Surviving Bankruptcy

Landing on your feet after Filing for Bankruptcy can be Done—but It Takes Time

By Joe Nowlan, Associate Editor -- Industrial Distribution, 5/1/2006

Not long ago, there was a large company located on the West Coast. The man who started the business saw it prosper, eventually growing to the point where it was doing up to $50 million in sales. His son was working in the company for a while and, eventually, the father transferred the business to the son.

His son, however, didn't quite grasp the intricacies of running the business, at least not as well as his father did. But the son was wise enough to hire someone to come in and run the business for him as an outside CEO. That CEO, in turn, hired another friend to come in as the CFO. From there, trouble began and didn't stop.

Eventually, the company's difficulties accumulated, and in due time, its finances deteriorated so much that they reached the point of having $20 million in assets—but also $27 million in debt.

A variation on this story gets played out whenever a company declares bankruptcy—or, technically, files for bankruptcy protection, more commonly referred to as Chapter 11.

In the early 2000s, such a scenario was played out in many industries across the country. Combine the vagaries that come with running any type of business, with the dot-com crash that made waves across many industries, throw in the then-slumping banking industry and related difficulties—and reports of failing companies were becoming all too common.

Dave Thompson, president of Kennedy Manufacturing, can speak first hand of such an experience. Based in Van Wert, Ohio, Kennedy manufactures industrial tool storage equipment, such as steel tool chests, stationary and mobile workbenches, modular storage cabinets and specialized tool storage.

Unlike the son in the West Coast company, however, Thompson has a solid grasp on the industries to which Kennedy sells as well as the overall running of the business. In fact, it may be this very grasp that has enabled Thompson and Kennedy to forge through their Chapter 11 struggles of recent years.

Kennedy Manufacturing expanded considerably just before 2000, primarily to fit the projected needs of one of its top customers. But it soon turned out that the customer they expanded for didn't have the product demand that had been anticipated.

"At the same time, our bank decided that small manufacturers in the Midwest were not who they wanted to do business with," Thompson says.

Over the next few years, Kennedy went through a lot of downsizing and job cutting to keep their heads above water, Thompson says. Eventually, the company trimmed close to two-thirds of its payroll.

"As business fell drastically, we eliminated payroll," he says. "We let longtime employees go who were great people. But the requirements of the business had changed and their desire or ability to change with it wasn't in sync with how quickly we had to move."

Thompson is candid in recalling those days. While a big factor was what, in hindsight, looks like overly enthusiastic expectations by a favored customer, he doesn't point to that as an excuse.

"At the end of the day, management is responsible for when to expand and when not to," he says. "We didn't see the recession coming. But we were not alone in that."

Thompson kept his employees informed as things went along, he says. Kennedy was always an open company and he saw little reason to change, he explains.

Unfortunately, as Kennedy's industry was in overall decline, so were many others across the country, including the banking industry. A kind of economic version of a perfect storm was developing.

Kennedy had to work with various banks, in large part because some of the banks themselves were going through hard times, eliminating departments and transferring loans from one group to the next. It all added to an already unstable situation.

Eventually, the bank Kennedy was working with downsized and made the strategic decision that they didn't want Kennedy's loan anymore, Thompson says.

Every time a bank would go through this revolving door process, the pressure got more intense at Kennedy, he explains.

"We knew this was going to go nowhere," Thompson says now. "The longer the process goes, the more you're dealing with people who are truly caught in the cross fire."

More layoffs followed, but Thompson wasn't kidding himself or his employees. He realized that a Chapter 11 filing was a possibility.

Kennedy formally filed in February, 2004. Even more Kennedy jobs were being trimmed, as difficult as it was for him personally and the company.

"Business went in a different direction and their skills were no longer required," he says. "And that gets difficult. And, as you downsize, you are requiring people in certain positions to adapt to new skills. And if that's a challenge for them, then you're stuck."

When all attempts at payroll cutting, loan refinancing, etc., have been attempted—and Chapter 11 is filed—then what?

Bart Basi is president of the Center for Financial, Legal and Tax Planning, Inc., in Marion, Ill. He tells struggling companies that, ironically, the people who might be getting impatient, or worse, about delayed payments can often be allies in coming out of bankruptcy.

One company that Basi cites had its creditors put so much pressure on them, that there was not much left for the owner to do but to file for bankruptcy, he recalls.

"You've got to be sensitive to the creditors' needs," he says. "But also be aware that the creditors could close the business down, or help them to come out of bankruptcy."

Creditors are in a position to be a help or to play an adversarial role when a company goes into Chapter 11. A certain amount of mutual understanding and patience can enable the business to get back on its financial feet and, eventually, make payments and get back into a successful and profitable relationship.

Bankruptcy doesn't stop a business from operating, Basi explains. What it does is stop creditors from enforcing their claims. If a business files for bankruptcy protection, Basi says, it prevents lawsuits being brought against them to collect money.

But that business then has to go to court and work with a court-appointed receiver to turn the business around and eventually start making those payments. A list of creditors is compiled and the company is restructured. The receiver will also oversee a committee, usually consisting of business peers and, sometimes, a few of the company's creditors.

"The receiver is responsible for running the day-to-day operations," Basi says. "The committee members are only advisors or have advisory capacities."

More common these days is for companies to use the services and expertise of a turnaround specialist—a lawyer who determines what a company can do, and cannot do, to get out of Chapter 11 and, hopefully, become a profitable business again.

Holly Felder Etlin is an attorney with XRoads Solutions Group in New York. She is also the president of the Turn-around Management Assn., a non-profit organization focusing on corporate renewal and turnaround management.

"When we get to them, they will typically be on the verge of having to file for bankruptcy or do a major restructuring," Etlin says. "The first thing is to stop the bleeding and figure out what's causing the precipitous negative cash flow the company is experiencing. Find other sources of liquidity—or find things to stop spending money on—to at least bring the company, on an interim basis, to a break-even point."

Filing for Chapter 11 bankruptcy protection can be one way to do this, Etlin says. The struggling company would then not pay their vendors, at least for a while, and eventually get some breathing room. Once that's accomplished, it's vital to determine just what the company's specific problem is and if it can be corrected or not.

"You try to figure out whether the underlying fundamental business issue is solvable," she explains. "Are their competitors five or 10 times bigger, and so they just can't be competitive because they simply aren't big enough?"

In such an example, the eventual sale or liquidation of the company might be unavoidable. However, Etlin adds, if the issue is that the company's competitors have lower cost structures, for example, or have figured out a better format for customer service—perhaps the company could still be restructured and saved.

Once the underlying business problem is established, the turnaround specialist and the company's management team will attempt to negotiate with the creditors and various constituencies for the necessary time to fix the underlying business problem and, if possible, restore the company to profitability.

Many times, leaders of struggling companies are in a state of denial, according to Basi. A realistic approach, such as what happened at Kennedy Manufacturing, is somewhat unusual.

"It's very difficult for a business person to accept the fact that he's going down the tubes," he says. "[At that point], he can't effectively manage the business from a business standpoint. He knows his products, but he's too close.... They know how to sell but don't always have common business sense."

How long should all this take? One-size-fits-all answers are few and far between when it comes to Chapter 11 filings. But typically, Basi says, it takes four to six months to clean up the company and set up payment schedules with creditors—and, hopefully, get on the way back.

"If it can't be done, typically, in 10 months or so, then that's it, probably. You'll start closing down," Basi says, meaning the company files for Chapter 7. In Chapter 7—sometimes called a straight bankruptcy—any non-exempt assets are liquidated (or converted to cash) to pay part of the company's outstanding bills, as a prelude to the closing of the business.

From Etlin's perspective, the time frame varies, but if the company continues to have losses while you're turning it around, at some point, you'll just run out of money, she points out.

As part of the Chapter 11 process, the receiver will try to restructure the company to generate cash so the debt can be repaid in a way the creditors will find acceptable (e.g. over five years, with interest). If that's not agreeable to those creditors, often that will be the point when a sale of the business might be considered.

"If [creditors] would rather have cash instead of waiting—either because they don't have confidence in the management, or don't have confidence in the industry the company is in—they may say they'd rather have less cash now, instead of more cash tomorrow and the [potential] uncertainty."

On the other hand, Etlin points out that certain industries today are going through substantial consolidations and acquisitions, to the extent where the vendors may not like having fewer companies to sell to. In this case, many creditors will agree to be more patient towards a Chapter 11 company.

"That can shift the balance of power between the vendors and their customers," she says. "In those situations, the vendors would be willing to take partial recovery, perhaps...to be sure there is a 'go forward' business that they can sell product to. They can't afford to lose the [potential] volume."

As part of its recovery process, Kennedy Manufacturing had some of its creditors on its bankruptcy committee, Thompson says. It represents another factor that can be a potential advantage to recovering companies—their ongoing relationships with customers and manufacturing partners.

"This is a very relationship-driven channel," Thompson says. "The relationships alone won't allow you to keep the business [running] if your value proposition is wrong. But at least it will allow you to hear about it if something is out of whack.... And it has to be a two-way street. You have to be willing to be open [to comments], and not just with regard to the stuff that you're doing really well."

This includes customers, of course, but also distributors and other manufacturers, Thompson says, adding that he personally told as many people as he could about Kennedy's filing for Chapter 11.

"I've been fortunate enough to be in the industry for a while and know most of our customers personally. I wanted them to hear it from me instead of somebody else," he says.

Overall, Thompson says that his and Kennedy Manufacturing's dealings have gone well, Chapter 11 or not.

"Our major vendors were all supportive and our major distributors were supportive," he says, "[even though] we cost them some money. We tried to convince them that the path out was one of working together."

Thompson has lived in Ohio for most of his life. He started at Kennedy in 1980 and has been its president since mid-'90s, after taking over Kennedy from his father. Thompson had several chances, he recalls, to keep Kennedy's brand name alive while closing the operation.

"But that's really not who we are or what we are. I have a blended identity with the company, if you will," he said. "I believe what we do here is unique and that there is a need for our product. It's not like we were way out of sync with the market and there was no way to get back in sync."

Good will alone can't pay bills, of course. But Thompson thinks that his being open and upfront about Kennedy's Chapter 11 filing has been helpful as the company makes inroads towards recovery.

"Volume is staring to pick up and we're seeing our business come back somewhat," Thompson says. "We wanted to operate the company through this [Ch. 11]. We feel we fill a niche in the market and that it is a unique niche."