In bankruptcy as in business, structure has its place and purpose. It is the stakeholder's assurance that process will be followed and progress accelerated—but only to a point. If needs change while the structure remains static, action is stalled and benefits compromised.

Increasingly, creditors in bankruptcy proceedings need liquidity as much as they want resolution. The prospect of a multi-year recovery period is frustrating as it mandates the continued involvement of creditors when such involvement is not part of their business objective. Profits are hurting—and the realization of a recovery is on hold. Moreover, creditors—along with the debtor—are faced with an ongoing and often costly administrative burden.

Some fresh thinking in the area of creditor recovery is proving advantageous to all parties in such proceedings. A liquidity program created by a third-party resource and customized to the specific circumstances surrounding a case is providing a creative solution to these issues. With default levels and bankruptcy proceedings at a 10-year high, this is the time for customized liquidity options.

Bypassing the debtor to purchase creditors' claims is nothing new in the field of bankruptcy. Many firms have done it with varied degrees of success, and varied degrees of satisfaction, for those financially at risk. What differentiates this new solution, financial structuring advisors agree, is its ability to enhance the effectiveness of the reorganization plan or liquidation.

The process is one of collaboration. Once due diligence, financial analysis and legal reviews are complete, the cash payment offered to electing creditors is negotiated and agreed upon. Terms pursuant to which electing creditors can opt for this immediate cash payment are finalized. The lender, in cooperation with the debtor, provides sufficient equity capital to effectuate the liquidity program and assumes the creditors' position for the remainder of the case. The objective is to earn a target rate of return based on the projected future recovery to be realized by the debtor.

Benefits of this customized liquidity approach are far-reaching and include:

• expansion of options for cash-limited debtors;
• rapid cash recovery to creditors when such recovery is otherwise unavailable;
• immediate exit for creditors who seek such an outcome;
• potential expediting of plan approval if creditors have access to liquidity; and
• administrative simplification to the debtor or trustee, given creditor consolidation.

Candidates and Criteria

What bankruptcy cases are best served by customized liquidity strategies? Likely debtor candidates share most or all of the following attributes:

• They have targeted creditor classes: general unsecured claims, trade claims, administrative claims, convenience class claims, bonds and odd-lot bank debt.
• They are chapter 7 or chapter 11 bankruptcies where all or a significant percentage of the recovery is expected to be derived from asset sales or liquidations, payable in cash.
• They are bankruptcy estates with more than $50 million in assets and with aggregate recovery amounts greater than $5 million due to the targeted class.
• The number of creditors in the targeted class is greater than 500.
• The payout period following plan confirmation extends up to four years.
• They are in real estate, health care, retail, aviation, transportation, manufacturing, media, oil and gas, specialty finance or other hard asset-based industry category.
• Their claims are reconciled and settled by the debtor or warranted as such.

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With default levels and bankruptcy proceedings at a 10-year high, this is the time for customized liquidity options.

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Two Studies, Two Strategies

Case 1. A New York-based health care provider is an owner and operator of hospitals and nursing homes. It is non-religious affiliated, nonprofit organization and has served East Coast residents for 150 years. The company was forced to file for chapter 11 in 1999. The catalyst for its financial difficulties was the sharp reduction in reimbursement for Medicare services that resulted from the Balanced Budget Act of 1997.

The lender structured a cooperative agreement with the company to offer a liquidity program as a part of the reorganization plan. This solution allowed the lender to purchase trade claims at 21 percent of par as an election on the company's ballot mailed to creditors. The debtor's plan was approved on the first ballot.

More than 640 unsecured creditors with $33 million in claims elected to participate in the lender's liquidity program. This represented 25 percent of all outstanding claims. Moreover, the existence of the liquidity option for creditors served to facilitate plan approval.

Case 2. An owner/operator of a New York elder care facility filed for bankruptcy protection in 1999 after suffering from the effects of declining medical reimbursement rates. The company's original reorganization plan provided that the claimants receive distributions from operating cash flow over three years.

Working with the lender, the company was able to offer creditors a liquidity option in its reorganization plan, eliminating their three-year wait. More than 40 creditors with $1 million in claims (20 percent of total) elected to participate in the program. Moreover, the lender's plan enabled the debtor to eliminate numerous small claims, reduce administrative costs and consolidate disparate claims.

Summary

At this writing, total distressed debt nationwide is at its highest point in years. Many of the companies forced to seek bankruptcy protection will be those founded by some of the most innovative thinkers this country has seen. As participants in the process designed to protect their creditors while providing them relief, we have an opportunity—perhaps even a responsibility—to be equally creative in crafting solutions. Customized liquidity is one such step.