Restructuring and bankruptcy practice has evolved dramatically in the past few years, driven by market forces and modifications to bankruptcy laws. As a result, the role of the chief restructuring officer, or CRO, has also changed. This article will consider the changes, aspects that have remained constant and implications for clients and practitioners.
Increasingly complex capital structures, BAPCPA (the 2005 changes to the Bankruptcy Code) and inter-creditor strife (“tranche warfare”) have made it harder to truly reorganize a distressed business. Also, purchasers of debt in the secondary market demand an accelerated process so that they can monetize their investments quickly. Consequently, the goal in many restructurings today is to move valuable assets from a “sick” balance sheet to a healthier one quickly and efficiently, rather than to take the time to fix what is broken over the course of a more expansive (and expensive) reorganization process.
Selecting the Correct Type of CRO
As a result of these changes, the role of the CRO increasingly diverges from its traditional form. Today, CROs may be divided into two primary types:
Clients and practitioners involved in selection of the CRO should be guided by whether the situation requires a turnaround CRO or a sale CRO. They should make a conscious decision at the outset to select a CRO with the appropriate qualifications.
The turnaround CRO must be capable of operating the company, managing constituencies and developing a strategic vision. She should be part of a firm with resources to support this role. In contrast, a sale CRO needs to be more nimble. She should either be an investment banker or hire an investment bank to run the sale process. The sale CRO should not be part of a cumbersome firm as such firms inevitably drive up costs.
Both CROs, but particularly the turnaround CRO, need to provide leadership and establish control of an often chaotic situation. The turnaround CRO, especially, functions in a senior management role.
Both CROs must have a firm grasp of the restructuring and bankruptcy process and regulations. Regardless of the type of CRO, it is important for the CRO not only to project authority but also to work cooperatively with employees, fellow professionals and the various constituencies.
It is a truism that companies wait too long before appointing a CRO. The reluctance of the company’s leadership is understandable: No one relishes losing control, the CRO may uncover mistakes and the CRO’s loyalty is often in question. Legal counsel to the company can play an important role in helping the business owner or CEO move forward by serving as a trusted and wise guide. Recommending a particular type of CRO may ease the uncertainty of company leadership as the direction will be clearer — sale or restructuring.
Although written analyses of the CRO’s role avoid the topic, practitioners are aware of the frequent tension between the CRO and the company’s legal counsel. Each party blames the other — “lawyers do not understand business,” “the lawyer is just interested in running up the fees,” “the CRO is a cowboy,” “the CRO does not understand the complexities,” and “I can never reach him.” However, there are ways to alleviate the problem.
The first step is recognizing the sources of the tension. The training and focus of lawyers and CROs are different. Lawyers tend to see the issues through a legal lens whereas CROs are focused on financial considerations. Each generally underestimates the role of the other.
Here again, selection of the right type of CRO is important. Installing the appropriate CRO reduces tension because it provides accord on the direction of the engagement — sale or turnaround.
The next step is to choose a CRO who can complement the skill set of the lawyer in the restructuring or the sale. A CRO who can perform his role but also understands legal concerns is ideal.
At the outset, the company has to determine to whom the CRO will report. Understandably, a CEO generally prefers that the CRO will report to her. However, this may hinder the effectiveness of the CRO, particularly the turnaround CRO, whose analysis and judgment should be independent.
The preferred structure, particularly for the turnaround CRO, is for the CRO to report directly to the board of directors. Nevertheless, the CRO should exercise sensitivity in dealing with the CEO as a cooperative CEO is preferable to an obstructive malcontent.
The engagement letter should reflect the reporting structure and, if executed prior to a Chapter 11 filing, provide for such a possibility.
Managing Cash Flow
Both the sale CRO and the turnaround CRO need to take immediate action to manage the short-term cash flow issues. But there are subtle variations in their use of the CRO’s key tools — the “13-week cash flow” and signing power.
The “13-week cash flow” is not an easy tool to build with precision in a very short period so both types of CROs need to be proficient in achieving reasonable accuracy in a hurry. However, the sale CRO’s use of this tool is designed to bridge the company to a sale, whereas the turnaround CRO’s view is longer term.
Companies are loath to turn over signing power to an outsider but, to achieve true efficiency, the CRO should have control over the company’s spending — this is particularly important for the turnaround CRO. Even when granted this power, the CRO has to be vigilant as every company has its “back doors.” A CRO who is not only forceful but also wins the hearts and minds of the employees will be most effective.
While both the sale CRO and the turnaround CRO have to get immediate control over the cash situation, the turnaround CRO must also improve the company’s operations and develop (or work with others to develop) a long-term strategic vision for the company. The sale CRO in effect just has to keep the company alive and operating until an out-of-court sale or a sale under the bankruptcy code. If the sale CRO makes business changes, the focus is short-term — to prepare the company for sale.
Advances in communications are a major advantage for the CRO. The modern CRO should develop a consistent and clear “message” that will be disseminated both by the company and by third parties across all media, including the internet. The old boundaries between trade, employees, stockholders and other constituencies are mostly gone — all constituencies have access to communications. Also, instead of taking a defensive position, the CRO should communicate frequently, even if the news is bad. News travels fast and communication by the CRO of bad news enhances the CRO’s credibility. The “message” should begin with the “first day filings” and the CRO’s affidavit and continue consistently. The CRO can develop support from the various constituencies by conveying as soon as possible whether the goal is restructuring or sale. Selection of a sale CRO or turnaround CRO will signal the constituencies and facilitate consensus building. If the “message” changes, the change and reasoning should be quickly and decisively communicated.
The CRO needs to ensure that the secured lender will support the direction and timing of the company’s strategy. This can be achieved by consistent communication and reporting that demonstrates to the secured lender that it is protected and a viable strategy is being implemented. The task of the turnaround CRO is more complex in this regard but even the sale CRO needs to assuage the secured lender’s concerns and, particularly on timing, be willing to challenge the secured lender.
Many duties are relevant to both types of CROs but the turnaround CRO needs to take a longer view than the sale CRO. These duties include maintaining, modifying and finding debtor-in-possession financing and subsequent financing; executory contracts analysis, rejection and assumption; asset sales; vendor (including critical vendor) and customer negotiations and programs; employee retention, plans and programs; claims negotiation and resolution; managing outside professionals; plan development and developing a culture of trust within the company.
The CRO has to be prepared to make a hard decision as early as possible regarding the key question: “Is there a business?” If there is not, even the turnaround CRO needs to move to a sale or liquidation rather than an expensive and futile restructuring. If a viable business is salvageable, then the CRO must be prepared to articulate the way forward and, especially in the current situation where there are fewer of the old well-disposed constituencies, battle anyone opposed.
In a key respect, the CRO’s role remains constant — the CRO is hired to effect change. This requires forceful leadership. Unfortunately, “cowboy” CROs mistake decisiveness for reckless action. They are correct that a CRO must take decisions but they cast aside the thoughtfulness that is the hallmark of true leadership.
A successful leader brings convergence among the constituencies. The seemingly unlikely combination of strong will and consensus building is in a CRO’s DNA.
A leader inspires others to act. The financial and emotional strength of a company is sapped by protracted engagement of outside personnel. It is more effective for the CRO, especially the turnaround CRO, to win the confidence of the company’s employees. To do so, the CRO provides vision, honesty, transparency and realism. Tom Landry captured the essence: “Leadership is a matter of having people look at you and gain confidence, seeing how you react. If you’re in control, they’re in control.”
The decline in Chapter 11 filings and the truncation of Chapter 11 time periods have resulted mainly from factors beyond the control of practitioners but the expensive nature of the Chapter 11 process has contributed to the decline in the restructuring industry. Due to the leveraged structures of many large law and consulting firms, it is often difficult for process costs to be constrained meaningfully. Therefore, if the crisis situation calls for a truncated process, a sale CRO should be selected. A turnaround CRO should be installed only if there are the resources and the will to attempt a true turnaround. Selection of the correct type of CRO also makes available to the company the right experience and expertise. The appropriate CRO then can use the tools of the trade, provide leadership and work cooperatively in order to bring convergence between the constituencies. Clients and practitioners responsible for the selection of a CRO, therefore, should from the outset determine the appropriate type of CRO and select a CRO with the skill set required to achieve success.
Sheon Karol is a Managing Director of The DAK Group, an investment bank specializing in middle-market, privately-held companies, advising business owners on sell-side and buy-side transactions and financial restructuring. He has extensive experience working with clients both domestically and internationally. Atlas Award – 2018 Boutique Investment Banker of the Year. E-mail Sheon directly at skarol@dakgroup.com.