Podcast: Directionally Correct Podcast: Turnarounds, Bankruptcy and Restructuring

An economic downturn is expected in the next 18-24 months. As someone in the turnaround business I was asked to sit down with Greg Saltsman as a guest on the Directionally Correct Podcast.

TranscriptION:

Welcome to Directionally Correct, where we talk about stories in the news and what it might mean for your business. I’m Alicia Hicks, with Southern Oak Consulting. We’ve talked a lot on this podcast about the state of turnarounds in the US right now, with our coverage of the turnaround management association and their conferences over the past year. We’ve said it before, an economic downturn is expected in the next 18-24 months. 

In this episode, we get perspective from someone inside the turnaround business. Greg Saltsman talks with Josh Eppich, partner at the law firm of BondsEllis in Fort Worth, TX. Here’s Greg Saltsman with Josh Eppich.

Greg: Thank you so much Josh for joining us today. Before we get started with some of our questions, if you’d just give us a brief background on your experience and the firm of BondsEllis’ specialties.

Josh: Sure. So, I finished law school back in 2005. When I was in law school I always thought I wanted to be an m&a attorney, and my civil procedure Professor pulled me aside one day and told me that I should go work for Judge Lynn in Fort Worth and see how I liked bankruptcy and restructuring. She seemed to think that would be a good fit for my personality and what I like. So I went to work for Judge Lynn without knowing anything about restructuring and completely fell in love with it. The puzzle aspect of it, the idea of getting to help companies both in bankruptcy and out of bankruptcy and actually the idea of trying to help something like an organization progress. I thought that was really interesting. So, I've been doing bankruptcy work since then, kind of moved around Texas a little bit, started with Judge Lynn, stayed in Fort Worth, moved down to Houston and worked for a big firm. Was down in Houston for a while, then came back top Shannon Gracey as a partner and a couple of years ago five of us decided to leave Shannon Gracey and we started BondsEllis. Our firm is about 70 to 75% focused on restructuring a bankruptcy work, and the other 25 to 30% does commercial litigation with a kind of a big emphasis and construction litigation. We been going for two years and we really like it. We’ve had some pretty good success. We have 10-11 lawyers, kind of fluxuates between 10 to 12. And one of the fun things is that Judge Lynn, who I started my career with, has come to work with us, so that’s been a fun thing. So, that’s a little bit about BondsEllis, we’re based in Fort Worth but kind of go all over the country.

G: Really interesting. That's that's amazing that your mentor is now part of the firm. That must be a real treat.

J: It is. It’s lot’s of fun. Although he still likes to tell me how things work, so…

G: I imagine so. From your perspective, what is the current state of turnaround in the energy industry or since you mention the construction industry in that industry either?

J: So we’ll start with energy. Commodities based industries are wonderful because they can make any restructuring professional look brilliant - as long as you start working with a company when commodity prices are depressed and the commodity prices go way up - by the end all of a sudden you’re brilliant and you’re able to fix anything. I would say that since the big peak of the Readjustment in the energy industry I would say that there are not as many cases filed but there are some interesting things going on in the energy industry on the restructuring side. One of those being in the cases that are being filed a lot of the cases revolving around executory contracts, such as gas Gathering agreements, and flaring agreements. So the question is more becoming how do you handle those types of agreements in bankruptcy, and how much leverage does the debtor have over the counter-parties to those agreements to try to force a renegotiation of the agreement, and then even going to the extent of how do those agreements affect the buyer of the assets, if there's an assets sale as opposed to a true restructuring of the company. You can see it right now in the OOGC case down in Houston, that there are some interesting issues involving flaring. And how the debtor's idea to flare the gas that comes off the oil as opposed to sell it and market it because obviously gas prices are still low, versus how it affects the other parties who are also a party to those leases. So I think that’s a really interesting issue in the energy industry and those cases, and it'll be exciting to see how those go forward, as there was such a big gap over 20 years in the energy industry of not having a lot of litigation over those types of things and bankruptcy and then it hitting again over the past five or six. And that of course the servicing side, the service inside of the industry's been interesting. You had a lot of bankruptcies all that servicing side. And as the commodity price comes up, the question is for those guys who have survived, can they get the producers to, and the exploration companies, the NP companies, to raise the rates fast enough so that they can cover all of the debt that they incurred during the downturn and then negotiate out that debt to continue moving forward. So, these companies may have great cash flow now, and if you wiped out their bad debt over the past 2 or 3 years, they’d be making profit like gangbusters. But you still gotta go in and try to fix that debt side. Which, in my opinion, those companies are really ripe for getting professional help on the restructuring side to try to help with that issue, whether its in court of out of court. 

G: Yea. That’s really interesting. Both of those issues. The flaring situation, with the long-term implications of the bankruptcy on others that are party to those leases, and then the side you mentioned with the services side. I think that those are going to be some of those issues that will probably come into fruition as the cases get decided here in the next year or two. But I want to ask you, without offering any specific legal advice, what are some of the lessons learned from bankruptcies, that business owners could benefit from in your opinion? 

J: So we specialize in companies that are a couple hundred in million in revenue, with I would say most of my clients are in the 75 million, 50 million and under in revenue. So these are businesses that generally were started by the guys or girls who are still operating them. And it creates an interesting situation where its very personal. I mean, this is something that they’ve built, that they’ve worked very hard at, and some of the advice that I would give this size of business is first, when you’re starting your business or even after you’ve had some success, you need to pay attention to your entity structure. Having all the different entities may seem cumbersome at some times, but if you do it right at the outset, you can isolate some of the risk. For example, if you’re a consultant type person, who consults on a very specific industry, you may have a couple of different side businesses, but you may have assets that are contracts that you have with larger companies, whether it's in the oil and gas industry, or the aviation industry. Or whereas you also may have your own business on the side. You would want to isolate those two businesses. So you would want to have an entity that enters into specific contracts where you’re doing the consulting work, for in case something goes wrong you can deal with those in an entity that doesn’t affect your cash cow business, is what I would say. And then I would also suggest that they pay attention to accounting. You think about what entity you’re paying bills from, what entity received the bill, and make sure that entity is the one that pays the bill. Make sure that you’re paying attention to your payables and receivables. You don’t let one of your customers get out 180 days, 200 days. You’ve gotta stay on top of it and make sure you’re getting those bills paid. And that deals with a lot of different things. Receivables can affect your cash flow, as well as payables, but if your customer ends up going bankrupt because if they start going from paying every 60-days to every 120-days, that’s a good sign they’re having issues. You don’t want to all of a sudden get a big check and then have that customer file for bankruptcy the next day and then you get hit with a lawsuit from a trustee asking to claw back the money. And then also this is more of a personal issue, but I would think hard before I entered into a factoring agreement. And I would really get some advice before I did that. Now obviously there’s different industries, but in general these smaller that I see who have entered into factoring agreements, it tends to be the first step towards them entering into having financial issues, just because of the way that factoring agreements are structured. And lastly, for this range of business, I would really look at how the owners document their infusions of cash into the company, and think about whether it’s going to be a loan, a secured loan, an unsecured loan, whether it’s going to just be an equity infusion. Because that can have a lasting ramification down the road if the company does need to restructure, whether in court or out of court. And it can also affect how they bank when they’re looking for loans. 

G: Wow that is a lot of really good information. And I feel like there’s some backstory on each one of thsoe points. I could be wrong…

J: Well we all learn from our experiences. 

G: Indeed. Indeed. Especially, of all the things you said, all of them were strong points, the one that stuck out to me was making sure your payables are going out from the right company and you’re not blurring the line between two different interests. That’s probably a real problem that a lot of people who are maybe not from a sub-hundred million dollar industry haven’t thought about before, but I know that it’s something that happens quite a bit and we see quite a bit in the lower-middle market. 

J: Absolutely. And the risk of it is like I said, if one of those customers goes into bankruptcy, if you’re using your different entities to pay bills regardless of who incurred the debt, that's a really easy target for a trustee to try to do a claw back action to try to get the money back. 

G: Aboslutely. And so to finish up our conversation today, I want to talk about trends. I want to talk about what trends do you see developing in bankruptcy cases in the current markets? And then maybe looking a year or two out, what do you think is coming down the road?

J: So I’ll answer this in two different ways. And one of the big trends I guess I've seen in my market is trying to restructure the companies without going into bankruptcy at all. I would say now that 50-60% of my work is working with companies to keep them out of bankruptcy, and to strike a deal with the lenders and all of the creditors to help the company either sell off its assets to a new buyer who will keep the company going or to liquidate without ever filing. And that's interesting to me, that, that seems to be something that the clients are pushing. I always seems to be something the lenders are pushing because they never want to deal with a bankruptcy, unless things are really, really difficult. But the two-sided approach to be willing to try to strike deals without Court intervention. And then looking at the other side of the trends and bankruptcy as to you know what industries maybe we’d be looking at. And obviously everyone can see that retail is changing, and thinking about what's going to happen with all of the malls. You know the other day on Saturday I drove by Ridgmar Mall, which is here in Fort Worth, and just looking at how much empty space there is there, you can just think about all those types of real estate developments that are across across the country, and what are we going to do with all of those. Are we going to turn them into a different type of destination, that's an entertainment type destination? And then also looking at the HealthCare industry. HealthCare is always really interesting in the restructuring world. Recently we’ve been hit with nursing homes, and rehab facilities across the country going into bankruptcy, due to different reimbursable rates that just aren’t high enough to cover the current wage costs that are being demanded, or the increase in pharmaceuticals, that these nursing facilities are just becoming cash strapped because the rise in costs without the rising revenue source from the government. So I think that’s really interesting. We just worked on one that we did out of court on some nursing facilities, it will be interesting to me to see how many can stay out, and how many operators will be changing hands in those facilities across the country. Because that really obviously serves a community interest, making sure people have access to those types of facilities. 

G: Those are 3 really strong points. I love the one about the retail, we’ve talked about it quite a bit on the podcast. I read an article in the Wall Street Journal, I think it was last week, that said mall lease rates, or at least their percentages, are at their all-time low. And there’s a few people that were trying to make a play out of that, I think, trying to buy up that real estate cheap and do the entertainment centers like you mentioned, but I think just in general real estate is going to be this rally interesting topic over the next few years. We’ve talked about about a lot of different aspects from gas stations, to malls, on this podcasts, and so I think that’s going to be a huge opportunitity, but it’s going to be something that’s not necessarily clear at the outset what’s going to happen. ANd of course with the medical as you mention with the reimbursement ratres is definitely a cautionary tale for other parts of the medical industry when you look at the way their businessse are opporating in relation to reimburseables, and then figuring out whether or not they have any exposure out there to avoid this. But the thing you said that I thought was most interesting was your first point, was the thing about avoiding bankruptcy completely and just going into liquidation. It’s interesting that that is a trend that’s out there, and as you said it’s something that banks have always been for it but the fact that people are looking for it now, to me, is extremely interesting. 

J: Yeah, it's been something new. And I would say more than just liquidation, I mean actually trying to restructure the entire company without going into bankruptcy. And I guess the banks are becoming more sophisticated when looking at these companies that I deal with as to the cost versus benefit scenario. Because even as a lawyer I can tell you professional fees can get extremely expensive in these cases, and you don’t want a company to not be able to restructure just because of professional fees. And that’s something that I try very hard to work with, I just don’t want smaller companies do not have access to good advice and good representation. And they should have the same access to the benefits that everyone else does. It’s not just a big boy game. 

G: Yeah absolutely, as you and I know all too well being in the lower-middle market. Thank you Josh. This has been extremely helpful and I really want to thank you for coming out today and providing this insight. If anyone wants to reach out to Josh they can find him at BondsEllis.com. I’ve just been extremely impressed with the knowledge of their firm and I’m so pleased that we were able to get him on today.

J: Thank you. I was happy to be able to be here. 

The Directionally Correct Podcast is a production of Southern Oak Consulting. We help middle-market private equity investments achieve higher returns. Find out more at SouthernOakConsulting.com.