Editor: Please tell us about your background.
Wilen: I am an accountant by training, but my entire career has been focused in restructuring and turnaround business advisory matters, Chapter 11 bankruptcies, and forensic accounting investigations supporting bankruptcy litigation. I started with Arthur Andersen and also worked in the restructuring practice of Coopers & Lybrands, which was a national practice and now part of PriceWaterhouseCoopers. My involvement with a very high-profile bankruptcy in New Jersey (First Jersey Securities) led me to EisnerAmper, where I started a practice from the ground up. Today our Litigation Services consulting group consists of nearly 100 client service professionals, with over 25 professionals focusing on restructuring, turnaround and bankruptcy matters. We are a national practice with a global client base.
Editor: What is the role of a creditors’ committee in a Chapter 11 case?
Wilen: Any given company that is a Chapter 11 debtor-in-possession (DIP) has hundreds, if not thousands of vendors, landlords, litigation counterparties and other unsecured creditors. As a matter of practicality and judicial economy, these parties cannot individually be represented and active as stakeholders in the Chapter 11 process. Accordingly, the Office of the United States Trustees (UST), which is part of the U.S. Department of Justice and serves as a watchdog in Chapter 11 cases, appoints an Official Committee of Unsecured Creditors to represent all unsecured creditors in a particular bankruptcy – effectively on a fiduciary basis. In my view, committee participation is a powerful tool for creditors to represent their own interests and mitigate a large financial loss when a debtor company goes bankrupt.
Editor: Who is eligible to participate?
Wilen: Eligible participants include any unsecured creditor that is owed money by the debtor company and whose claim is not in dispute, which is a key distinction because debtor companies might dispute claims just to keep certain creditors off the committee. In these cases, the creditor must address the issue with the UST and explain why the claim is not rightfully disputed. Typically, if there is great interest in committee participation, the largest creditors are given priority; however, the UST also wants a fair representation, so it will allow a variety of other participants, including landlords, trade creditors, service providers, unions and governmental agencies.
Editor: What dynamics are at play during the bankruptcy process?
Wilen: Fundamentally, the process involves a bankrupt (or debtor) company; secured creditors, such as banks and holders of secured bonds; priority unsecured creditors, such as taxing authorities, and finally, general unsecured creditors. Standing above only the shareholders, who very rarely recover any value in a Chapter 11 bankruptcy, general unsecured creditors have a better chance of recovery if they take an active role in the process. Thus, an active committee can be a powerful player, and it is often viewed as a “thorn in the side” of the other players inasmuch as the available assets of the debtor company are of limited and often diminishing value.
For example, a bank or other secured creditor usually will demand all available assets as collateral protection for pre-petition secured loans and/or new money in the form of DIP financing, but where there are unencumbered assets, the creditors’ committee can negotiate for global settlements or carve-outs over the use of cash collateral or approval of DIP financing. Remember, creditors have different and sometimes unexpected reasons for wanting certain outcomes. Some prefer to keep the debtor company in business, thus preserving future sales, versus liquidating and taking what they can get. This goal may be shared by other committee members, such as unions, for the purpose of preserving jobs.
Editor: Is time a critical factor in this process?
Wilen: Time is often the key factor. These days, companies in Chapter 11 are highly leveraged with extreme liquidity constraints and a very limited runway before the administrative cost of Chapter 11 becomes too burdensome. It is very rare for a company to go into Chapter 11, undergo an operational restructuring and emerge as the same company. The restructured company may continue to exist under the old name, with the same assets and in the same locations, but a change of control of some kind usually occurs in the form of a debt-for-equity swap or a going-concern asset sale. While there’s a lot of activity during the first few weeks of Chapter 11 matters, these cases are finalized very quickly, so it’s important for a creditors’ committee to get involved right away.
Notwithstanding, some cases will linger after the initial aspects are handled and a going-concern or sum-of-the-parts asset sale goes through – usually in three to five months – but the committee doesn’t necessarily stay involved. Typically, these cases are handed over to a liquidating trustee, or they are converted to a Chapter 7, and a trustee takes over after the transfer of assets and pursues the remaining claims.
Editor: Does that outcome usually result in a meaningful recovery for the unsecured creditors?
Wilen: No. After secured creditors are paid, there is usually little or no value available for unsecured creditors. However, if the committee takes an active role, a sale often will result in assets being carved out for distribution to unsecured creditors, or unsecured creditors will agree to be satisfied with the elimination of a possible cause of action against them. In today’s bankruptcy cases, unsecured creditors often want two things: a debtor company that continues to operate and the assurance that committee members will not be sued for what’s called a preference.
Editor: What is a preference?
Wilen: This is a cause of action against creditors that get paid on antecedent, or older, debt within 90 days of a bankruptcy filing. The idea is that creditors should not be “preferred” and get paid during the pre-bankruptcy time when a company is presumed insolvent, while others don’t get paid. To provide a level playing field, the bankruptcy estate may sue the “preferred” creditors to recoup and redistribute that money according to the priorities provided for in the Bankruptcy Code. While we’ve successfully defended against such claims, the current trend is for the committee to circumvent this problem via negotiation of settlement terms that specifically eliminate the option for the estate to pursue these claims.
These terms represent one of the biggest values to a creditors’ committee, effectively mitigating the risk that a creditor with $1 million in debtor-company receivables might also be sued by a bankruptcy trustee for a $100,000 payment that was made three weeks before the bankruptcy filing. It sounds archaic, but it’s our law. The idea of redistributing funds paid to creditors within that 90-day period has become a very big issue for committees. Creditors certainly welcome some form of settlement, but more importantly, they don’t want to go out-of-pocket again.
Editor: What results might creditors’ committees expect in seeking your assistance?
Wilen: When we get into these cases and look at the overall transaction, there is often a need for a very quick assessment as to best opportunities for the committee’s purpose. Again, obtaining the largest settlement is not always a first priority; there may be other factors, and the true goal is to maximize the creditors’ overall recovery. Sometimes this involves getting the debtor company to agree to a quick sale transaction, and we’ve engineered this outcome for numerous clients.
A different scenario might find us telling the committee that something just doesn’t look right, at which point we’ll step in as forensic accountants and start deciphering historical transactions. Perhaps we’ll realize that this debtor hasn’t been 100 percent truthful in its financials or that questionable asset transfers were made to other companies, non-debtor affiliates, equity holders or other insider parties. While a healthy company may legitimately make such transfers, they are “constructively” fraudulent when a company is insolvent or becomes insolvent as a result of the transfer, and we’ve successfully unwound transactions when this is the case.
Editor: Are creditors’ committees afforded any influence in bankruptcy negotiations?
Wilen: Yes, and that’s a very important part of our work. First of all, an entity cannot emerge in a bankruptcy reorganization process unless an associated class was impaired, meaning its assets become valued at less than 100 cents on the dollar. Typically, if the bank as a secured creditor is paid in full and unsecured creditors get only 25 cents on the dollar, a creditors’ committee will be allowed a fairly substantial voice in the process. In that case, the unsecured creditor class is the fulcrum security, meaning that it is the most likely to be converted to equity in a reorganization process. Since creditors rarely desire ownership interests in the reorganized company, the committee can negotiate for “equity-like” returns with additional recoveries if the company exceeds performance thresholds after emergence. Here, our experience in the valuation of distressed businesses can be instrumental in the negotiations.
Even when banks aren’t paid in full, unsecured creditors retain some status because the courts don’t necessarily want secured creditors to use the Chapter 11 process to sell assets and leave unsecured creditors with nothing. Most judges feel that Chapter 11 should provide some benefit for unsecured creditors; otherwise, secured creditors could simply foreclose on their collateral pursuant to their rights and remedies under state law. While the court’s attitude might sound favorable to unsecured creditors, banks understand this dynamic and tend to view it as an acceptable offset to the benefits of the bankruptcy filing.
Finally, all creditors can benefit enormously from certain outcomes, such as a § 363 sale, which essentially involves an auction of the debtor’s assets during a bankruptcy. Section 363 of the Bankruptcy Code allows for the transfer of assets “free and clear” of all liens, amounting to the best possible title in the world. It enables buyers of troubled assets to proceed with perfect confidence that there will be no future title issues, and it is probably the most valuable asset in a U.S. Bankruptcy Court proceeding.
Editor: Tell us about the committee’s fiduciary duties.
Wilen: The fiduciary duty is clear as day, and members have an obligation to all creditors. Now this doesn’t mean that members can’t vote their own claims but rather that they cannot push for a plan that clearly is against the interests of other creditors. Also, members cannot trade on information while serving on a committee, so larger cases often involve court orders that bar members from trading in the aftermarket for claims and/or debt. Since this is big business in many cases, hedge funds typically don’t want to sit on these committees.
Offsetting these limitations is the fact that committee members have deeper access to information about the proceedings, which can form the basis for better decision making. If you have a big receivable, it’s better to be in the know than in the dark on matters critical to your business interests, and this is why, on balance, I advise clients to participate on the committee.
Editor: Do you have some closing thoughts?
Wilen: Well, when clients ask me about participating on creditor committees, first I tell them that I am sorry they are in the position of having a material receivable owed by a Chapter 11 debtor. To make the best of this situation, I advise participation on a creditors’ committee in order to stay informed about matters of great business/financial importance and to potentially influence the process toward a maximized return. This process also helps creditors present a united front and make sure everyone gets a fair share, particularly in situations where debtors are looking for ways to preserve value. Finally, participants can use lessons from these experiences to benefit their own companies, for instance in suggesting a fresh review of the company’s portfolio or a comparison of companies in a similar situation, which can lead to more productive policies on the balancing of sales efforts and risk management.