Posted on: Sep 1, 2024
Bar Bulletin Blog: General
By Anthony J. Neupert, CPA
One of the more popular quotes you hear in business and leadership development circles is, “Knowledge is having the right answer; intelligence is asking the right question.”
I recognize the wisdom in that statement having just finished work on a high-profile Chapter 11 bankruptcy proceeding that concluded with a confirmed, consensual plan. Our firm was retained in this particular case by counsel for the senior, secured creditor who was seeking an expert opinion on the feasibility of debtor-provided projections included in a reorganization plan.
One of the many tools we use in situations like this is sensitivity analysis, in which we take a company’s projections and subject them to various forms of stress testing. This typically involves expanding company-developed spreadsheets to develop a model that allows evaluation of the financial impacts from changes to key inputs. Our focus is on the interrelationships between projection components.
When revenues increase, as an example, what happens to existing cost inputs? More importantly, what other new costs may be introduced to achieve top-line growth? In our experience, what often comes back to bite companies is not necessarily what is included in those projections. It is what they failed to consider or include.
Can You Trust What You See?
Engaging a financial expert who is familiar with sensitivity analysis in a bankruptcy engagement, ideally a professional with both operational and bankruptcy experience, can add value that far outweighs its costs. Not only does it improve the odds of a debtor successfully emerging from Chapter 11, but it can also substantially increase the probability of the company’s continuing to operate successfully going forward.
Such analysis ultimately protects the interests of creditors, both secured and unsecured. A successful reorganization depends on a viable financial plan that allows the reorganized debtor both to succeed and to meet its creditor obligations. Determining whether a plan is feasible should consider the impacts when results do not meet projections. This requires sensitivity analysis.
Feasibility analyses in support of reorganization plans are required for corporate debtors. Although a judge’s decisions on feasibility grounds must involve subjective considerations, an objective, third-party examination may help persuade a judge that the debtor is unlikely to liquidate or require another restructuring once it emerges from court protection.
Keep in mind that the bankruptcy code does not require a debtor to prove its reorganization plan will be a guaranteed success. Judges who have doubts about a plan’s feasibility may still confirm it if there are no objections and it is a better alternative to liquidation.
Avoiding the Path’s Perils
Reorganization plans always carry a measure of risk. They may include sales projections that are too optimistic or may not adequately consider changing market dynamics, where many businesses either underestimate or fail to prepare for disruptive technologies, shifts in customer preferences, or moves in the general economy itself. There may also be concentration risk. We often see this in cases involving professional service firms, where performance projections are heavily dependent on a few key individuals to maintain or exceed projected billing levels.
Having been retained in many court cases as expert financial witnesses, developing a plan acceptable to all parties involved is far more complex and rigorous once a company enters Chapter 11. First, the reporting process is very different than operating without court oversight or even in receivership. Second, the landscape can be crowded with attorneys representing clients with competing interests.
The value of sensitivity analysis can begin even before the petition for Chapter 11 is filed. During the pre-petition phase, it is important to engage in conversations with key stakeholders to ensure that the plan framework fairly addresses their divergent concerns. These discussions may include both a bank and its attorneys and other senior or key creditors and their attorneys.
Asking the right questions early leads to better outcomes later and it certainly did in the case I mentioned earlier, where the reorganization plan went through a series of modifications before ultimately being approved by the judge. While there is obviously a cost to conducting third-party solvency analysis, it is still one of the best and least expensive insurance policies a debtor or creditor can have in Chapter 11.
Tony Neupert is a Director at Seattle-based restructuring and corporate advisory firm Revitalization Partners and a Certified Public Accountant, He has an extensive background in senior financial management. His experience includes the evaluation of reorganization, restructuring and refinancing alternatives for distressed companies, serving as Distribution Manager and Plan Administrator under approved plans of reorganization, overseeing the sale and closure of operations, and distribution of assets in liquidation, as well as serving as an expert witness about damages, lost profits, and business transactions.
