November 2022 Bar Bulletin
By Bill Lawrence
Given the current business climate, particularly in light of recent negative economic indicators, there is little question that more businesses are showing signs of distress. For example, the U.S. business activity gauge contracted for the third consecutive month, according to an S&P index, as a result of high inflation and increasing interest rates. Loan default rates have also more than doubled since the beginning of the year. Furthermore, U.S. bankruptcies are forecasted to increase over 50% by the second quarter of 2023 compared to the prior year according to Trading Economics.
It’s unsurprising then that many businesses have been unable to cope with the rapid increase in inflation, rising interest rates and a slowdown in demand for their services or products. No company is immune from these factors and the ability to cope with such challenges can be hampered by management’s inability to deal with them in a timely fashion. This inaction ultimately results in a rapid decline in revenue and cash flow and frequently leads to the business becoming insolvent.
When businesses become insolvent, they have only a few choices to deal with the problem. The most frequent thing we hear in these circumstances is that “we will just file for bankruptcy and reorganize the business.” Once management has contacted an insolvency attorney, they often find this option is either not a viable solution due to the lack of resources to pay professional fees, and/or they don’t have a realistic plan to generate enough cash to pay back their creditors.
How it Works in Washington
Washington laws provide for an alternative by way of a court-ordered “Receivership” or an “Assignment for the Benefit of Creditors.” In this situation, a neutral, third-party professional steps into the shoes of a business-owner and manages the process in a way the maximizes the value of the assets for the benefit of creditors. The “receiver” is considered to be an officer of the court and manages the process based on the powers they receive as outlined in the Washington State Receivership Act.
There is typically a belief that the receiver’s job is to wind down the business rapidly and sell the company’s physical assets at an auction. While this is a possible solution in some situations, it does not always provide the best return for creditors or stakeholders. There is usually a better alternative, where the receiver operates the business as a going concern and eventually sells the assets of an operating business to the highest bidder.
The Value Proposition of Receivership
As part of this process, the receiver rapidly streamlines the business and optimizes cash flow, with the goal of generating enough free cash flow to pay all expenses including the expense of the receivership. In many situations, the amount of cash generated can exceed the expenses and as a result the receiver actually improves the value of the estate by increasing cash balances.
Another significant benefit of operating the company in a receivership, is to leverage the receivership statutes in a way that enables the receiver to collect cash that might not have been collectable otherwise. For example, the receiver can compel collection of past due accounts receivable or payments on construction contracts, regardless of outstanding liens or other encumbrances. The receiver has the support of the receivership statutes, their legal representatives and the court to compel these payments, which might otherwise remain uncollected. These actions also increase the value of the estate by adding to the cash balances
Selling the business as a going concern benefits the receivership estate by generating more cash than would be achieved by outright liquidation. In these situations, the assets are valued based on their use to the individual buyers, as a package that generates ongoing cash and therefore has more value. One additional benefit is that employees of the company are retained by the receiver and typically end up being employed by the company that purchases the assets subsequent to the sale of the business. Another benefit is that creditors of the business typically continue to supply goods and services to the receiver and often continue to sell to the company’s new owners.
When attorneys, lenders and companies look at options to deal with insolvency, it is important to look at all potential solutions. When considering receivership as an option, make sure to talk to professionals who have the experience in maximizing the value of assets for all stakeholders.
Bill Lawrence is a Principal at Seattle-based restructuring and corporate advisory firm Revitalization Partners, which has served as a receiver in more than 30 cases in the Pacific Northwest. He and his partners write regularly about the operational and financial challenges in successfully restructuring companies. Learn more in the firm’s blog as well as its e-book, “Insights to Grow, Build or Save Your Business!”