Fiduciary Services

Overview

---

MorrisAnderson is often engaged to act as a fiduciary for a financially distressed company or its estate. Often these projects involve a court supervised process, however, other times they are performed out-of-court. These projects are typically associated with either an asset sale or a business liquidation where creditors may not be paid in full. Fiduciary engagements are generally triggered by the lender’s Special Asset or Loan Workout Officer who decides that the lender will no longer lend to the company because they believe the business is either no longer viable or that a Turnaround Plan requires funding that neither the lender nor the owner is willing to provide.

Receiverships are primarily a state court remedy for a lender and are often agreed to in the event of a default under the negotiated loan documents. State Court Receiverships are mostly used as a more cost-effective way to sell or liquidate a company rather than the more costly Chapter 11 bankruptcy process. Because a state court can only issue rulings to bind parties within that state, state court receiverships are typically not used when a business has significant assets located outside of that state. Many states have rewritten their Receivership statutes in the last 10 years to provide processes very similar to Chapter 11 but for smaller local businesses and avoiding the costs of Chapter 11.

The use of State Court Receiverships for general business is a state-by-state issue of what is common practice in a specific state. In a Receivership, a fiduciary is transferred the assets of a company, but not the liabilities, that he or she holds the assets in trust and sells as either an operating business or in part as a liquidation to pay off creditors based upon creditor priority.

Federal Receiverships are also typically a consensual arrangement between business owner and lender, but the case must involve either an issue of federal law (this is difficult as loan documents are contracts of specific state law governance) or involve diversity between the parties (i.e., the owner and lender are domiciled in different states). Parties prefer to use Federal Receiverships when a company has substantial assets in several states or when a company has active litigation of a federal nature or of state court nature outside of a company’s home state. There is very little statutory guidance for a Federal Receivership and in general these processes are conducted using a process very similar to Chapter 11, but again, without the cost of a Creditors Committee.

Although all types of Receiverships are typically consensual, courts do grant motions to appoint a Receiver when filed by the lender in cases when the loan documents allow for that remedy or when the owner or management has committed a material bad act such as theft. Often when a business is facing the threat of a non-consensual appointment of a Receiver, the owner or the Board will choose to file Chapter 11 to retain control of the company.

Assignment for Benefit of the Creditor (ABC) is either a judicial process or a common law process without judicial oversight. The use of ABC’s is a state-by-state issue based upon what is common practice in a specific state. ABCs operate very similarly to State Court Receiverships in that the fiduciary is transferred the assets, but not the liabilities, and that he or she holds the assets in trust and sells the assets in whole as an operating business, or in parts as a liquidation to pay off creditors based upon creditor priority.

In general, Receiverships and ABC’s are usually consensual arrangements between the business owner and its lender (typically a bank), with the goal of getting the lender’s secured loan fully paid off and hopefully, some pro rata distribution to unsecured creditors. Since unsecured creditors have no statutory right to legal representation as a group in Receiverships and ABCs as they do in Chapter 11 cases, professional fees are much lower in Receiverships and ABCs than in Chapter 11 and the general unsecured creditors have little leverage negotiating a “process facilitation payment” as they often do in in a Chapter 11 case.

Additionally, MorrisAnderson can serve as a Chapter 11 Examiner which is a court appointed position serving as an officer of the court with responsibility to review one specific issue such as whether the owner(s) handled cash or other assets in a manner that was detrimental to creditors, or if professional fees charged to the estate were reasonable and necessary.

Finally, MorrisAnderson can serve as a Chapter 11 Trustee. This position is selected by a US Trustee to effectively replace the Board and the CEO of Chapter 11 company and is typically only granted by the Bankruptcy Court in cases of egregious company misconduct.

Independent Board Member

---

Companies may need to fill a Board of Directors role in the event of a director resignation, or if the Board is solely comprised of ownership relationships and company management, yet the insolvent company may be sold back to prior ownership presenting a potential conflict of interest.

Senior MorrisAnderson consultants are regularly asked to join Boards for the above reasons. Having an Independent Director for a distressed company especially where a Chapter 11 filing is a clear possibility is good governance and demonstrates that company ownership and the Board are taking due care to protect the interest of “all” stakeholders and preserve the company’s value.

Insolvent companies are typically worth less than the total amount of liabilities they have incurred. Chapter 11 can be used as a vehicle to sell the company “free and clear” of its debts with the sale proceeds being paid to creditors according to the bankruptcy’s Absolute Priority Rule. This simply means that the sale proceeds will be paid in legal priority order to creditors. Typically, unsecured creditors receive little value from these sale transactions.

However, in this scenario ownership may want to buy the company back a second time. An Independent Director will manage the marketing and sale process in a fair manner so that current owner doesn’t get an advantage over competing bidders, to the detriment of creditors recovery.

State and Federal Receiverships

---

These are state or federal court supervised processes where an independent party called a “Receiver” takes all the assets of a company into trust for the benefit of the creditors. Receiverships are legal actions where a creditor, most often a lender, petitions the court for appointment of a Receiver. The basis for appointment of a Receiver is usually contractually based with company consent given in the loan documents or based on an alleged bad act by the company’s owner or management that materially harmed the lender.

Most Receiverships are State Court Receiverships, but Federal Receiverships do happen as well. Typically, Receiverships are initiated consensually between the owner and the lender, although lenders can file for non-consensual Receiverships.

Judges are generally measured and cautious in granting Receivership motions. Typically, a Receivership Motion includes a lender recommended individual to be a Receiver. Judges do not always appoint the recommended person and occasionally appoint someone they are more familiar with. MorrisAnderson has performed State Court Receiverships in numerous states as well as multiple Federal Receiverships.

In general owners don’t like to give up control of their company, yet they are required to give up control in a Receivership. As such, if the Receivership Motion is not consensual, owners often file Chapter 11 before a receiver can be appointed to maintain control of the company albeit in a Chapter 11.

The primary duties of a Receiver are to marshal assets and determine the strategy to maximize net recoveries for creditors. Typically, that’s either a sale of the company or an asset-by-asset liquidation. Although Receiverships sometimes pay pro rata dividends to unsecured creditors, as in Chapter 11, these dividends are typically small.

Assignment for Benefit of the Creditors (ABCs)

---

Assignment For Benefit of the Creditors, or “ABCs” as they are commonly called, are essentially the same as a Receivership. Each state has a common practice of either doing State Receiverships or ABCs as opposed to a combination of the two within one state. ABCs are governed by statute in some states and operate under court supervision. In other states, ABCs operate by common law without court supervision.

ABCs are entered into consensually between owners and creditors with assets placed in trust with an Assignee for Benefit of the Creditors. The company or its assets are then sold. Although ABCs sometimes pay pro rata dividends to unsecured creditors, like Chapter 11, these dividends are typically small.

Liquidation Trusts

---

For the end of a Chapter 11 case that resulted in a company sale or liquidation, the Unsecured Creditor Committee has created a vehicle to provide some potential recovery for Unsecured Creditors and is known as a Liquidation Trust. Typically, a Trust is created at the end of a Chapter 11 case with a small amount of money and is charged with:

1. Pursuing Litigation
2. Collecting left behind assets
3. Reconciling Unsecured Creditor claims

Litigation is mostly pursued with attorneys on a contingent fee basis and often takes many years to fully resolve. Primary litigation areas are:

1. Creditor Preference Payments
2. Fraudulent Conveyance Transactions
3. Director and Officer lawsuits

Left behind assets often include assets such as: prepaid assets, deposits, cash collateral posted, and supplier over-payments. Finally, it is the duty of the Liquidation Trustee to review and reconcile all Unsecured Creditor claims so that pro rata distributions can be made in future. MorrisAnderson has extensive experience working in this fiduciary role.

Business Liquidations Management

---

Some businesses unfortunately must be liquidated because they are either simply not viable, or the business needs more capital, yet no one is willing to provide funding. Business Liquidations can be done in any setting: out-of-court, Chapter 11, Receivership, or ABC.

Although they may seem relatively straight-forward, Business Liquidations are more complicated than you would think. To maximize value, you should bring in experts like MorrisAnderson. There is a delicate balance between optimizing asset recovery value and minimizing costs that is constantly being evaluated during a liquidation.

Here is listing of key questions / issues to consider during a Business Liquidation:

• Accounts Receivable (AR) – How do you best protect recovering a high percentage of outstanding AR?
• Inventory – How do you sell substantially all inventory? Additionally, how should you handle goods on order or work-in-process inventory in the plant?
• Employees – How do you keep the core employee group around to help in the liquidation process? What type of financial incentives do you offer them? Do you give the WARN Act Notice and when
• Landlord – How do you communicate to the landlord that you will be shutting down and leaving the facility soon?
• Suppliers – How do you communicate the situation? What if you need more materials? How do you handle that?
• Customers – What do you communicate to them? How can you persuade them to buy some of your inventory and get paid on outstanding AR?
• Lender – How to you manage this communication?

Business Liquidations are often the most challenging projects we handle.

Bankruptcy Claims Management

---

When a company files Chapter 11, its Creditors should engage two strategies to ensure their specific debt or claim is recognized by the bankruptcy estate. First, all Creditors of record get notified of the Chapter 11 filing and should in all cases file a Proof of Claim as this is their best strategy to have their correct claim recognized. Second, the creditor should ensure the company’s information regarding their claim is correct. The company Schedules filed with the bankruptcy court lists all known debts of the company. If a creditor’s debt or claim is accurately reflected on the company’s Schedules and the company does not object to a creditor’s claim, then that represents a valid claim. The company’s Schedules may be incorrect due to delays in billing or applying payments, or due to generally poor accounting processes.

When a filed claim is materially different than a “Scheduled” claim (i.e., what’s on the company Schedules), then that claim needs to be reconciled. These claims are typically reconciled by the company, its Financial Advisor, or the Liquidating Trustee. The process is simply done by comparing the detailed open invoices each party shows, identifying the reconciling items, determining whether they were paid or not, and getting both parties to agree on the amount to resolve the claim. Often this reconciliation occurs years after the Chapter 11 filing. The company’s Schedules are public records that are available electronically. The company typically files these approximately one month after its bankruptcy filing. Article: Saving Midmarket, Closely Held Companies With Traditional Workouts by Dan Dooley