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“Troubled Loans Still the Issue of the Day - Workouts Can Provide Relief”

By

Mitchell Miller, J.D. & M.B.A. and Ben Harvey, J.D.

As published in the October 2011 California Hotel & Lodging Association E-Newsletter.

Despite improved operating performance in many markets resulting in improved operating cash flow and somewhat improved property values, 2011 is still a marketplace full of loans in default and scarce debt financing for refinancing or acquisitions.  If your loan is in default , pre-bankruptcy workouts can provide relief at a lesser cost, and without the hassle and stigma of filing for relief under the bankruptcy system.

Generally, there are two types of bankruptcies: Chapter 7 (“Ch. 7”) liquidations by which assets are sold to  pay off creditors leaving debtors free from further obligations for those debts; and Chapter 11 (“Ch. 11”) reorganizations in which current debts of the debtor are restructured to meet the cash flow realities. Using these possibilities as a back drop in workout negotiations can improve the outcome for the borrower.

Borrowers try to avoid liquidation because they lose their assets.  In Ch. 7, lenders often receive less than they might otherwise.  In contrast, the successful Ch. 11 requires that the creditors receive at least as much as they would in Ch. 7.  Consequently, creditors usually view their situation with liquidation in mind, even though the Debtor will not undergo liquidation.

With a bankruptcy filing  as an unwanted but real option, borrowers are using the potential outcome of that process as leverage to persuade lenders to workout defaulted loans without the borrower having to actually file a Chapter 11 proceeding.   By using the bankruptcy process as a framework for settlement negotiations, borrowers can alter a bank’s perception of its potential outcome in a Ch. 11 proceeding,  thereby enhancing the borrower’s negotiating position. 

In Ch. 11, secured debt that exceeds the value of the secured asset will be treated as unsecured debt.  So long as unsecured lenders receive more in the Ch. 11 reorganization plan (“Plan”) than they would in a liquidation (“Ch. 7”), the Court will often approve the Plan with payments over as long as five years, often at a small percentage of the underlying obligation.  After the Plan is approved, the secured debt moving forward will be the fair market value of the property, not the face value of the Note.  The Plan can also readjust interest rates, payment amount and even extend loans that are close to maturity sometimes without the lender’s approval.

Presenting the potential Ch. 11 outcome in a pre-bankruptcy workout setting can be very useful in successfully negotiating a workout with your lender.  Even if unsuccessful, the strategic work necessary to formulate and present a proposal to the lender can be used in documenting the Plan in a Ch. 11 proceeding, thus decreasing the cost of preparing a Plan.  These negotiations and processes are complex but can be very effective.  The foregoing is intended to alert the reader to the opportunities,  but in no way a comprehensive discussion.   The main point to remember is that positive outcomes can be realized.

Miller Law Group, P.C. is a full-service hospitality law firm representing hotel owners and management companies.  For more information about the firm, visit www.millerlg.com or contact us at 650-566-2290.