trends

The B Word

David Adelman
Without question, we are in the midst of one of the worst global economic meltdowns of the last hundred years. Few industry sectors have been spared, including the adult entertainment sector, which until now had been considered by many industry experts to be recession-proof.

Some adult companies have already fallen by the wayside. Many other adult companies are really struggling to survive.

The adult companies which will survive are those being run by proactive rather than reactive owners - owners capable of facing the harsh realities of this economy, owners with the intestinal fortitude to ask very tough questions, owners willing to consider new and innovative approaches to their previously tried-and-true business methods and owners with the courage to act swiftly and decisively when necessary.

So your content revenue is way down from last year, you've had to lay off your best post-production guy and one of your salesmen, you're locked into a five-year lease, which is now priced way over market, you've just received a letter from your bank informing you that your credit line has been reduced and you haven't been able to take a draw for over a month. What to do?

The proactive owner won't be afraid to pick up the telephone and speak with his trusted advisors (his attorney, his accountant, his business manager) about his options, one of which should be the "B" word – "Bankruptcy."

In Ernest Hemingway's "The Sun Also Rises," Mike Campbell, a drunken, grizzled Scottish war veteran, is asked how he went bankrupt. He replies, "Two ways - gradually and then suddenly."

This quote requires some explanation. Businesses start to go bankrupt slowly - spending exceeds income, debts pile up, bills go unpaid. The pressure builds at a slow and unrelenting pace. Then the suddenness kicks in - collections get worse, credit lines are not renewed or are reduced, a big customer goes elsewhere, a lawsuit is filed, a writ of attachment hits a bank account. All of a sudden, everyday business comes to a screeching halt.

For the business in distress, the proactive owner must move beyond the denial stage and recognize the scope and seriousness of the problem. The best remedy will depend on a variety of factors, which will be examined below. The first and most important decision a business owner should make when staring up at these seemingly insurmountable obstacles is the retention of an experienced bankruptcy lawyer. Bankruptcy, a truly specialized legal field, can be a trap for the unwary lawyer.

Bankruptcy Court rules and procedures are unique, the strategies employed can be complex and the inevitable negotiations that will occur must be handled delicately.

Also, the thousand-pound gorilla in this situation will always be the bank that has extended credit to the business in a variety of forms, typically, accounts receivable financing and term loans that are secured by the assets of the business.

Coming to terms with the secured lender is also an important first step and involves open communication. The full story needs to be told so that the lender can make an informed decision on whether it will be prepared to assist in the workout process.

On the assumption that the relationship has been good up until the time of business reversal, most lenders will cooperate in a process designed to keep the company going or realize maximum value for the assets if the owner decides to shut it down.

The Workout Scenario
If the decision is made to go forward and the secured lender is on board, then a troubled business should rely upon its bankruptcy lawyer to attempt to negotiate individual settlements with creditors. Make no mistake, this can be a frustrating, time-consuming and expensive process.

As one deal is negotiated, another deal pops up, and so it goes with new claims and potential litigation following the ones that have been successfully settled.

In certain situations which involve a large number of creditors, the bankruptcy lawyer may recommend that the troubled business engage the services of a nonprofit credit management association to assist the insolvent company either with a workout or liquidation plan. This is often a cost-effective alternative to bankruptcy.

In a workout scenario, this process starts with an invitation for creditors to meet with the troubled business and its bankruptcy lawyer at the association's offices. Financial information is prepared and delivered along with background information related to the problems at hand.

Typically, the distressed company will request a moratorium on the payment of accounts payable in order to allow it to stabilize, reduce operating expenses, maximize revenue and formulate a payment plan.

During this period, the troubled company will continue to transact business with its creditors, typically on a COD basis, although all parties are free to negotiate terms. At the end of the moratorium period, the troubled company will propose a plan to pay its creditors, which could involve an extension (additional time), a composition (paying back less than 100-cents on the dollar) or even a combination of both.

My law firm recently concluded one such matter working with a credit management association.

The troubled company had more than 75 creditors. While the proposed plan lasted six years, it resulted in every creditor eventually being paid 100 cents on the dollar – which amounted to over $6 million. In the interim, the troubled company retooled, continued on with its business and now operates in a much more profitable manner, without ever having had to file a bankruptcy proceeding.

The Reorganization Scenario
In those instances where the sudden event is of a nature that threatens the ability of the troubled company to continue transacting business, then recourse may be to the Bankruptcy Court.

Types of situations which would point in the direction of a bankruptcy filing would include the enforcement of a lien by a secured creditor so that the troubled company would be stripped of its operating assets, the enforcement of a tax lien by the IRS or the FTB, the enforcement of a judgment through a writ of execution resulting in the seizure of funds held on account, the issuance of a writ of attachment that blocks access to money or any other event which threatens the business's day-today operations.

The immediate advantage of a Chapter 11 filing is the immediate issuance by the Bankruptcy Court of an automatic stay, which stops creditors, taxing agencies and other claimants dead in their tracks. The Chapter 11 proceeding provides a comprehensive level of protection, primarily time, which allows for the development of a plan of reorganization that will serve as the road map for payment of creditor claims.

It is a complex proceeding that could take a year or longer from filing to confirmed plan. The primary benefit of a Chapter 11 filing lies in the fact that the business owner is allowed to remain in control of the company, its assets and business as a debtor-in-possession.

All pre-petition debt is put on hold and dealt with as part of the Plan. Historically and generally speaking, unsecured of a business are best positioned to get the best price for those assets. Eventually, a distribution would be made to creditors under a liquidation plan. A recent Chapter 11 liquidation being handled by our office resulted in the owners engaging a broker to solicit bids from its competitors and eventually selling the assets to one such competitor for over $7 million, $4 million of which was used to pay off creditors and the remainder of which the owners put into their pockets.

What started out as the business owners' worst nightmare ended up to be a pretty darned good exit strategy.

The third path is a Chapter 7 liquidation. The difference between a Chapter 7 filing and a Chapter 11 filing lies in the fact that a third party known as a trustee will be appointed in a Chapter 7 situation.

He or she becomes an officer of the court whose task it is to sell the assets, raise money for creditors and parcel that money out once all professionals have been paid. Historically, this produces the worst result for creditors because there are so many layers of additional expense needed to hire auctioneers, brokers and others.

I hope this article has provided you with a flavor of some of the options available to a company in distress. Despite the vast sums of money tied to bail-outs and stimulus programs, little if any relief is being made available to small business.

As a result, the rate of business restructuring has dramatically increased. The decisions made by owners in response to a financial crisis can have a dramatic impact on the final result. Recognizing the problem early is critical, followed by open communication with all creditors and the implementation of a carefully crafted plan that will provide for continuity if the business is viable or orderly liquidation and winding up if it is not.

Just to see if you're still awake, I've decided to end this article with a joke. What do a porn star and a bankruptcy lawyer have in common? Each will give you a discharge. Just one of the perks when writing an article for XBIZ.

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