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Loan work-outs

A better alternative to bankruptcy?



Bankruptcy should be considered a last resort for any business. Loan work-outs can save a business from complete collapse, but a company must convince creditors that they'll get more money that way.

In the November 19, 2008 issue of the New York Times an article entitled "Advantage of Corporate Bankruptcy Shrinks" discussed the disturbing trend that, "True reorganizations, in the spirit of the bankruptcy code, are becoming extremely rare," especially in light of the "absence of credit" in the current financial markets. While this article focused mainly on large corporate bankruptcies such as Linens & Things or S&A Restaurant Corp. (Bennigans), many of the problems being incurred by debtors discussed in this article apply to small and mid-sized restaurants companies and franchisees as well.

Disadvantages of bankruptcy

Bankruptcy should be considered as the last resort if all negotiations fail between you and your lenders. This course of action can entail costly legal and filing fees, bad publicity, bad morale and loss of critical employees. In addition, bankruptcy can be time consuming and will result in many distractions from the operation of your business due to court-mandated requirements for compiling information, filing endless reports and schedules, attending creditor and other court hearings and countless meetings and discussions with your attorney.

In the past, filing a Chapter 11 reorganization or even a pre-packaged bankruptcy allowed the debtor enough time to work out a plan for its survival by devising a structure or process to re-pay secured lenders and essential creditors (such as landlords and key vendors) and either discount or dismiss much, if not all, of its remaining debt. However, in the current "credit crunch" environment, lenders have become extremely aggressive in requiring immediate re-payment of the entire debt and want to reduce their exposure to further losses. Since they are no longer in a position to lend additional funds or have critical cash needs of their own, they have been more likely to press for immediate payment of the entire debt.


Larry Simmons

Larry Simmons: Try a work-out before declaring bankruptcy.

Furthermore, many lenders are now demanding that a receiver be appointed to run your business to preserve their collateral, thereby removing you from any management decisions. Any receiver will have a steep learning curve in understanding your business or market and will more likely decide that the best value for the lender is to sell the assets of your company. Most sales in bankruptcy will almost always result in a lower price due to the appearance a "fire sale" of a distressed business in need of quick cash. If the sale does not result in full repayment of the accrued debt and you have a personal guarantee, you then face the possibility of having to pay the deficiency. Accordingly, distressed debtors are becoming less interested in filing for Chapter 11, since it could greatly enhance the chances of converting into complete Chapter 7 liquidation.

As a result, many borrowers have increasingly turned to loan work-outs to save their business from a complete financial melt-down while maintaining control of their assets. If done properly and timely, loan work-outs save the time and expenses of a bankruptcy while allowing a borrower the ability to turn its business around without unnecessary interference of third parties who may not make decisions in the best interests of the borrower or the business.

Due to the increased scrutiny and concern over troubled loans, a debtor must get ahead of the issue and move quickly before it is threatened with or pushed into a bankruptcy. Accordingly, it is imperative that a borrower who is in jeopardy of a payment default have a complete understanding of its current financial situation including any threatened or current breaches of loan covenants and required coverage ratios. In many cases, a small to medium size business will not have a CFO with work-out experience or even an outside accountant or attorney who has both the financial and legal experience in restaurant finance work-outs. If this is the case, the borrower should retain the services of a dedicated restaurant loan work-out consultant who can analyze and value the business, and translate the numbers into a concrete plan that can be presented to the lenders.

Given the current "urgency" in the financial markets, time is not on the side of the borrower and any delay or denial in confronting a potential default can be a critical and fatal mistake. In many cases, your lender, franchisor or vendors will not work with you unless you address your financial problems head-on and take a professional and analytical approach to your situation. All of your creditors will require real-time information in order to make their own business decision as to what works for them. Any delay or lack of information, at best, only creates suspicion of your motives or, at worst, creates the impression that you do not know how to run your business well enough to protect the value of their secured assets or to make payments in the future.

Comprehensive loan work-out plan:

Lenders initially do not want to give up the leverage that they believe they have in foreclosure and bankruptcy. Accordingly, it is imperative that you or your advisors convince your lenders, franchisor and critical vendors that a work-out is more preferable. Your plan must show that the creditors will receive greater proceeds than bankruptcy, which is what really matters to them.

Depending on the current credit cycle and your specific financial issues, every work-out proposal will be different and must contain a complete analysis of the financial and legal ramifications and a realistic implementation strategy. Some potential examples of a work-out proposal could involve a refinancing to pay off the creditors at a discount while others may involve an equity investment to turn the business around, or a restructured loan involving lower payments with any excess cash flow routed to capital renovations to avoid breaching the franchise agreement. Whichever approach is adopted, it is important to avoid confusion, conflicting approaches, extra professional fees and wasted time by selecting one point of contact who will be responsible for coordination of strategies and communications with creditors.


Larry Simmons is a principal for MarshallMorgan, LLC, which specializes in loan work-outs and franchise finance transactions. He is also an attorney and holds a Certified Commercial Investment Member designation in real estate finance and sales. He can be contacted at lsimmons@marshallmorgan.net.

It is imperative for the borrower to show that its proposed plan is flexible and has taken into consideration potential strategies to pay back its creditors the maximum amount attainable. Creditors will have to be convinced that they have "not left any money on the table" by foregoing foreclosure or bankruptcy, especially if you expect them to grant any concessions (such as dismissal of debt). Therefore, any proposal or negotiation should include the benefits or disadvantages of refinancing, restructuring, bankruptcy, sale of assets (including sale-leasebacks), management compensation and any operational, management and cost cutting improvements. Additionally, your proposal should include how you intend to resolve any other issues or objections that creditors may have, such as outstanding taxes, liens, legal liabilities, governmental breaches/penalties or any other obstacle that may stand in the way of implementing your work-out plan. Accordingly, if you are able to successfully utilize the above strategies and approaches, your chances of avoiding bankruptcy, controlling your future and returning to profitability will be greatly enhanced.

Any truly successful loan work-out should not only save you money through the dismissal or diminishment of outstanding debt, it should also save you the time and expense of mounting legal and court fees, reduce the risk of losing your business and create a new, permanent financial structure that returns your business to profitability and growth.

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