More than 250,000 middle-market businesses are in trouble. Usually, by the
time the warning is sounded, performance has deteriorated to the point of
jeopardizing lending relationships, customer contracts, credit ratings, and
employee confidence. Some symptoms include cash shortages, eroding market share,
falling margins, escalating employee turnover, and aging accounts payable.
The problems responsible for these symptoms may be bloated inventories and
mismanaged credit and collection policies, ill-founded marketing and sales
strategies, high waste and poor defined lines of responsibility and authority,
or poor management of productive assets. Solutions become realities only through
fundamental changes in the way the business is run. This is where the
restructuring consultant enters the picture.
As the business’ lawyer, whether in-house or not, the quality of your
relationship with the consultant can spell the difference between your client’s
survival or demise. This article will discuss what turnaround consultants do,
how they do it, and how you can help them to do it well enough to get your
client back on track.
The Role of the Turnaround Consultant
The turnaround consultant (also
called a crisis manager or restructuring consultant) traces the symptoms,
defines the problems, and proposes the solutions that are possible within the
context of available human and financial resources. The process is best
accomplished through a compatible professional team involving lawyers
representing the company and its management, and when appropriate, additional
representatives of the various interests at risk which may include the board of
directors and the equity holders. The consultant’s role is advisory only. The
expectation is that implementation will remain within the management team.
In extreme cases, the turnaround
consultant may have to serve as an interim manager. An interim manager assumes
the duties of a chief executive or chief operating officer for a defined period
of time to accomplish specific turnaround objectives. The senior executive
agreed to step aside through the crisis period. In addition, a consultant may
serve as interim chief financial officer, sales manager, or in some other role
that helps to stabilize operations.
The Goal and the
An effective turnaround plan
balances the interest of all the various participants. It does not exist to
favor the interests of only one party, but to put the entire business back on
track. The very nature of the environment within the troubled company makes this
task a daunting one. Few managers, although they may be well trained, mature,
experience, and fully knowledgeable about their products and markets, have
applied these attributes in crisis conditions. Few schools educate business
students in the elements of troubled enterprises.
Atmosphere of Limited
Crisis intervention does little
to bridge the gap that broken trust creates. Intervention only helps to lower
the emotional level sufficiently to help the parties understand what will happen
if they don’t stop infighting. This is by no means easy. It may take years, not
months, to accomplish. The period of intervention, then, cannot be so short that
an effective beginning is interrupted by a return to the culture that created
Before the Engagement
The troubled debtor (or
aggressive creditor) will often approach the company’s counsel after some
problem has developed in the business. This begins the formation of the
Defining the Client
This is a critical juncture. You
have to identify the client at this point. Is it management? Shareholders?
Directors? The corporate entity? Fiduciary obligations differ for each of these
possible clients and may change as the financial condition of the company
deteriorates. For example, as the corporation approaches technical insolvency,
directors become increasingly responsible for creditor interests in their
corporate governance role.
Identifying Qualified Consultants
Qualified candidates can be found
- recommendations from other professionals with similar
- industry participants who may have gone through
- selected trade creditors; and
The client, once defined, will
determine the preliminary professional agenda. An outline of the scope of
involvement of each member of the professional team will help the selection
process by ensuring that expectations are agreed upon by all constituencies: the
client, other professionals in the case, lenders and creditors. Also define the
work product for each anticipated phase of any engagement. Will it be a report?
A new financing? Establishment of interim management objectives? It is also a
very good idea to establish rules of disengagement, milestones, and review
Directories of relevant trade and
consulting associations may be helpful. The directory of the Turnaround
Management Association (an association of turnaround and crisis management
professionals) is the most comprehensive source of currently active
restructuring professionals. Search the trade and financial literature. Capable
professionals often are quoted in or write articles about significant issues
related to the case a hand.
Experience with financially
troubled companies, particularly with companies that suffered a similar crisis,
is more critical than industry or product experience. Industry-specific
knowledge can be provided by the company’s staff or trade associations.
including education, certifications (certified turnaround professional,
certified insolvency accountant, certified management consultant), related
management experience, and references are important elements in selecting the
professional. Certification is peer confirmation of certain expertise and basic
knowledge. Insist on references from prior clients, other professionals, and
sources of referral to verify representations made by the candidates.
Standards of Conduct
Ask the consulting candidate for
information about the codes of ethics and standards of professional conduct
under which he or she practices. These codes are an important indicator of the
consultant’s practice principles. Verify that a senior member of the firm will
be an active part of the project team.
Ask the consultant for a specific
fee proposal. There are several acceptable arrangements, time-based and fixed
project fees being the most common. Be wary of contingent fee proposals—they are
appropriate only in limited circumstances such as sale of selected assets,
recoveries above expectations, or tasks with clearly defined objectives and
directly measurable benefits. Be warier still of equity-in-lieu-of-fee
proposals—they present a potential conflict of interest. Independence and
objectivity designed to serve the client’s interests can quickly become lost in
favor of the interests of the service provider.
Interview each potential
candidate. Describe the current circumstance in detail. You want the consultant
to know what he or she is up against and you want to be able to judge whether he
or she is equal to the job. Verify technical expertise, analytical skills, and
negotiating performance. And pay special attention to human relations
considerations including temper and disposition—these factors will be important
indicators of how the consultant will conduct the engagement. Ask yourself some
of these questions:
Meet with the Consultant and the In-House Crisis
- Does the candidate seem to be someone who can deflect
the pressures of competing forces in the business and maintain his or her
objectivity and integrity?
- In previous turnarounds, did this candidate actively
seek out the input of a wide cross-section of the business’s constituencies
(its managers, professionals, directors, and the like)?
- Were the candidate’s proposed solutions complete,
timely, practical, and suitable given the client’s circumstances? If so, were
the recommendations implemented?
- Were hoped for benefits actually realized?
the last client or two that the consultant worked for retain him or her
After you have narrowed the
field, set up meetings to introduce the best candidates to the in-house crisis
team. Make it clear that no obligations are involved or implied at this stage.
One purpose is to discuss the proposed scope of the engagement and to expose the
candidate to selected information about the client. Another purpose is to give
members of the in-house team, often with selected advisors and directors, an
opportunity to evaluate how well the candidate will fit into the company’s
culture as well as the consulting firm’s ability to meet objectives on a timely
Formalizing the Engagement
The information shared during
discussions with the in-house crisis team will form the basis of a proposal for
the consultant’s services. Think of the proposal as a discussion document. It
may take on a new form. Never let the engagement proceed without a written,
properly executed proposal—you need it to memorialize the exact boundaries of
the engagement and its goals.
Contents of the
The proposal should describe the
expertise that the consultant will bring to bear on the problem and describe the
role that the consultant will play in support of the in-house crisis team. It
helps to designate which professional will serve as team leader, coordinating
the tasks and monitoring the schedule.
The written proposal should
describe at least the following elements:
- The background factors leading to the engagement,
with a description of the circumstances of the crisis;
- The objectives of the engagement;
- The scope of the engagement, including areas for
evaluation, work product, and support documentation;
- The consultant’s methodology, any special tools or
procedures, milestones, reviews, and reports;
- The staffing, including a description of the project
team, key staff, and the extent of support that the client will furnish;
- The schedule, including the starting date, dates for
reviews and interim recommendations, and a target date for the final result;
- The consultant’s fee arrangement;
- The terms of the engagement. This covers the
consultant’s role (advisor, team member, interim manager), as well as
negotiated clauses (hole harmless, best efforts, confidentiality,
non-competition, and so on); and
consultant’s acceptance and acknowledgement of the terms.
An acknowledged proposal serves
as a satisfactory document of understanding between the parties when the
consultant’s role is purely advisory or informational. The key element is that
acceptance and implementation of any recommendation remains the decision of
client’s management or directors.
Interim Management Proposals
An interim management engagement
requires a more complex contract. Role definition is critical. As an interim
manager, the consultant assumes authority and accepts responsibility as the
senior operating executive.
Scope of Authority
It may be possible to assign
certain fiduciary responsibilities and risks to the interim manager. Statutory
limits curtail the authority which can be granted to any manager, particularly
in matters of corporate governance. The proposal should also set forth the
contractual limits on capital spending and the authority to make long-term
strategic decision without board approval.
Spell Out the
Define the obligations that will
exist between the interim manager and your client during the engagement period.
Staffing, fees, terms of engagement, disengagement provisions, and limits of
responsibility are but a few of those elements. Urge the client to consider
shorter contract terms (quarterly, for example) with more frequent renewals as a
means of forcing periodic performances reviews and reevaluations of objectives.
This process enhances the value of the relationship.
Confidentiality becomes critical
when the consultant serves as an interim manager. For some purposes, existing
management may need access to confidential information that should not be shared
with the interim manager. And in other cases, it may be absolutely essential to
share confidential information (prior and potential competitors, trade secrets,
and the like) that the interim manager may have to learn about and prepare
appropriate nondisclosure agreements.
Interim Manager’s Personal Liability
The proposal must spell out the
consultant’s degree of performance indemnification, as well as all
representations and warranties of potential personal liability. Tax and
environmental exposures are of particular concern with many troubled companies.
(You may want to obtain status acknowledgements from the pertinent agencies
before an interim manager assumes responsibility in these cases.) The interim
manager may be unwilling to be personally responsible for liability in these
cases; neither errors and omissions nor malpractice coverage is available when
the consultant acts as a decision maker.
Evaluating and Addressing the Crisis
An important tool for getting the
problem under control is the operations evaluation checklist. It is used to
identify the strategic alternatives and to quantify risks associated with the
courses of action open to the client. Specifically, the checklist is designed
- Determine the viability of the enterprise,
- Identify the problems that have been causing
deteriorating performance, and
to alternative solutions and recommend a preferred option.
The proposal must spell out the
consultant’s degree of performance indemnification as well as all
representations and warranties of potential personal liability.
The Need for
- Establish a basis for forecasting how the proposed
solutions will affect the company’s financial condition, income, and cash
- Establish a basis for an implementation plan; and
the resources required for successful implementation.
Objectivity is critical when
working through the operations evaluation. The information generated has to be
interpreted conservatively to reduce the risk of misrepresentation. Each
evaluation task has a corresponding purpose ultimately aimed at improving
performance and enhancing cash flow. The task-and-purpose relationship is
The time available to perform
this evaluation and to establish at least a preliminary plan for future action
depends on the severity of the client’s crisis. Under the most critical
circumstances, only a few days may be available to identify the strengths to
build upon, to find the sources of ongoing working capital, and to propose an
immediate plan to stop the bleeding and preserve available cash. These are
operating issues. The legal options may depend upon how quickly the operating
tourniquet can be applied and credibility of the proposed plan to those at
Minding the Workouts
The elements of any workout
require legal guidance, confirmation, and participation. Review the consultant’s
communications and actions with any of the constituencies to ensure transactions
and language are without pitfalls and do not represent additional exposure under
federal or state insolvency statutes or under the Uniform Commercial Code.
The Bankruptcy Factor
A bankruptcy petition alters the
roles of the professionals and the urgency of the situation. Usually, you will
assume the lead role in guiding the client through the bankruptcy process. The
consultant can focus his or her attention on operations and developing a plan
for confirmation. The diagnostic process remains the means of determining the
causes of prior failure and in developing a course for improving performance.
Implementation issues may be less frenetic, helped by the automatic stay, and by
the well-defined structure of any cash collateral order or debtor-in-possession
financing agreement. The consultant offers a reality check—measuring the risks
involved in any future plan. The forecasts are important tools to be used in
negotiating creditor plans. Aggressive expectations often lead to plans that end
in default or a loss to the client and all related parties.
It Takes Some Patience
The case does not end at the time
of plan confirmation or upon agreement among the parties in an out-of-court
restructuring. The professional team has much to gain if it continues to support
the client through the full course of the operating restructuring to ensure that
stability has been achieved and that recovery is being built upon a sound
foundation. The process is often slow and laden with fits and starts. There is
no quick answer. Recovery is not built upon one new customer or one new product.
It is the summation of change in the culture of the enterprise, its tolerance of
risk, the skills of its leadership and the soundness of its strategy.
The members of the professional team should not wander
too far. The engagement can be considered successful if cash flow has been
stabilized, customers are being serviced, creditors are receiving payments on a
timely basis, and the emotional crisis has passed.
Copyright 1996 by The American Law Institute.
Reprinted with the permission of