We Are on a Dangerous Course and Everything Is at Stake

(TMA International Headquarters)

Two TMA events held in Chicago last year—“Holding Court 2008: A Bankruptcy Judges’ Forum” in May and a luncheon for CTPs in December at which the chief credit officer for Wells Fargo Business Credit discussed “Ethical Issues for the Turnaround Professional”— gave me pause.

The bankruptcy judges’ forum was a great seminar that featured a fantastic panel of judges. However, by the end of the day, a number of disturbing conclusions were apparent:

• The social and economic benefits of business reorganization under federal bankruptcy laws no longer exist from a practical standpoint, except for the largest of U.S. companies.
• The social and economic objectives of Chapter 11 of the U.S. Bankruptcy Code have been undermined by Section 363 sales, hedge funds with unknown and competing economic interests, and unproductive demands made on small businesses in bankruptcy.
• State insolvency laws generally do not provide for reorganization.
• Few turnaround professionals are doing turnarounds, particularly tough, creative ones. Liquidations and sales appear to be the predominant activities. Excellent fees and an easier process have enticed professionals away from financial, much less operational, restructuring.

The New Gold Standard?

“Market value,” as determined by a pool of willing buyers for a distressed business, has become the gold standard for driving the bankruptcy process. Through the entire eight-hour judges’ seminar, not one panelist or audience member interjected the idea of an actual turnaround as a significantly better economic and social alternative outcome for all stakeholders, our economy, and country.

Clearly, the market value established by a pool of willing buyers for a distressed business is much more realistic, objective, creditable, liquid, and less risky than a future turnaround value. However, savvy buyers do not pay for potential or future performance predicated on the efforts or resources to be put into the turnaround process. Consequently, market value for a distressed business, although higher than liquidation value, is significantly less than the future turnaround value, whether measured in terms of market, economic, or social value. But this has always been so.

In my 30 years of engineering turnarounds, not one company had a future turnaround value that was more believable, objective, creditable, or liquid than the value determined by a pool of willing buyers in the marketplace for the distressed company. However, even the mildly successful turnarounds generated a market, economic, and social value that dwarfed those distressed market values, and the outcome was a win-win for everyone, not just for the secured debt.

In terms of market value, the spectacular turnarounds were just that—truly spectacular. Chapter 11 was conceived and drafted because the economic and social value of a successful turnaround/reorganization was fully understood and intended.

The difference in today’s environment, thanks to the Internet, is the speed and efficiency with which likely buyers can be identified, a price determined, and a transaction consummated. But is this speed of a sale at “market” worth the tremendous loss in capital, jobs, know-how, and economic cost to this country that a successful turnaround would preserve?

Without practical legal reorganization options, state receivership laws have resurfaced as tools for secured lenders to use to force auction-type sales on smaller companies, with no regard for the unsecured creditors, employees, owners, community, or country. As a result, the courts, both federal and state, for all practical purposes are now simply administering secured creditor remedies for all but the largest of companies. Except for those large companies, the economic and social value of a reorganization/turnaround, together with the intent of Chapter 11, has been abandoned by the courts.

Ironically, “turnaround” professionals have greatly facilitated, if not driven, this “sale” phenomenon while significantly benefiting financially in the process. But, at what expense to the profession has this occurred?

The unique skill set and capabilities inherently needed for successfully engineering creative and difficult turnarounds were the entire basis for the formation of TMA and the Certified Turnaround Professional (CTP) designation. This unique skill set and capabilities, coupled with the real value of a turnaround, justified our professional existence and our fee levels. With sales replacing difficult, creative turnarounds, this unique skill set and capability are giving way to expediency, timidity, and mediocrity.

Our profession will not survive without recognizably unique skills and capabilities. This recognition comes from successfully engineering comprehensive and complicated turnarounds, not from selling distressed companies. Along with the courts, have we also lost sight of the real economic and social value of turnarounds?

Ethical Concerns

The sales phenomenon also presents ethical issues for the turnaround professional. During the December CTP luncheon, Bruce McGrath, chief credit officer for Wells Fargo Business Credit, challenged the ethics of firms/individuals hired as “turnaround” consultants who recommend selling companies and then become actively involved in those sales.

Citing the fees charged, both hourly and commission-based, coupled with the ease and speed at which a sale could be consummated relative to a turnaround, McGrath questioned whether the subject client, the bank, and all parties concerned were realistically getting what was contracted for—a turnaround professional/firm that was truly dedicated to turning around the company. Were the client and bank being advised to sell when the subject company could be turned around?

McGrath’s questions strike at the heart of our professional existence. The ramifications encompass not only ethics, but also our independence, objectivity, competence, quality, and credibility. And his questions were not hypothetical; they were based on real-world knowledge and experience in the marketplace.

Tough, challenging turnarounds require time, effort, resourcefulness, strong leadership, a full mobilization of resources and, above all, an unrelenting perseverance and focus. Anything less than this and the turnaround will not occur. McGrath and Wells Fargo know this. They have experienced first-hand successful turnarounds involving companies that had been in extremely dire circumstances. They know what can be accomplished.

The mere psychological availability of a high-fee alternative course of action (sales option) that is relatively quick, easy, and low-risk negatively impacts the focus required for a successful turnaround. The added pressure, within and outside a firm, to take the low-risk fast path undermines the probability of a turnaround outcome. As a result, a viable strategy and plan for turning around a subject company does not emerge, the required action does not take place, and the professional turnaround advice is to sell.

Within the profession for the past 15 years and increasingly over the last five years, high-profile, well-branded firms have used their reputations and connections as turnaround experts to secure engagements and then proceeded to work both sides of the street. In the process, the turnaround experts convinced the clients, the referral sources, and themselves that viable turnaround options did not exist. Consequently, high-quality, tough turnarounds have been replaced by sales. Few seem to question anything about this phenomenon, especially within the profession. On the contrary, rationalization and justification for the action dominate all discourse.

McGrath said Wells Fargo is seeing businesses that potentially could be turned around being sold prematurely by turnaround experts. They are not being fooled, and in the long run, no one else will be fooled either.

Dangerous Course

Instead of focusing on the full economic and social benefits of reorganizations/turnarounds, Congress, the courts, and unfortunately our profession have focused on the small leverage issues driven by the larger and shorter cycled financial interests. Consequently, the concept and value of reorganization, as envisioned and intended under Chapter 11, have been replaced with Section 363 sales and similar auction-type sales at the state receivership level for all but the largest companies. As a result, an economic and social remedy for all parties has given way to one that benefits only holders of secured debt.

Ironically, turnaround professionals are not only facilitating, but are also co-driving this sale mentality, and in the process challenging turnarounds are being abandoned. As a consequence, the unique skill set and capabilities required for tough turnarounds that have defined our professional existence are being replaced with mediocrity.

And now, our objectivity, independence, competence and creditability as turnaround professionals are being challenged by one of the largest lenders in the marketplace.

We are on a dangerous course, and everything is at stake. We’d better wake up.