The COVID-19 pandemic and forced shutdowns have wrought a wave of financial distress globally for individuals and businesses, large and small. Three months in, the effects of the shutdowns have begun to materialize in the United States in the form of bankruptcy filings. According to a recent report, in May 2020 alone, some 27 companies reporting at least $50 million in liabilities sought court protection from creditors. This is the highest one-month number since 2009, when the credit crisis ushered in the Great Recession.
A growing number of companies have suddenly found themselves in distressed territory. High-profile victims include retailers J.C. Penney Co., Neiman Marcus, and J. Crew Group Inc. Tourism-linked companies, oil and gas companies, and restaurant chains are also particularly vulnerable to the economic headwinds. Waiting on the sidelines are distressed credit investors that, according to a 2019 estimate, have raised nearly $82 billion in dry powder that is ready to be deployed into restructuring situations.
As a plethora of distressed situations are created, distressed debt investors will benefit from actionable intelligence and careful due diligence, as will distressed companies seeking to negotiate with new creditors suddenly interested in their capital structure. Information about key executives and vulture investors can provide game-changing value.
Tools of the Trade
Investigative services can complement the goals of shrewd distressed asset investors deploying capital on a fast-track schedule. Decisions are made on an accelerated basis and factions amongst investor classes form quickly. Following are two common examples:
- Potential asset sales spurred by bankruptcies demand due diligence beyond financial and legal reviews. An examination of the integrity and suitability of management teams, along with their track records, is essential to making an informed decision. This enhanced due diligence can help bidders seeking to get up to speed on management teams, company culture, and other intangibles.
- Bankruptcy proceedings can evolve into protracted legal battles in which competing creditor classes turn against each other or against the debtor. In these scenarios, creditors may have reason to believe that asset valuations may not be accurate, and that plans of reorganization put forth may undervalue their subsequent recoveries. By employing due diligence and forensic accounting resources, all parties can obtain a better understanding of a debtor’s finances and operations and open new legal strategies to pursue an alternative plan of reorganization. Taking these steps can help mitigate the risk of an over- or undervaluation, providing a clearer picture to stakeholders.
In addition, free-fall bankruptcies that catch companies and investors by surprise can often spur additional avenues in which investigative services could prove valuable. Additional market intelligence can also support adversary litigation proceedings that may arise out of particularly complicated and often unexpected cases. Examples include:
- From the perspective of a creditor, conducting public records screens of management teams to flag adverse findings, including mismanagement and leadership controversies. Investigators can also help bring to light fraudulent conveyances, or transfers, that may have occurred during the time period leading up to the bankruptcy filing.
- From the perspective of a debtor, public record reviews and source work can help shed light on the track records, portfolios, and modus operandi of distressed investors’ positioning in a debtor’s debt instruments.
- In cases where trustees and/or examiners are tasked with fact finding, corporate investigators can assist in establishing timelines, preparing corporate postmortems, and tracing potential assets to pursue for recoveries.
- As recent reports emerge of big bonuses being paid to executives before filing for bankruptcy, understanding the company’s descent into distressed territory is more important than ever.
Information gathered by a creditor or a debtor—or another key stakeholder—during an investigation may provide additional leverage that can serve as an advantage at the negotiating table. Such critical information sheds light on a company’s true position and enables a more informed decision both on value and associated risk.
During times of uncertainty and distress, the rush to exit bankruptcy protection cannot outweigh the importance of ensuring all stones have been turned. Investigative due diligence and tailored market intelligence can help drive a more successful outcome, leaving fewer opaque details and unpredictable scenarios.