Deconstructing Bankruptcy

You’ve seen the headlines. They’ve become almost commonplace: “GM Files for Bankruptcy,” “Chrysler Files for Bankruptcy,” “City of Detroit Files For Bankruptcy.” Still, you think bankruptcy is for other folks, or businesses that are losing money, have too much debt and massive pension obligations. Bankruptcy will never happen to you, you say. And for most of us, it doesn’t.

The industry is currently enjoying record profits as sales have rebounded and the universe of dealers has contracted. Most dealerships are generating operating profits this year. Still, there are times when the world throws you an unexpected curveball. You must consider every possible tool to solve the problem and keep your dealership. Let’s take a look at three scenarios in which filing for bankruptcy protection may be a viable solution.

1. Litigation

You’ve operated your franchised dealership profitably for years and suddenly find yourself confronting a lawsuit. In the event of an adverse verdict in the litigation, the creditor may then obtain a judgment against your dealership and start attaching the assets, including the dealership bank account.

We just faced this exact circumstance in a case concerning a Southern California dealer. The dealer, who was quite profitable, was hit with a judgment for millions of dollars. He was unable to reach a consensual settlement with the judgment creditor. So he filed for Chapter 11 bankruptcy protection and his professional advisers were able to negotiate a consensual settlement with the judgment creditor in the bankruptcy.

Ultimately, the dealer got to keep his dealership. The judgment creditor reduced the amount of his claim and the dealer negotiated a payout of the agreed amount over a number of years. The discount obtained on the balance owing to the judgment creditor was many times the amount of professional fees spent on the bankruptcy case.

2. Mortgage Debt

Another circumstance we see with some frequency involves the mortgage loan on a dealership’s real estate. Many dealers overbuilt their facilities during the last 10 years. In many cases, the dealership real estate has declined in value. The loans mature and the lender, particularly a bank lender, may not be able or willing to renew the loan because the loan-to-value ratio doesn’t meet the lender’s regulatory or underwriting requirements. Other lenders may be unable to accommodate a refinance for the same reason.

At an impasse on a renewal or refinancing, the lender may then issue a notice of default. In some states, the time for a lender to complete a foreclosure on real estate is measured in weeks. Now what?

Well, if such a situation arises, the dealer may hire professional advisers and assess the possibility of filing for bankruptcy. The objective here is to impose a restructuring of the mortgage debt on the lender. It may be possible, under the right circumstances, to restructure the existing mortgage debt in the bankruptcy with an extended maturity and revised interest rate and amortization — even over the vigorous objections of the lender.

3. Embezzlement

We just completed a case in which a dealer lost a seven-digit amount thanks to an employee embezzlement case. The loss rendered the dealership insolvent even though it continued to operate profitably. The debts of the dealership were compromised and discounted with a new lender coming to the party as part of the bankruptcy process. The dealer kept his store with a cleaned-up balance sheet.

The common denominator in all of the cases previously covered is that the dealership was operating profitably but faced a crisis which threatened the business. The fact is, a profitable company has a very real chance of confirming a bankruptcy plan and retaining his or her dealership post-bankruptcy. Obviously, that can’t always be the case.

If a dealership is hemorrhaging losses (remember 2008?) and has no viable plan to get the store back to profitability — other than waiting for a cyclical upturn — a bankruptcy is not designed to be a panacea. This is the time to scrutinize expenses and cut everything that isn’t essential to survival, put together a plan to restructure your obligations and restore profitability. Even in these cases where profitability can’t be restored, a bankruptcy may still be a viable strategy to sell the store to a third-party buyer free and clear of existing liens and other claims, which might be difficult or impossible outside bankruptcy.

If you are facing some intransigent creditor issue, there may be a solution to the problem, even over the objections of the creditor. A bankruptcy does not necessarily mean you liquidate or lose your store. It may provide an opportunity to keep the store and restructure your obligation through the process in such a way that you can keep the store with a newly viable balance sheet.

J. Michael Issa is a principal at GlassRatner Advisory & Capital Group LLC. He is a CPA and a Chapter 11 bankrupcty trustee in the Central District of California.

Kerry Krisher, a fellow GlassRatner principal and CPA, contributed to this article. This article is not intended as legal advice and should not be taken as such.
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