By Peter S. Goodman, Turnaround Expert
The following is a list of indicators/ warning signs that your company may be insolvent and in need of restructuring its balance. Promptly forecasting or discovering these indicators is a critical management function that can mean the difference between a successful corporate financial restructuring versus financial failure. Upon discovery that your company may be in financial extremis, management must make sure they have the expertise on hand to deal with the problem. Generally, the C-Suite does not have the corporate expertise to address insolvency and thus turn to hiring outside turnaround experts.
Turnaround experts may include the hiring of a corporate officer with expertise in financial turnarounds as well as a law firm and financial advisor that specialize in this area. If the company’s financial situation is severe, these professionals can assist with a turnaround plan that may include the filing of a bankruptcy petition under Chapter 11 of the United States Bankruptcy Code. A Chapter 11 petition allows for current management to continually operate the company in bankruptcy and automatically stays from collection all creditor claims. By staying all creditor enforcement actions, a Chapter 11 bankruptcy filing allows your company time to restructure its operations and exit bankruptcy under a payment plan approved by the Bankruptcy Court that binds all creditors.
Indicator 1 – Your company is in breach or is expected to be in breach of financial covenants in credit agreements or other material contracts.
- Promptly discovering or forecasting the breach allows your company time to engage with its lender. Normally, the lender would like to avoid a borrower default/bankruptcy filing. Consequently, the borrower has some leverage to negotiate an interim waiver or standstill agreement with its lender. The interim standstill will give the parties time to negotiate a turnaround plan.
- Should these discussions fail, the filing of a chapter 11 petition in bankruptcy automatically stays the action of a lender to collect on its loan.
- Many of the indicators discussed below can also lead to a breach of the company’s financial covenants.
Indicator 2 – Your company’s supply vendors require cash on delivery.
- If trade vendors suspect your company is insolvent, they can demand cash on delivery terms. COD demands can further exacerbate a company’s liquidity problems.
- If your company has an available line of credit it can offer letters of credit to important trade vendors.
- Discussions with the vendors, including discussions of possible turnaround plans may assist in providing terms other than cash on delivery, particularly if the vendor wants to preserve the business relationship or is concerned about a possible bankruptcy filing by the company.
- In the event your company files a chapter 11 petition, vendors that ship post- bankruptcy receive a priority claim that comes ahead of pre bankruptcy trade debt. Additionally, upon filing for Chapter 11 your company can request that the Bankruptcy Court authorize the payment of certain critical vendor’s pre-bankruptcy claims.
Indicator 3 – Your company faces an impending judgment that the company cannot afford to pay.
- The filing of a chapter 11 petition in bankruptcy automatically stays the execution of the judgement and may allow for an appeal of the judgement without the requirement of filing a bond.
- As an alternative to filing for bankruptcy your company can seek to negotiate an agreement with the judgement creditor delaying the execution of the judgement.
Indicator 4 – Your company has a negative valuation.
- While companies do not regularly conduct formal valuations of the corporate enterprise, if management suspects that the company may be insolvent it may be helpful to engage a valuation expert to perform either a formal or informal valuation so management can then assess its options while it still has time and liquidity.
Indicator 5 – Your company faces significant financial exposure, e.g, the company is upside down on financial hedges or has other significant off-balance sheet financial liabilities.
- Companies frequently find themselves in trouble because of ill-timed or poorly designed hedging transactions.
- The filing of a Chapter 11 petition may not stay the liquidation of the financial hedges, but it may stay the enforcement of a resulting claim against your company.
Indicator 6 – Loss of a major customer impacts your company’s ability to pay debts as they come due.
- The loss of a significant customer may adversely affect your company’s balance sheet and depending upon the significance of the resulting revenue loss can lead to bankruptcy/insolvency,
- The filing of a chapter 11 petition can buy time for your company to rebuild its customer base and reduce its overhead in the wake of the loss of the customer.
Indicator 7 – Your company has negative cash flow beyond two or more consecutive quarters and insufficient financial reserves to cover the gap.
- A company cannot survive without cash and negative cash flow over several quarter can deplete reserves, breach loan covenants and lead to insolvency.
- The hiring of turnaround experts who can assess the reasons for the cash losses can assist in the turnaround process.
- If the loss of cash cannot be quickly addressed and the company’s financial reserves are nearing depletion the filing of a chapter 11 petition must be considered to buy time to properly address the company’s financial structure.
Indicator 8 – Your company has dwindling cash reserves.
- Company’s that have no cash on hand make poor candidates in restructuring/bankruptcy cases. If reserves continue to be historically low and/or insufficient to continue operations bankruptcy or an out of court restructuring alternatives should be considered.
- The filing of a chapter 11 petition in anticipation of a successful restructuring requires the hiring of professionals e.g., lawyers and financial advisors, paying post-bankruptcy vendors, and other significant costs so having cash on hand at the time of a bankruptcy filing is critical.
Indicator 9 – Your company has significant financial losses.
- Occasionally, a significant financial loss can lead to insolvency and a bankruptcy filing.
- The impact of the financial loss on the company’s solvency and ability to conduct operations should be immediately assessed so that appropriate action can be taken. Such actions may include the retention of restructuring advisors as discussed above.
Indicator 10 – Your company is facing significant regulatory fine or penalty.
- Regulatory fines or penalties can lead to a cessation of critical operations and ultimately lead to a bankruptcy filing.
Indicator 11 – Your company discovers financial fraud.
- Financial fraud can be a common precursor to financial insolvency and a bankruptcy filing.
- Financial fraud can result in significant financial loss. In addition, the actions by regulatory authorities and court intervention resulting from the fraud can adversely affect your company’s financial condition and lead to a financial restructuring and/or a bankruptcy filing.
Indicator 12 – Material write-downs or write-offs of material assets which may impact your company’s financial viability.
- Writedowns and write-offs of key assets such as a significant customer receivable or the company’s inventory (if material) can lead to insolvency and a potential bankruptcy filing.
Indicator 13 – Your company’s loss of a material contract, license, or lease.
- Finally, it is not an uncommon event that the loss of a key contract, license, or lease leads to a company’s insolvency.
- As previously discussed, in the event of such a loss, your company should consider hiring turnaround experts to assess its alternatives going forward.