“The time to buy is when there’s blood in the streets.” – Baron Rothschild
When a client or a competitor files for bankruptcy, it is natural to reflect on the downside. What’s going to happen to my outstanding receivable? Is the market primed for a downturn? How am I going to replace any lost business? These concerns are very real and require meaningful thought and discussion. However, solely focusing attention on the downside can prove short-sighted. There are incredible opportunities in bankruptcy for the astute business person.
Imagine for a moment that you are the chief executive officer of Jane’s Pie Company, a third-generation bakery started by your grandmother, Grandma Jane. At 85 years old, Grandma Jane is still nominally involved, but you have been running the business for the last 10 years. Over the course of its 65 years in business, Jane’s has weathered numerous economic downturns and increasingly strange diets. Although Jane’s is largely a wholesaler – selling its pies almost exclusively to restaurants and grocery stores – you have been exploring opportunities for expansion. Now, imagine that Danny’s Desserts, a confectionary and retail bakery with fifteen locations across the state files for bankruptcy. Danny’s was a client of Jane’s and represented 15% of Jane’s total pie sales. Further, Danny’s owes Jane’s $200,000 upon its bankruptcy filing, a significant sum for your company that may not be repaid.
The pitfalls are obvious, but where are your opportunities?
First, breathe. In many chapter 11 bankruptcies, the company will continue to operate during its case with the financial assistance of a secured lender, most often its bank it has been using for years. Danny’s owes a lot of creditors a lot of money and the company is probably more valuable as a going concern than as a cadaver.
Once you’ve caught your breath, it is time to take stock of what Danny’s bankruptcy filing means to Jane’s Pie Company. First, sit down with Grandma Jane. Over the course of 65 years, Grandma Jane has helped Jane’s Pie Company weather more than one storm, including most assuredly, the insolvency of a key customer account. Despite market fluctuations or changes in the economy, most basic economic principles remain consistently applicable. Perhaps years ago, Jane’s Pie Company acquired a competitor in foreclosure, leading to exponential growth. Or maybe Grandma Jane’s insistence on diversifying sales between grocery stores and retail bakeries was premised on the loss of a key customer. Whatever it may be, a customer’s bankruptcy filing is far from a unique occurrence and you should look to your brain trust to grow from the experience.
Second, examine the market and any macroeconomic implications. Why did Danny’s file for bankruptcy? Is Oprah getting everyone back on a health kick or is general discretionary spending on baked goods down across the country? In either case, what happened to Danny’s is a lesson that cannot be ignored. If there is a health craze, then find a way to market healthier pies (e.g., gluten free crust with organic low-fat blueberries). If the impetus was macroeconomic, reevaluate whether paring back your expenses will help Jane’s avoid the same fate as Danny’s.
Third, if Danny’s downfall was not based on factors impacting the industry as a whole, what was the cause specific to Danny’s? Did Danny’s expand too quickly? Did Danny’s rent or own its locations, and in either case, was this the more prudent financial decision? Or perhaps Danny was simply charging too much for his desserts. In any instance, the opportunities in bankruptcy here show there is much to learn from failure and the collapse need not be your own for the lessons to be learned.
Danny’s bankruptcy may have led you to a few sleepless nights and an almost unhealthy review of your finances. For whatever reason, you can’t shake the nagging sensation that this may be the opportunity to expand Jane’s Pie Company that you’ve been searching for. When a client or competitor files for bankruptcy, there exists a unique opportunity to acquire the bankrupt company’s assets free and clear of all liens and encumbrances, often at an incredible discount compared to purchasing the same assets from a healthy company.
Assuming Danny’s cannot successfully reorganize its company, which requires extensive creditor support, its assets can and will be sold through bankruptcy. This sale can include Danny’s Desserts as a going concern (someone buys the still operating business and runs it). It can be a sale of Danny’s Desserts as multiple going concerns (several different parties each buy some of Danny’s retail shops to run them as separate businesses). Or it can be a pure liquidation of Danny’s assets (someone buys the coffee mugs and dessert plates, but the locations are shut down). In all three cases, assets can include both tangible and intangible property. For instance, in Danny’s case, its state of the art equipment, its premier lease at the corner of State and Main, and its accounts receivable can all be acquired through the bankruptcy. You can even buy customer lists and intellectual property, including its copyrights and trademarks.
What if Jane’s wants to acquire Danny’s as a going concern but doesn’t want the expensive lease at State and Main? Bankruptcy provides for the opportunity to cherry-pick those more favorable contracts while negotiating or rejecting less favorable ones. In other words, you can buy Danny’s as a going concern and decide at the time of sale that you don’t want the State and Main lease, which can be left in the bankruptcy. Post-sale, you will own Danny’s but won’t be burdened with the State and Main lease that ultimately led to Danny’s financial distress.
Alternatively, after looking in the mirror and chatting with Grandma Jane, you decide not to branch into retail. That, of course, means that you need to find a way to replace any lost business that may arise should Danny’s close its doors. One way to accomplish this goal is to help direct the sale of Danny’s Desserts to one of your other clients or Danny’s competitors. By acting as an ad hoc broker for the bankrupt company, Jane’s may help find a friendly buyer, thereby averting a loss of revenue.
[Editor’s Note: For more information about the basics of buying assets from a bankrupt entity, you may benefit from reading Buying Operating Assets from a Distressed Seller: a Practical Guide to Assessing Legal Risk and 90 Second Lesson: First Step When Purchasing a Distressed Business.]
In addition to the aforementioned opportunities in bankruptcy, there is more gold to be mined from a bankrupt entity. For instance, the bankruptcy of a client or competitor creates a chance to hire some of the company’s current (and best) employees. In the case of Danny’s Desserts, assume that in addition to selling Jane’s pies, Danny’s also sells its own baked goods. In fact, Danny’s employs the renowned Chef Waldo, a pastry chef known for his cherry cobbler. The bankruptcy of Danny’s Desserts creates an opening for Jane’s Pie Company to woo Chef Waldo, who wants to assure his own financial security.
Also, because bankruptcy requires comprehensive disclosures, an observant party can learn what other relationships the bankrupt company may have, and how much they may owe these counterparties. What if, for example, in reviewing the bankruptcy filings you learn that Danny’s Desserts has a contract with Perry’s Pies, your main competitor, and that Perry’s is selling pies for $2 less per pie than Jane’s. You may want to revisit whether Jane’s can reduce its price per pie. But what if you find that Danny’s owes Perry’s $750,000 at the time of its bankruptcy filing, an amount that threatens Perry’s financial stability. Jane’s awareness of its competitor’s challenges can prove advantageous.
But be careful not to open yourself up to a lawsuit based on a non-compete provision or on a legal theory such as intentional interference with contract.
Digesting the vast opportunities in bankruptcy that have arisen from Danny’s Desserts doesn’t make the $200,000 outstanding receivable go down any easier. While a bank can seek to foreclose on its collateral if it isn’t paid, it’s unlikely that Jane’s debt is secured by any of Danny’s assets. The last thing Jane’s can afford to do is to throw good money after bad. In other words, it probably doesn’t make sense for Jane’s to pay its corporate counsel $25,000 to chase a receivable that suddenly looks like it may not get repaid.
Congress sought to redress this issue. Under the Bankruptcy Code, the United States Trustee, an office of the Department of Justice, is obligated to form an official committee of unsecured creditors as soon as reasonably practicable after the bankruptcy filing. Unsecured creditors are those such as Jane’s whose debt is not secured by any of Danny’s collateral. The committee, generally made up of between three to seven unsecured creditors, is entitled to participate in the bankruptcy case and to fight for the rights of all of Danny’s unsecured creditors. The committee is authorized to hire its own attorneys and other professionals, which are paid for by the bankrupt company’s estate at no cost to the committee members individually. That means that Jane’s can participate in Danny’s bankruptcy case as a committee member, with legal and financial representation, to ensure that neither Danny’s current executive team nor Danny’s senior lender take advantage of unsecured creditors.
The committee acts as a board of directors, meeting regularly (often over the phone) to make business decisions about whether to support or oppose the bankrupt company’s decisions and to be provided information that is of interest to the committee members from its professionals, who obtained such information from the company. For instance, if Danny’s sought to sell all of its assets to one of the owner’s cousins for less than fair value, the committee could instruct its attorney to oppose the sale. Likewise, if Danny’s lender agreed to finance Danny’s bankruptcy filing but sought an exorbitant interest rate, the committee could push back on the agreement. And because unsecured creditors are often the most affected by a company’s bankruptcy filing, bankruptcy courts often look to creditors’ committees for direction.
You, as a committee member, will also learn specific details of Danny’s financial condition and operational prospects that are invaluable to your daily business decisions as a supplier. Is Danny’s having trouble making payroll? Should I continue to supply Danny’s while in bankruptcy? Is it safe to extend credit or should I be on COD? Is there sufficient liquidity to pay for the next shipment I am preparing? Is Danny’s likely to continue operating, or are they facing a situation where they will have to close all their locations? When are closures planned? Who is interested in purchasing Danny’s business, and what are their plans? When and how much can I expect to get paid on my $200,000 receivable?
And most importantly, knowledge is valuable but often difficult, time-consuming, or expensive to obtain. Through serving on a committee, creditors such as Jane’s gain an unparalleled insight into the anatomy of a bankrupt company and advice of experienced bankruptcy professionals. While some of the information obtained must remain confidential, there is no prohibition on using the information gained for your own benefit when making decisions. Serving on the creditor’s committee is an ideal way to participate in the bankruptcy case.
Success in business is in no small part based on opportunity and creativity. The opportunities in bankruptcy provide a unique opportunity to learn, pivot and grow. If Jane’s Pie Company hopes to be selling pies in generations four, five and six, you’ll need to find ways to use the Danny’s Desserts you come across to your advantage.
Michael A. Brandess, a partner at Husch Blackwell and part of the Bankruptcy, Reorganization and Creditors’ Rights practice group, is consistently recognized for his dedicated and zealous representation of his clients, finding the most efficient and creative solutions, securing his clientele the most value for their claims. Michael’s practice focuses on the representation of asset…
Mr. Crockett has considerable experience in providing financial analysis and financial, litigation, and bankruptcy consulting. He assists creditor committees, debtors, secured lenders, management, boards of directors, and fiduciaries with bankruptcy, restructuring and turnaround, financial and accounting issues, merger and acquisition due diligence, profitability enhancement, operational performance improvement, recapitalization, damages analyses and various other transactions both…
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