In The COVID-19 Wave Of Bankruptcies, Creativity Is Key

By Vince Sullivan
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Law360 (April 10, 2020, 6:01 PM EDT) -- An onslaught of bankruptcy filings expected in the wake of the COVID-19 outbreak is forcing restructuring professionals to engineer creative solutions to protect their clients' value as they ask courts to be flexible when administering cases in these turbulent economic times.

While no standard protocol has yet been adopted, the recently altered landscape includes efforts by new debtors to in effect mothball their estates pending the end of the COVID-19 crisis, and bankruptcy judges have been amenable to such requests.

Stephen Lerner, global chair of the restructuring and insolvency practice group at Squire Patton Boggs LLP, told Law360 that the flexibility of the courts will be key for many debtors to mount successful Chapter 11 cases in the near future.

"I do think we're going to see courts feeling they need to bend the rules, not break them, in order to provide relief that may not be strictly in accordance either with the Bankruptcy Code or the way things have been done," Lerner said. "This is an opportunity for creative professionals to find ways to convince bankruptcy courts that, absent certain relief they're seeking, this restructuring effort will fail and people will lose jobs."

Debtors have deployed these tactics already, with sporting goods retailer Modell's gaining approval for a 45-day pause in its Chapter 11 case from a New Jersey judge and restaurant chain owner CraftWorks Parent LLC getting similar relief from a Delaware judge. Those debtors sought to minimize the costs to their estates after restrictions on nonessential businesses because of the pandemic forced them to cease operations virtually overnight, eliminating their revenue streams and leading to massive layoffs.

The key to convincing courts that this type of "mothballing" relief is necessary and appropriate is forging consensus among all parties to the case, Lerner said. If there are no objections to a pause, judges are more likely to grant that type of relief, he said.

"When you have a debtor, its lenders, its creditors committee and the United States trustee all supporting a mothballing of a case, or not requiring rent to be paid for a period of time, I think the courts are going to very easily go along with that," Lerner said.

Efforts from home furnishing retailer Art Van Furniture to enact this type of "life support" mode for its own Chapter 11 case crumbled in early April when agreement between the debtor and its secured lenders proved elusive, and the bank was no longer willing to fund the case. The COVID-19 restrictions also led that company to shut down its operations and lay off employees, and mounting labor and benefit costs outpaced the pledged funding from its lenders. Art Van Furniture converted its case to a Chapter 7 liquidation April 6.

The unique challenges of the current climate are far more pervasive than in the 2008-2009 economic downturn, according to Karol K. Denniston of Squire Patton, who told Law360 that entire industries have had their revenue dry up and their lending market frozen in response to the unprecedented and paralyzing global impact of the disease.

Companies that were already teetering on the edge of the bankruptcy precipice will be the first to tip into court, she said, but the seismic shift in the landscape will be sure to drive otherwise healthy companies into bankruptcy, and there isn't yet a road map for how to handle the current circumstances.

At least initially, these cases will likely take the same track as Modell's or CraftWorks and seek to press pause until a path forward becomes evident, Denniston said.

"The idea is you can park and wait until you get some sense of what the new normal is going to be," she said.

During a webinar hosted by Squire Patton and the American Bankruptcy Institute on April 6 discussing tools to navigate the crisis, Michael C. Eisenband of FTI Consulting Inc. said many lenders are expected to be more permissive in terms of calling defaults on borrowing companies in order to fend off a bankruptcy filing in the next few weeks and to avoid a rushed liquidation of the assets serving as collateral.

"I think you're going to see a reluctance of lenders pushing companies into Chapter 11," Eisenband said during the webinar. "Under the current environment, you're talking about potential liquidations that would be bad for everybody, including all lenders. They lead to very minimal recoveries."

Also during the webinar, Denniston said the lenders appear to be more willing to work with companies that are open and clear about their liquidity needs. It is in everyone's best interest to preserve value, and a quick-trigger fire sale destroys value in a landscape where it is becoming increasingly difficult to get an accurate valuation, she said.

The time allowances that have gained support from bankruptcy judges in the last few weeks will also provide opportunities for debtors to explore loans or grants from the federal government under the recently passed $2.2 trillion Coronavirus Aid, Relief and Economic Security, or CARES, Act. Ravn Air Group, a regional Alaskan passenger and freight airline that filed for Chapter 11 on April 5 in Delaware, said it has submitted applications for funding under the CARES Act but couldn't afford to wait for a decision on its eligibility before seeking protection in the courts.

Former Ohio Rep. John Boehner, who was speaker of the House from 2011 to 2015, also participated in the webinar in his role as a strategic adviser at Squire Patton and said additional federal spending bills are likely on the horizon and will seek to provide more targeted relief as Congress tries to stabilize the economy.

"Clearly there is going to be more action taken by the federal government in response to this challenge," he said.

While bankruptcy professionals did not specifically predict a worldwide disease outbreak, those who read the tea leaves say they were prepared for an inevitable retraction of the economy and expanded their bankruptcy teams and internal organization in expectation of a recessionary period after seeing certain markers — like the inverted yield curve that emerged in 2019. When short-term bond investments yield higher returns than long-term bond issues, the yield curve is said to be inverted, which has been a reliable indicator of a coming recession for decades.

Christopher R. Donoho III, global restructuring head of Hogan Lovells, told Law360 recently that the firm has been preparing for more than a year when it became evident that the longest economic expansion in history could not last forever. Since mid-2018, the firm has more than doubled its U.S. restructuring practice, he said. The pandemic clearly accelerated the contraction of the economy, but Donoho said his team was ready.

"We obviously view this as a remarkable, once-in-a-hundred-years kind of event," he said. "But also we recognize that this was, as much as anything, a catalyst for overlevered companies and companies that had been in trouble anyway, but kept afloat by the enormous liquidity in the market."

Hogan Lovells' expansion efforts have bolstered its American practice as well as its international offices, with restructuring attorneys added in London, Paris and Hong Kong, Donoho said. With more than 2,700 attorneys worldwide, he said the firm is set up to represent large companies, institutional lenders and cross-border interests.

With the widespread impact of the disease on the economy, Donoho said that now, more than ever, it is critical to have team members who are able to react nimbly to disarray in any business sector.

"All bankruptcy people at their core are industry-agnostic, but also incredibly adept at learning enough about an industry to understand the fundamentals of how it works and be able to understand how to restructure it," he said. "What we did in terms of our hiring was less industry-focused and more focused on what part of the market we are most able to participate in and where do we see our work coming from."

The attorneys that have been brought on over the last year were targeted for their ability to serve clients in a meaningful and effective way, rather than with an eye toward bulking up revenue through mere quantity of work, Donoho said.

"This was really a coordinated effort to build a synchronized team capable of advising clients in really complicated situations," he said.

At Squire Patton, Denniston said she is leading a large COVID-19 task force filled mostly with restructuring and insolvency attorneys, and that the firm has embedded some of those attorneys in other practice areas to have an "on-call" presence as clients need restructuring advice in the ever-evolving crisis.

A critical part of the firm's response has been its daily policy updates giving its attorneys frequent information about the federal government's actions in response to the pandemic. The policy team at Squire Patton is key to answering questions about the CARES Act and has brought all of the practice areas together for two or three calls a week to inform everyone about the opportunities available under the legislation.

Denniston said the most important thing for survival in the current climate is the ability to pivot when needed and the need for current information to make the best decisions for clients.

"We are going to wake up every day in a new world whether we like it or not," she said. "The businesses that survive are the ones who understand that."

--Editing by Jill Coffey and Alanna Weissman.

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