Five Actions to Mitigate Cash Flow Disruption and Avoid Default

The commercial real estate market has experienced a significant increase in delinquencies for commercial mortgage-backed securities since April 2020 — with an additional rise in loans under special servicer arraignments. If you are a debtor experiencing a disruption in normal cash flows due to the COVID-19 pandemic, there are actionable ways that you can successfully avoid default and mitigate financial distress.

Before we dig into the steps you should take, it’s important to understand that you can benefit from financial restructuring as a tool to alleviate diminished cash flow. The primary goal of this process in the short term is to avoid default, satisfy current liabilities and protect assets. Longer-term, the goals are to, as necessary, alter the business model, the operating platform and/or the capital structure so that financial and operating distress will not recur in the foreseeable future.

1. ASSESS YOUR FINANCIAL SITUATION

The foundation of a successful debt workout is to thoroughly understand your financial situation. Identify all liabilities including taxes, leases, employment contracts, retention agreements and all other obligations as well as contingent liabilities. In addition, review all of your loan documents to refresh your understanding of any loan covenants, rights, and other obligations contained in those agreements. Once you create a complete inventory of all liabilities, they should be prioritized in order of importance and seniority.  

Next, all sources of cash flows must be recorded. This includes cash flows from continuing operations, as well as from the potential sale of assets. In the event you choose to sell assets, the effects of those sales should be accounted for in the projected cash flows from continuing operations. 

Based on this assessment, you should be able to make a thoughtful determination of your best course of action, whether it be forbearance, debt restructuring or bankruptcy.

2. CONSULT YOUR EXPERTS

Debt restructuring, forbearance arrangements and bankruptcy each have their own costs (direct and indirect) and each have unique legal, tax and accounting implications. For instance, debt restructuring and forbearance generally will require new legal agreements. These actions may also impose tax liability if the agreement forgives any debt. It is essential that you consult with your legal, tax and financial advisors before finalizing and implementing a plan.

3. DEVISE A DETAILED PLAN

To succeed, you must create a detailed plan that demonstrates your understanding of current circumstances and your plan for the future operations of the business/property. The plan should highlight your strengths, unique advantages, capabilities and describe the short-term nature of the related difficulties. The plan should also include a strategy for repayment of any short-term debt relief, if applicable.

4. BE TRANSPARENT

Be prepared to engage in open and honest communication with your lender(s) and key stakeholders. Provide notice as quickly as possible regarding your situation and the reasons for the business disruption. This communication should include: 

(i) a candid description of the business disruption and current distress,

(ii) current financial statements, cash flows and anticipated changes in financial position,

(iii) documentation to support the above and 

(iv) a detailed plan to continue operations and service the debt.

It is also important, if possible, to highlight to your lenders the temporary nature of the disruption and to provide a timeline of when you expect to resume normal business activity.

5. BE REALISTIC

You should be realistic in your assumptions and expectations when seeking a forbearance agreement or debt restructuring. When a lender is faced with a borrower that is unable to satisfy their obligations, such lender will take a critical and conservative view of the debtor’s business/operations. 

The assumptions you make in your recovery plan will not necessarily be the same assumptions that the lender will use. At the very least, the lender will “stress” those assumptions to ascertain the reality and likelihood that the plan will succeed and that they will recover the outstanding debt. Be prepared to address the lender’s concerns, and be reasonable if asked to compromise, or make concessions.

COVID-19 has created a stressful business environment across all sectors of the economy. Understanding your options with regard to debt restructuring and bankruptcy will help you emerge successfully if your business suffers financial distress.

At Friedman LLP, our team of professionals has experience working with clients in financial distress, and considerable knowledge and experience to achieve the best possible results. Contact us to get our expert advice if your business is considering restructuring its debt.

This content was originally published on friedmanllp.com.