There are many reasons why companies falter and create opportunities for financial advisors and investment bankers: incompetent or inefficient management; rapid expansion (and often loss of quality control); overleveraging of assets (often to support the lifestyle of the principals); failure to shed unprofitable locations, divisions or products; and more. Financial advisors are typically brought in by the distressed company or its counsel, or the primary secured lender or its counsel, to provide financial and operational advice to improve the bottom line, improve cash flow and/or restructure the debt load. Investment bankers may be brought in by the distressed company, the secured lender or the financial advisor if a determination is made that the company needs to refinance existing debt, take on additional debt, sell assets, sell equity, or a combination thereof.
In the last recession (between about 2008 and 2013), financial advisors and investment bankers were flocking to the restructuring space to get in on the flood of large commercial business bankruptcy filings. Commercial business bankruptcy filings peaked in 2009 but have been on a steady decline since then. In 2021, Epiq reported that there were only 3,724 commercial business bankruptcy filings. In the wake of such a massive decline in filings, that begs the question: What is a financial advisor/investment banker in the restructuring space to do?
On March 27, 2020, the Small Business Reorganization Act of 2019 (SBRA, as subsequently amended) was enacted.[1] The legislation was designed to make the long and often winding and expensive road to confirmation of a plan in a small business bankruptcy faster, cheaper and easier. To be eligible to file a small business bankruptcy, a debtor must meet the following tests: (1) the debtor must be a person (individual, partnership, corporation); (2) engaged in commercial or business activities; (3) that has total noncontingent liquidated secured and unsecured debts as of the filing of not more than $7.5 million (excluding any debt owed to affiliates or insiders but including any debts of affiliated debtors); and (4) its primary business activity cannot be owning single-asset real estate.[2]
While traditional commercial business bankruptcies have been on a steady decline, small business bankruptcy filings are increasing and represent most of all chapter 11 cases filed. Since the SBRA was enacted, 2804 subchapter V cases have been filed. Approximately 52 percent of the subchapter V cases filed to date were filed in the Ninth Circuit (541), Eleventh Circuit (522) and Fifth Circuit (408). Florida is a hotbed in the Eleventh Circuit, with 390 of the 522 cases, or 75% percent.
As a Florida subchapter V trustee, I find that one of the most significant challenges facing small business debtors is that they lack in-house resources to comply with the financial mandates of the Bankruptcy Code, Bankruptcy Rules, U.S. Trustee’s Operating Guidelines, and the local rules, practices and procedures of the bankruptcy court. Often, debtor’s counsel is forced (but ill-equipped nonetheless) to assist the debtor with preparing an initial two-week cash-collateral budget, a 13-week cash-flow forecast, a weekly budget to actual cash-collateral reports, monthly operating reports, plan projections, liquidation analysis, and a schedule of plan distributions. In other instances, the debtor prepares these items, only for debtor’s counsel to painstakingly review and attempt to address or correct errors. Even where debtor’s counsel has the education and expertise to assist the debtor with these tasks, doing so distracts debtor’s counsel from his or her primary responsibilities in rendering legal advice to the debtor, communicating with the subchapter V trustee and the Office of the U.S. Trustee, negotiating with creditors, preparing and filing the plan and other relevant pleadings, reviewing and objecting to claims, prosecuting causes of action, and representing the debtor at the initial debtor interview, the § 341 meeting of creditors and hearings before the court.
The primary role of the subchapter V trustee is to facilitate a consensual confirmation. The subchapter V trustee can certainly assist the debtor and parties in interest with other matters during the case. However, unless the debtor in possession is removed, it is not the role of the subchapter V trustee to prepare financial projections or reports that are the obligation of the debtor in possession. Most debtors need an objective third party to prepare these projections and reports and to provide advice regarding operational and financial restructuring options. Subchapter V debtors also typically require professional services beyond confirmation of the bankruptcy case to ensure plan compliance and overall success, making them excellent long-term clients.
In my experience, there is a void in the subchapter V market for financial advisors who have the financial expertise and the experience in the restructuring space. That is because many advisors (and their firms) are not interested in smaller engagements. There is a huge opportunity for financial advisors who are willing to rethink the traditional business model and focus on developing a system to handle a large volume of smaller cases professionally and profitably. The same goes for investment bankers.
How do you find out about subchapter V engagement opportunities? First, develop long-term relationships with the local bankruptcy bar and the panel of subchapter V trustees through organizations like ABI, the International Women’s Insolvency & Restructuring Confederation, the National Association of Bankruptcy Trustees, and local bankruptcy bar associations. Second, monitor NextGen filings for recent subchapter V filings. Third, reach out to your network when you see an opportunity, and don’t be afraid to ask for it.
How do you secure engagements in subchapter V cases? It seems taboo to talk about fees unless we’re talking about the payment of fees in full upon court approval, the closing of some transactions, or the effective date of the plan. But the reality is that subchapter V filings are outpacing large commercial business filings. In nonconsensual subchapter V cases, the debtor can stretch administrative expense claims, including those of its own counsel, the subchapter V trustee, and other professionals like financial advisors and investment bankers over the plan term.[3] As a subchapter V trustee and a primarily chapter 11 debtor’s lawyer, I understand all too well that stretching fees over three to five years is less than ideal. However, to match the shift taking place in the restructuring space and capitalize on subchapter V opportunities, financial advisors and investment bankers need to reinvent their existing business models. Instead of trying to land the Enron, GM or Toys ’R Us engagement, focus on securing a high volume of smaller subchapter V engagements. Sure, the retainers will be smaller and the overall fees lower. But the goal is to make up for it in volume and develop a stable, long-term stream of revenue, which is preferable to the prospect of bleak (or no) revenue due to the dearth of large commercial business filings.
Given the vast benefits of subchapter V, I anticipate that subchapter V filings will continue to outpace traditional chapter 11 filings. That will certainly be the case if Congress extends the $7.5 million debt limit, either temporarily or permanently. While the engagements in the subchapter V market are smaller and less lucrative on an individual basis, I expect there to be substantially more volume. Financial advisors and investment bankers who are willing to rethink their traditional business model will have opportunities abound.
[1] See 11 U.S.C. § 1181, et. seq. (subchapter V).
[2] See 11 U.S.C. § 1182(1).
[3] See 11 U.S.C. § 1191(e).