As Bankruptcy Storm Brews, Legal Pros Say Save Cash

By Dorothy Atkins
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Law360 (April 2, 2020, 10:42 PM EDT) -- The economic tailspin caused by the novel coronavirus outbreak will likely trigger a wave of bankruptcy filings across industries after local stay-at-home orders are lifted, legal experts say, prompting some to advise businesses to save cash and others to call for lenders and landlords to be flexible with debtors.

Although many businesses are already financially distressed, legal experts told Law360 that they don't expect to see a significant uptick in bankruptcy filings until a few months after the pandemic has waned and after shops are allowed to reopen.

By then, business owners will have had a chance to try to stabilize their balance sheets and pursue other out-of-court solutions before resorting to bankruptcy, said Cleary Gottlieb Steen & Hamilton LLP partner Sean A. O'Neal.

"We think companies are really going to try to use all the tools they can before pulling the trigger," O'Neal said.

O'Neal added that the economic fallout caused by the novel coronavirus has the potential to be as far-reaching as the 2008 financial crisis in terms of the number of bankruptcies filed, particularly since its impact goes beyond the financial sector and the housing crisis that triggered the Great Recession.

"It's a very challenging moment," he said.

O'Neal said businesses should start working now with lenders, who he suspects are also thinking about how long the stay-at-home orders will last and how much flexibility they can offer.

"Conserve cash, try to maintain good relationships with your lenders," O'Neal said. "But don't be afraid to be aggressive."

Chris Ward, chair of Polsinelli PC's bankruptcy and restructuring practice, said he, too, is advising clients to be patient and save cash, noting that "cash is king." He said that once the stay-at-home orders are lifted, he anticipates that more distressed companies will resort to balance-sheet restructurings and, if they are forced into bankruptcy, filing prepackaged plans so they can get through the process quickly.

Retail stores, restaurants and the hospitality industry are already dealing with revenue drops, but legal experts say there are also less obvious industries — including aviation, real estate, automotive, health care, energy and even the banking sector — that could face a financial blow from the outbreak, if they haven't already.

Ward said a "trickle-down effect" can occur when so many businesses close and workers lose jobs, with some businesses seeing revenue drops later than others.

For example, he said, if tenants stop paying rent on commercial space, that could put commercial mortgage-backed securities in jeopardy and threaten to upend the banking sector. Some health care facilities that rely on elective surgeries and other nonemergency procedures to beef up their revenues are already being forced to downsize and cut back workers' hours, he said, and those cuts could have long-term impacts.

Kleinberg Kaplan Wolff & Cohen PC partners Matthew Gold and Dov Kleiner said they've already seen an uptick in bankruptcy filings and expect more to come.

They said the pandemic can pose challenges for companies that try to proceed in bankruptcy during a crisis. As an example, the pair pointed to the high-profile bankruptcy case of Modell's Sporting Goods Inc. in New Jersey. A judge agreed to pause the case on March 27 after the retailer said government-mandated store closures had made it impossible to conduct liquidation sales that would help fund post-petition expenses like rent.

Even after stay-at-home orders are lifted, Bryan Cave Leighton Paisner LLP partner Jason J. DeJonker said some industries could see a delayed impact on their businesses as employers change their practices in ways that could have ripple effects.

For example, some companies might allow employees to continue working at home and decide not to rent office space, while others might be reluctant to let employees travel, which could take a further toll on the already-struggling airline and hotel industries, DeJonker said.

DeJonker added that the Coronavirus Aid, Relief and Economic Security Act, which was signed into law last week, may not be as helpful as lawmakers hope, and he said some businesses may try to save stimulus money for when they might need it the most, after the stay-at-home orders have been lifted and business is slow.

"It's not like you're suddenly going to have a line out the door," he said.

Gold and Kleiner noted that the two-year loans offered under the CARES Act, which can be forgiven if spent on rent and payroll, could serve as a major lifeline to some small businesses, but they said it's unclear what the overall impact will be.

"We're dealing with what is really an unprecedented event in American history and the American economy," Gold said. "Smart people can estimate how things will go, but what they have in terms of data and what they can point to in terms of how to calculate the impact [of the policies] is limited."

Ballard Spahr LLP partner Craig S. Ganz said that although the stimulus package will provide some short-term relief to struggling businesses, he doesn't think it will be enough to keep companies afloat if they were already struggling before the outbreak. There also will likely be a three-week delay in receiving financial relief under the CARES Act, which might be too late for some, he said.

"The bottom line is if you were an unhealthy company three weeks ago, this package is not going to help you," he said. "It may keep you on life support a little longer."

Ganz said he expects that once the wave of bankruptcy filings hits, the trend could continue through at least a portion of 2021.

For distressed businesses trying to avoid being part of that wave, Kleiner said they should apply for the benefits under the stimulus plan as soon as they can and make sure they have a strong understanding of their supply chains and customer base, and how those are impacted by the outbreak.

Jeff Bjork, global vice chair of Latham & Watkins LLP's restructuring and special situations practice, said companies and their boards should be doing everything they can now to maximize value, minimize costs and have proactive conversations with their lenders.

Bjork said some companies are already reacting by announcing layoffs and furloughs and taking other cost-saving measures, because they're likely looking ahead and preparing for a long-term drop in revenues.

"Everyone is navigating in this new environment and everyone is facing new challenges," Bjork said. "But waiting until you hit a wall is kind of the worst outcome."

Ganz, who works with property owners, is advising clients to partner with tenants and open up lines of communication to ensure those relationships aren't adversarial.

"This is not the time to start making enemies on either side of the table," he said.

Ganz said it's important that both landlords and tenants have a full understanding of a tenant's financial projections, and that companies staying open and thriving during this time aren't asking for rent reductions.

"This is not a time to be opportunistic," he said. "This is a time to be clear and level-headed, and to look at this as a partnership."

DeJonker, who works with lenders, struck a similar tone when discussing the relationships between lenders and debtors. He said although legal and contractual rights are important, holding equity in these companies is going to be just as important as companies try to navigate this financial crisis, and a lender's technique and conduct will likely come into play if the parties end up before a bankruptcy judge.

"Do whatever you can do to show a bit of humanity during this period of time," he said.

--Editing by Aaron Pelc and Emily Kokoll.

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