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Business Borrowing Basics 2020 - Dealing With Defaults


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Some borrowers default. One type of default is a payment default- the loan is not paid when due or a particular payment is missed. The other type of default is a covenant default. This webinar explains both, and discusses what happens when one happens.

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Business Borrowing Basics 2020 - Dealing With Defaults

  1. 1. 1
  2. 2. 2 Practical and entertaining education for attorneys, accountants, business owners and executives, and investors.
  3. 3. 3 Thank You To Our Sponsors
  4. 4. Disclaimer The material in this webinar is for informational purposes only. It should not be considered legal, financial or other professional advice. You should consult with an attorney or other appropriate professional to determine what may be best for your individual needs. While Financial Poise™ takes reasonable steps to ensure that information it publishes is accurate, Financial Poise™ makes no guaranty in this regard. 5
  5. 5. Meet the Faculty MODERATOR: Hajar Jouglaf - Sugar Felsenthal Grais & Helsinger LLP PANELISTS: Phil Buffington - Adams & Reese LLP Harvey Gross - New York Institute of Credit Christopher Horvay - Sugar Felsenthal Grais & Helsinger LLP 6
  6. 6. About This Webinar – Dealing with Defaults Some borrowers default. One type of default is a payment default- the loan is not paid when due or a particular payment is missed. The other type of default is a covenant default. This webinar explains both, and discusses what happens when one happens. 7
  7. 7. About This Series – Business Borrowing Basics Many companies, and most of any size, use borrowed funds as part of their capital structure. Depending on the nature of the business, its size, time in business, whether it has adequate collateral, and other factors, a business has myriad options when borrowing funds. This webinar series provides a guided tour of the various borrowing options available to businesses, from both a business and legal perspective. Learn the advantages and disadvantages of different types of loans, how to select the right loan for your business, how to negotiate terms, and what happens in the event the loan is defaulted upon. Each Financial Poise Webinar is delivered in Plain English, understandable to investors, business owners, and executives without much background in these areas, yet is of primary value to attorneys, accountants, and other seasoned professionals. Each episode brings you into engaging, sometimes humorous, conversations designed to entertain as it teaches. Each episode in the series is designed to be viewed independently of the other episodes so that participants will enhance their knowledge of this area whether they attend one, some, or all episodes. 8
  8. 8. Episodes in this Series #1: What kind of loan? Premiere date: 6/10/20 #2: Basic Concepts Applicable to All Borrowers & Lenders Premiere date: 7/8/20 #3: Alternative Structures- PO Financing, Factoring & MCA Premiere date: 8/5/20 #4: Dealing With Defaults Premiere date: 9/9/20 #5: Trade Finance Basics Premiere date: 10/7/20 9
  9. 9. Episode #4 Dealing with Defaults 10
  10. 10. What’s the Default? • Payment default • Technical default  Financial covenant  Other covenant  Technical but not covenant 11
  11. 11. The Changing Landscape of Bank Lending – How Commercial Lending has Changed over the Past Two Decades • Commercial loan officers do not have a prolonged apprenticeship so experience is limited; bank acquisitions have resulted in a loss of seasoned lenders • There is more money to lend than there are good loans to make so there is fierce competition for every deal • Lenders and their supervisors generally have compensation incentives tied to performance • There is a decline of the “generalist lender” and a growth of the specialists and niche lenders • Competition from unregulated lenders has increased 12
  12. 12. The Changing Landscape of Lending • Compliance issues have become much more important • Fee income is receiving more emphasis because of the competitive pressure on interest rates • Timing of write-offs and recoveries has become more important because of effect on stock price and compensation • Some borrowers have become “too big to fail” because of effect on financial performance of lender • Secondary markets for troubled loans have exploded • Amend and extend • Covenant-lite 13
  13. 13. Strategic Alternatives for Distressed Businesses 14 Chapter 11 Assignment for the Benefit of Creditors Creditor Composition Workout/ Forbearance Agreement Sale by Debtor
  14. 14. Strategic Alternatives against Distressed Businesses 15 Foreclosure Receivership Article 9 Sale Involuntary Bankruptcy
  15. 15. Factors that Affect the Decision 16 Future of the business going forward Size of the company Relationship with secured creditors Number of creditors and the amount of debt Cost and length of the process Buyer’s risk tolerance
  16. 16. Key Questions that Drive Strategy • Will customers care that debtor is having financial problems? • How is the debtor’s relationship with its key vendors? • Are any vendors irreplaceable as supply sources? • How competitive is the debtor’s business? • What is the liquidation value of the debtor? • What does a buyer want to do? • Are there personal guarantees? • Are related entities not troubled? 17
  17. 17. A Buyer’s Perspective • Buyers like to buy cheap but want to avoid risk • Some options are cheaper but pose more risk • Others are more expensive but pose less risk 18 Successor liability Allegations of fraudulent transfers What Legal Risks?
  18. 18. Chapter 11 Reorganizations • Petition is filed with the bankruptcy court (either voluntarily or involuntarily) • The debtor, as the debtor-in-possession, acts as the trustee of the business • Debtor-in-possession financing • Automatic stay • Rejection of certain executory contracts • Fixed priority order 19
  19. 19. Chapter 11 Reorganizations Advantages • Binds all creditors • Automatic stay (requires all creditors to cease collection efforts) • Sales are made free and clear • Rejection of burdensome contracts • Certain tax advantages 20
  20. 20. Chapter 11 Reorganizations Disadvantages • Higher cost • Longer process • Reporting requirements • Stigma associated with bankruptcy 21
  21. 21. Chapter 11 Plan Restructuring 22 Prepackaged (“Prepack”) Plan Prenegotiated Plan Consensual Plan Fast case (30-60 days); Creditors vote before filing; Unsecured creditors unimpaired, paid in full. Still often a speedy case; Creditors agree to terms before filing, vote after filing; Unsecured creditors may be impaired. More time needed; Creditors reach settlement after filing; Unsecured creditors represented by committee, impaired. Time consuming; settlement difficult and plan challenged by cramdown or impaired creditors or other stakeholders. Disputed Plan Petition Filing
  22. 22. Avoidance Actions • Borrowers may transfer assets or collateral to the detriment of the lender.  Keep assets away from lender in advance of enforcement actions or bankruptcy  Take advantage of documentation ambiguity or omissions when planning for possible distress or experiencing distress  Diminish value and enforceability of guarantees  Hide assets or divert assets to other more preferred creditors • Trustee or lender may avoid such transfers and bring the assets back into the mix through state law and bankruptcy law  Uniform Fraudulent Transfer Act – Uniform Avoidable Transactions Act  Bankruptcy Code sections on trustee’s avoidance powers, preferences, and constructive and actual fraudulent transfers (see generally 11 U.S.C. §§ 541-551). 23
  23. 23. Preferential Transfers • Preference transfer law (Section 547 of the Bankruptcy Code) provides after the fact protection to the debtor’s creditors • Preference statute covers payments on debt of “arms-length” creditors within 90 days of bankruptcy and payments on debt to “insiders” within one year 24
  24. 24. Preferential Transfers • Any transfer of an interest of the debtor in property:  To or for the benefit of a creditor;  For or on account of an antecedent debt owed by the debtor before such transfer was made;  Made while the debtor was insolvent (presumed for the 90-day period prior to the petition date);  Made (i) on or within 90 days before the date of the filing of the petition; or (ii) between 90 days and 1 year before the date of the filing of the petition, if such creditor at the time of such transfer was an insider; and  That enables such creditor to receive more than such creditor would receive if (i) the case were a case under Chapter 7; (ii) the transfer had not been made; and (iii) such creditor received payment of such debt to the extent provided by the provisions of this title • Unless all elements stated above are proven, a transfer is not avoidable as a preference (Section 547 of the Bankruptcy Code) 25
  25. 25. Preferential Transfers • If debtor proves all five elements, then a prima facie preference exists (debtor’s burden of proof) • To avoid disgorgement, creditor must then prove that one or more of the preference defenses exist (creditor’s burden) • The defenses are only relevant if prima facie preference exists  Contemporaneous Exchange Defense  Ordinary Course of Business Defense (ordinary for industry or between the parties)  Subsequent New Value Defense 26
  26. 26. Assignment for Benefit of Creditors 27 Much like a Chapter 7 Debtor assigns all of its assets to an independent fiduciary for creditors Fiduciary sells all the assets and distributes proceeds to the creditors Distribution is generally done in accordance with the Bankruptcy Code priority scheme
  27. 27. Receiverships • Available in stated and federal court • Receiver is similar to bankruptcy trustee • Distributions Similar to Bankruptcy Code • Single Creditor can seek appointment (versus standards of section 303 of Bankruptcy Code) • Greater flexibility within Receivership (less procedural rules and statutory regulations) • Receivership proceeding can be narrowly tailored in drafting the Receivership Order 28
  28. 28. Creditor Composition 29 Sometimes referred to as an out-of-court Chapter 11 Creditor composition is a contract between a debtor and its creditors All participating creditors agree to accept certain payments in full satisfaction of their claims
  29. 29. Creditor Composition Advantages • Will allow the company to work with its creditors to continue operations • May maximize going concern value of the company • Less expensive than Chapter 11 • No court or trustee oversight • No Chapter 11 stigma 30
  30. 30. Creditor Composition Disadvantages • Holdouts • May impose certain restrictions on Debtor • Lengthy negotiating process 31
  31. 31. Workouts • Since it may be difficult to obtain consent of nearly all creditors as required for a composition, a company may opt to seek concessions solely from its financial creditors (bank, equipment lessors, bondholders, etc.) • A Workout Agreement will restructure the debt of a particular creditor 32 Generally, Creditor will agree to deferred payments, extended time of repayment, and/or reduced total amount of indebtedness. In exchange, Debtor may be required to sell assets, grant additional collateral, meet certain operational benchmarks and/or be subject to heightened financial reporting.
  32. 32. Workouts Advantages 33 Because consent of all creditors is not required, generally easier to put in place Easier to negotiate because only one party and may not require disclosure of financial condition to other creditors
  33. 33. Workouts Disadvantages 34 Financial creditors are generally secured and may have little incentive to renegotiate terms Financial creditors may insist on restrictions on activities of the business
  34. 34. Tips for a Successful Workout • Borrower’s counsel will gain lender’s cooperation more readily if he or she is perceived by the lender to be part of the solution rather than part of the problem • During a workout, lender typically wants borrower to have access to effective legal counsel • If borrower believes lender’s actions in have created potential liability for the lender, borrower is faced with a choice because it is doubtful that lender will participate in a workout under threat • Replacement lenders do not come cheap, but borrower may want to pay price to preserve its causes of action. 35
  35. 35. “Naked” Sale by Debtor • Debtor sells its assets, generally to a secured lender, or to a third party (potentially to its own shareholders) with the consent of the secured lender. • Advantages  Quick and relatively inexpensive method of liquidating a business  May also serve as a quick method for the sale of a company as a going concern • Disadvantages  Requires consent of all lienholders  Treatment and impact of unsecured creditors.  Possibility of being deemed a fraudulent transfer  Breach of fiduciary duty concerns for board of directors of debtor 36
  36. 36. Article 9 Sales • Fast and inexpensive way to sell secured creditor’s collateral • UCC permits secured creditor to take possession of collateral and, without removing collateral from debtor’s premises, dispose of it • Sale must be commercially reasonable • Secured creditor may purchase collateral at a public sale but not at a private sale unless collateral has public market where the price can be readily ascertained • When the rules are followed, all of Debtor’s rights in collateral are transferred and subordinate security interests are discharged. • A good faith purchaser for value takes title free and clear even when secured party fails to strictly comply with the statutes 37
  37. 37. “Friendly Foreclosures” • Insolvent borrower + all assets liened + ready buyer = “friendly foreclosure” ? • Lender will want to make sure price being paid reasonably equivalent value of assets, certainly more than the lender could expect from a foreclosure and lender liquidation sale. • Other principal concern for lender is that the borrower and the purchaser are truly arms- length • Also may also “Bulk Sales” law (in those jurisdictions that have not repealed Article 6 of the UCC)  Foreclosing lender can sell assets without giving notice to borrower’s creditors because lender is not a person subject to the Bulk Sales Act. The lender is not regularly engaged in selling the goods being sold 38
  38. 38. “Friendly Foreclosures” - Process • Once lender has satisfied itself on the price and the independence of the purchaser and seller, lender will engage in an exchange of correspondence wherein the lender will declare a default, accelerate the loan and demand payment • In response, borrower will advise lender that it cannot repay the loan • Lender will then foreclose pursuant to its rights in the loan documents and the Uniform Commercial Code • Borrower will waive its rights to notice of the private sale, and lender will take control of the assets and sell them (usually without moving them) to purchaser who will receive lender’s bill of sale with warranty of title resulting from the foreclosure 39
  39. 39. Avoiding Lender Liability – The 10 Commandments for Lenders • In 1986, Helen Davis Chaitman writing in The Secured Lender (November/December issue) proposed a list of ten commandments for lenders involved in workout situations. Richard Carmody amplified them, and we thank both. • Do Not Make a Sudden Move  Unless absolutely necessary, give a borrower reasonable notice of your intent to terminate a lending relationship  Watch out for declaring a default under a “general insecurity clause” in a note (must be reasonably insecure)  Demand notes may not really be such if inconsistent provisions added  Document and substantiate the reasons for calling the loan 40
  40. 40. The 10 Commandments for Lenders • Do Not Tell a Lie or a Half-Truth –  This applies to credit inquiries and also to negotiations with the borrower; if you want to exit the relationship, tell the borrower up front • Honor Your Commitments  This applies to making loans and to working out loans. Stand by the terms of your loan documents  Commitments to make loans (or working out loans) or to take (or refrain from taking) other actions – the barest of writings has been held to be a commitment  If still negotiating, put a specific and explicit disclaimer in correspondence; do not soften language to make more agreeable to potential borrower 41
  41. 41. The 10 Commandments for Lenders • Do Not Run Your Borrower’s Business  Your liability can stretch to borrower and its creditors, including payroll taxes owed to the IRS  Too much control can make you a fiduciary, a principal, or a joint venture; decide how much control you really need  Potential liability to creditors of borrower if you “prop up” borrower to maximize your recovery while borrower purchases on credit  Do not control the board of directors and be extremely careful about having a banker serve as a director. Exercise of voting power can make you an insider under Bankruptcy Code 42
  42. 42. The 10 Commandments for Lenders • Do Not Use Third Parties to Bail Out of a Bad Loan  Insist on full disclosure to third parties because your desire to exit loan can be used against you • Keep Your Files Clean of Extraneous Comments  This also applies to your e-mail traffic within office  Disgruntled bank employees could deliver documents to a borrower  Make sure memos (and e-mail) are business like 43
  43. 43. The 10 Commandments for Lenders • Have a Workout Officer Take Over Troubled Loans  Personality problems can lead to cover-ups of bad situations or vindictive attitudes and action by the original loan officer  Need objective view of officer dedicated to maximizing recovery while minimizing liability • Confer With Workout Counsel  An early review of your situation and documents can be critical  You need an “emergency room” lawyer, not an “obstetrician” who insists on enforcing documents as written. Lawyer should be firm but not excessively confrontational. Situation may require change to lawyer with different style 44
  44. 44. The 10 Commandments for Lenders • Think Carefully Before Pursuing a Deficiency  Judgment proof debtors have nothing to lose by asserting counterclaims that are identified by counsel who would never have been involved but for a lender’s lawsuit • Do Not Be Arrogant  Lenders are not protected species  Put yourself in borrower’s position (are you being fair?) (is your action absolutely necessary to protect the bank) 45
  45. 45. About the Faculty 46
  46. 46. About The Faculty Hajar Jouglaf - Hajar Jouglaf is an associate at Sugar Felsenthal Grais & Helsinger who collaborates with clients to identify and resolve critical issues when dealing with distressed situations. Hajar also sits on the board of the Chicago Network of the International Women’s Insolvency & Restructuring Confederation. 47
  47. 47. About The Faculty Phil Buffington - Phil Buffington joined Adams and Reese in 2011 and serves as Leader of the Financial Services Team, and is a Partner in the Transactions Practice Group. For more than 30 years, Phil has served as a trusted advisor to community, regional and national financial institutions, and he routinely helps these institutions assess and analyze regulatory and litigation risks, including issues involving: His practice is focused primarily on the representation of financial institutions in corporate governance, transactional and bankruptcy matters. He serves on the Adjunct Faculty Staff of Mississippi College School of Law (Banking Law and Business Planning) and also serves as a Faculty Member at the Mississippi School of Banking (Commercial Lending I and II). He is a frequent speaker and presenter for CLE and other courses on topics related bank regulatory matters, commercial lending, secured transactions and other banking topics. 48
  48. 48. About The Faculty Harvey Gross - Harvey Gross is the founder and president of HSG Services Inc. He was formerly a vice president with Bank of America for over 30 years. He served as wholesale credit manager, wholesale team leader, and account executive. Gross supervised in sales, marketing, and insolvency recoveries. He was the past chairman of the Turnaround Management Association New Jersey Chapter and is currently a board member. Gross is also the executive director of IFA Northeast Chapter, IFA Southeast Chapter and executive director of the New York Institute of Credit. 49
  49. 49. About The Faculty Christopher Horvay - With more than 36 years experience, Christopher J. Horvay has represented senior creditors and asset-based lenders in complex litigation, workout and bankruptcy matters across the country. His practice also involves the representation of asset-based lenders in the documentation of complex loan transactions and in litigation disputes as well as the representation of creditor committees and liquidation trustees in litigation relating to fraudulent conveyances. Chris has consistently been recognized as an Illinois Super Lawyer since 2006, as well as an Illinois Leading Lawyer for the last two years in commercial bankruptcies and workouts. Chris’s recent creditor representations include senior secured lenders in Clark Retail Enterprises and United Airlines, significant landlord interests in K-Mart Corporation, and as special counsel to plaintiffs in Price v. Phillip Morris. He also served as debtor’s counsel in a number of significant business bankruptcy cases, including Ben Franklin Stores in the Northern District of Illinois. Chris has represented numerous asset purchasers, including Newport News, Inc. and Spiegel Catalog, Inc., and sellers in transactions involving troubled companies as well as assignees for the benefit of creditors in out-of-court liquidations. He recently defended former directors and officers of troubled companies in litigation brought against them by bankruptcy trustees. Chris has undertaken a leadership role in the Turnaround Management Association’s Chicago/Midwest chapter since its inception. He previously served as a TMA National Director from 1999 through 2002, as well as president of the Chicago/Midwest chapter in 1997 and 1998. In 2004, Chris was recognized by the Chicago chapter as its Educator of the Year. From 2014 through 2016, he has served as President of the Chapter’s Scholarship Foundation Board. In November, 2016, he received the Chapter’s Legend Award for outstanding service to the Chapter and the profession. 50
  50. 50. Questions or Comments? If you have any questions about this webinar that you did not get to ask during the live premiere, or if you are watching this webinar On Demand, please do not hesitate to email us at with any questions or comments you may have. Please include the name of the webinar in your email and we will do our best to provide a timely response. IMPORTANT NOTE: The material in this presentation is for general educational purposes only. It has been prepared primarily for attorneys and accountants for use in the pursuit of their continuing legal education and continuing professional education. 51
  51. 51. About Financial Poise 52 Financial Poise™ has one mission: to provide reliable plain English business, financial, and legal education to individual investors, entrepreneurs, business owners and executives. Visit us at Our free weekly newsletter, Financial Poise Weekly, updates you on new articles published on our website and Upcoming Webinars you may be interested in. To join our email list, please visit: