business. It’s usually because there’s a personal guarantee and they want to get rid of the personal liability,” Creighton said.

If an owner wants to bring in investors to keep a business afloat, they may demand stringent terms to protect themselves from risk. Even so, that can be a viable option as long as there is a solid plan, Larson said.

“If you’re just willy-nilly saying ‘invest because it will turn around,’ that’s a bad idea,” Larson said. “You’re getting yourself into deeper trouble if it doesn’t turn around. Now you owe not only Bank of America, but you owe your brother or your parents.”

The lawyers also said that selling a struggling business in this environment can be challenging.

“A lot of clients think their business is still valued at the 2005 or 2006 (level), but at the end of the day, their business is generally not going to be worth what you owe. Otherwise, they would have sold it already,” Larson said.

“The problem is, if you’re struggling, who’s going to want to buy a struggling business?” Creighton asked. “If your costs are too high because of the lease, or equipment costs are too high, no one is going to want to buy that business.”

“But if you’re struggling because, as a business owner, you’re not properly marketing the business, there is a tremendous upside and you don’t have that skill or that desire, that business may be marketable for a sale,” he added.

Another alternative is to privately restructure the company’s debt on terms that make sense for both the lender and borrower and that take into account current economic realities. This avoids the typical scenario in which a lender starts a foreclosure proceeding against a commercial property, then files a lawsuit asking that a receiver be appointed to supervise the property while it’s being foreclosed on -- with receivers typically charging hundreds of dollars per hour for their work.

“It makes financial sense for all parties involved to avoid bankruptcy, to avoid litigation, to avoid a receivership, which is very expensive,” Creighton said.

“Unfortunately, you’re limited sometimes in the behind-the-scenes stuff,” Larson added. “That’s largely dependent on who you owe money to. Will they be able to work with your debtor? If it’s a public entity, if it’s Bank of America, they’re limited in what they can do.”

Filing for bankruptcy

If a business has failed to deal with its financial issues early on or has tried to resolve them without success, bankruptcy may be the only option.

A Chapter 7 bankruptcy is a liquidation in which a business has or will shut down. A Chapter 11 bankruptcy is a restructuring and is typically used by businesses that intend to continue operations.

Individuals, too, can file for Chapter 11 if they have business obligations or can’t file for Chapter 13 because their debt is too high.

Local lawyers say the biggest problem they see locally with business bankruptcies is business owners who wait too long to deal with debt or who file for bankruptcy and in the interim invest their life savings into a sinking enterprise with no hope of getting it back.

“The single biggest issue most business owners have is not seeking advice soon enough,” Larson said. “If you have a viable business model and you can see where it’s going to go or you think it could go there, it’s much better to do it earlier than to just sink every last asset you have into the business.”

“The bad days are when I have someone who is 65 and they have bled into their business for 30 or 40 years,” Larson continued. “It was successful, it weathered the ‘70s, the ‘80s, the ‘90s and the 2000s. And now they’re here and they’re done. I’ll make the debt go away, generally speaking, but I can’t make their life what it was.”

For businesses that plan ahead and hire lawyers and financial advisors early enough, bankruptcy can be a simple and enterprise-saving exercise.

Commercial real estate defaults are responsible for many bankruptcies, and the Bankruptcy Code offers a simple and effective way to deal with those defaults: a “cramdown.”

In that scenario, debt against a property is “crammed down” to its current market value, yielding more affordable mortgage payments for the borrower. Banks and other lenders have to take a loss, but their loss typically would be the same or greater if they foreclosed on the property and re-sold it in the depressed market.

“With single asset real estate entities, Chapter 11 gives you the opportunity work with your lender on a resolution and possibly cram down (the secured debt) to the fair market value,” Creighton said. “It’s usually in the best interests of all parties involved and can be done to where the entity can continue to survive and the bank gets fair market value for the property. With a Chapter 11 business bankruptcy, theoretically you can be in and out in six months.”

Complications

Not every debt-restructuring deal or bankruptcy goes smoothly. All kinds of complications can crop up.

Borrowers and lenders might not agree on the fair market value of a property. If they do agree, the business might not be able to afford the proposed lower mortgage payments.

“You then either have to dismiss the bankruptcy case and move on and have the owner give up the property, or you have an infusion of cash to where the landlord can afford the mortgage,” Creighton said.

Another complication the attorneys have recently seen is borrowers who don’t know who owns their debt after it has been securitized, or pooled with other loans and sold to investors, often at a steep discount.

Some of the investors aren’t enthusiastic about seeing the debt they own crammed down in bankruptcy court. They don’t want to hold a mortgage note with a reduced value.

“In the past 12 to 18 months, we’ve had a lot of private companies and hedge funds buying these debts and they’re not in the business of being a bank,” Creighton said. “They’re not in the business of loaning money. When you’re proposing a seven-year repayment plan for the building, they’re not interested in holding that note for seven years. They want an exit plan sooner than that. It doesn’t make it impossible, but it makes it more difficult.”

Larson rattled off a long list of complications when dealing with debt investors, which he calls “vulture funds,” since they typically buy distressed debt at a discount in the hopes of making a profit. Many of them bought loans from the Federal Deposit Insurance Corp. (FDIC), which obtained them when local banks such as Silver State Bank and Community Bank of Nevada failed.

“If it’s a vulture fund that took over an FDIC loan from a Silver State bank situation, they’re going to be limited in what they want to do, ,” Larson said. “The way the system’s geared, they make money going after some of these assets. Sometimes to collect the (mortgage) insurance on a particular asset, they have to try to foreclose or get a judgment.”

In other cases, multiple funds have invested in a defaulted loan and can’t agree with one another on concessions or settlements the borrower has offered.

“That’s often times why you can’t settle without authority of the court, which is why bankruptcy is sometimes so good, because you can’t get these two entities to talk to one another,” Larson said. “They don’t want to tell their investors they’ll have to take a haircut. Often times, even if it’s a good deal, they don’t know how to disperse the haircut because no one wants their investors to take it.”

Creighton said that part of the problem for small businesses that default on loans is determining who owns the loan and what the new owner paid for it.

“Are we talking to Bank of America?” Creighton asked. “Are we talking to the true investor? Is the FDIC involved? Is securitization involved? You’re not talking apples and oranges. You’re talking an orange and a steak.”

Worse, Larson said he regularly deals with competing factions at law firms that represents debt holders.

“They get their bonuses and their salaries based on what they bring in and what they make,” he said. “If the litigation department is suing the debtor before it gets to bankruptcy, and I’m trying to resolve this debt, the litigation department may not be talking to the bankruptcy department. Or if I’m talking to the bankruptcy department, it might not be talking to the litigation department.”

“Usually I’m talking to the bankruptcy department and saying ‘Let’s work this out because it’s a lot cheaper for everyone involved,’ and the litigation department is not talking to the bankruptcy department and they’ll file something (like a lawsuit) that forces me to file bankruptcy,” Larson said.

The bottom line: Debt restructuring can be complicated, so it pays off to plan ahead with sound legal and financial advice.

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