Helping distressed businesses succeed: How an out-of-court process may prove better than bankruptcy
“For 2020, I’m pretty confident we will see more bankruptcies than in any businessperson’s lifetime.”
That’s the assessment of James Hammond, CEO of New Generation Research – which runs bankruptcydata.com – in a recent Fortune article. The economic impact of COVID-19, along with other socio-economic factors, is causing an unprecedented wave of bankruptcies in industries ranging from retail to hospitality to energy. This trend, unfortunately, is expected to continue.
Any business can find itself in a position of financial distress that requires it to embark on a restructuring process that may involve bankruptcy. Whether the impetus comes from a stakeholder with capital at risk, the board of directors, a private equity sponsor, or a lender anywhere on the debt spectrum, the option to file for bankruptcy protection may soon find itself a consideration for leaders of the distressed business.
Typically, bankruptcy is never the first choice. But it is part of a strategy forward for businesses saddled with angry creditors and dwindling revenues, especially during this unprecedented pandemic. Executives from companies that haven’t been through a bankruptcy process may initially be inclined to opt for the in-court route because they hear the word “protection” in bankruptcy protection. They see relief in the automatic stay and the court-ordered corralling of the many (often irate) stakeholders.
But, as we have found in our work as chief restructuring officers and financial advisors, an out-of-court process is often a better approach for many companies, depending on their specific set of circumstances. Yes, out-of-court is still expensive and requires the hiring of lawyers, accountants, and other outside advisors. But companies that initially opt for the bankruptcy route to satisfy creditors and other constituents often don’t consider both the short-term and long-term implications of a bankruptcy.
First, they fail to appreciate how much the process will remove control and expose them to second-guessing the minutiae of every action they’ve taken in the past and to be taken during the pendency of the case. Second, in some industries, the stigma of bankruptcy can have an irreversible effect on a company’s perceived value – be it brand reputation, customer loyalty, or employee morale. And finally, there’s the cost aspect. The expenses associated with bankruptcy will almost always be significantly greater than an out-of-court restructuring. This is due to the increased administrative requirements as well as the obligation that debtor companies pay for the expenses of not only for their own attorneys and financial professionals but also often those of their creditors.
An out-of-court success story: health network
We recently completed a healthcare industry case where amid criticism over our plan to restructure out-of-court, balanced cash triage, operational improvement, and asset monetization to create cash runway, get 10 non-syndicated secured lenders, 700 unsecured creditors, and the Department of Justice to stand still without court protection, keep physicians onside, improve operational profit, and create long term options for the thirty-year-old business. Here are the details of the case.
In April of last year, we were hired to serve as Chief Restructuring Officer (CRO) for a Pennsylvania-headquartered for-profit health network. The entity had grown over 30 years from a small sports medicine practice to a profitable $235M healthcare operations business comprising 80 legal entities, 105 physicians, and 1,400 employees. At its peak, the network was servicing 12,000 patient visits per week and operating from 22 owned and three leased facilities across the state and into New Jersey. The health network built an outstanding reputation with low rates and high doctor and patient satisfaction scores through a process that prioritized doctor efficiency and patient coordination.
From success to distress
By late 2017, the health network began to struggle as it found itself competing more and more with not-for-profit networks. To address this, it sought partnerships with two of these networks to drive its expansion. The expansion doubled the network’s administrative staff and it began the construction of two new hospitals as the partnership deals were being finalized. In late 2018, those deals fell apart. Coupled with this, an ongoing five-year DOJ investigation into the health network’s billing practices was expanded and a whistleblower action compelled it to agree to an eight-figure settlement plus a Corporate Integrity Agreement (CIA).
A healthcare investment bank was hired to negotiate the sale of the health network assets to a strategic buyer as the ramifications of the failed partnerships and DOJ settlement took their toll. By April 2019, the sale process had stalled, patients stopped coming in, and the health network mounted nearly $170 million in debt owed to secured lenders and for physician buy-outs. The health network was in crisis with just eight weeks of cash left on hand.
An out-of-court solution to preserve value
When we were first chosen as CRO for the health network, we believed that competitive pressures, along with growing hostility from creditors and other stakeholders, made a restructuring combined with a transaction the company the most feasible option for a good outcome. So, in addition to overseeing the restructuring of the health network, we were supported the path to sale.
Every step of the way, most stakeholders – even our fellow professionals – told us that a bankruptcy proceeding was the optimal path forward. They advised us not to attempt the restructuring and sale without the court protection afforded by bankruptcy. But, in weighing the in-court versus out-of-court-options, we concluded that a great deal of value that still existed in the health network would be destroyed by a bankruptcy filing. The bankruptcy would not only be detrimental to the health network, its employees and the community it would also significantly diminish the proceeds that would be distributed to creditors. So, we took what turned out to be a controversial path forward and opted for an out-of-court process.
Triage, turnaround, and an optimal outcome
To eventually complete a successful transaction for stakeholders, our restructuring work needed to improve the viability of the health network by propping up its value proposition and, consequently, its selling price. This work involved an initial cash triage to survive, an operational turnaround to drive options and value, an interim asset monetization/bridge funding to create a longer cash runway, and, ultimately, identifying the right buyer for the network and its stakeholders. All paths were pursued simultaneously and all components were critical to the success. Ultimately, the short-term cash triage, asset monetization, and operational improvement success extended cash runway from 8 weeks to 8 months and improved EBITDA from negative ($11.6.M) to positive $7.2M. These factors formed the basis for a feasible transaction and value sufficient to satisfy stakeholders.
After a lengthy process and despite numerous obstacles, the health network was acquired by a larger, Pennsylvania-based not-for-profit network with a history of financial stability and operational excellence. All 1,400 employees (1,200 full-time) were retained and offered jobs except for the owner and two family members. Of those offered jobs, only two out of 105 physicians declined to accept a contract with the new owner.
Keeping options open
Out-of-court is not, by any means, the right path for all distressed situations. A key element to helping businesses through financial turmoil is to keep as many options open as possible.
If a business is restructuring outside of the bankruptcy process, there are creative solutions to explore. While a bankruptcy filing may trigger several important protections for the debtor, it can also reduce some alternatives and hamper the decision-making autonomy of the executives or committee who might be best positioned to turn the business around. Bankruptcy can also impede cash flow compared to an out of court restructuring.
To that end, one of the most important things to remember in choosing a venue (in or out of court) is that focusing first on an out-of-court solution doesn’t preclude an eventual bankruptcy filing. It may become impossible to get all stakeholders on board without court protection and intervention. In many cases, the related negotiations can make the court process run more smoothly. If you can develop a plan that most major stakeholders support, even if you can’t get buy-in from a few holdouts, you’re well ahead of where you would be if you’re filing with the court as a first step.