Turnaround Management: Unlocking and Preserving Value in Distressed Businesses

Author

Alan Tilley

Managing director

Sian O’Neill

Turnaround Management: Unlocking and Preserving Value in Distressed Businesses is published by

Globe Law and Business Ltd

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Turnaround Management: Unlocking and Preserving Value in Distressed Businesses

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© 2019 Globe Law and Business Ltd except where otherwise indicated.

The Guidelines and Policy Recommendations reproduced in the Appendix are an excerpt from the final report Best Practices in European Restructuring: Contractualised Distress Resolution in the Shadow of the Law, edited by Lorenzo Stanghellini, Riz Mokal, Christoph G Paulus, Ignacio Tirado, first edition, 2018 © Wolters Kluwer Italia, Milan, Italy. Further details and documents relating to the project Contractualised Distress Resolution in the Shadow of the Law, which has been co-funded by the European Union and coordinated by the University of Florence, can be found at www.codire.eu.

The rights of Alan Tilley to be identified as author of this work have been asserted by him in accordance with sections 77 and 78 of the Copyright, Designs and Patents Act 1988.

All rights reserved. No part of this publication may be reproduced in any material form (including photocopying, storing in any medium by electronic means or transmitting) without the written permission of the copyright owner, except in accordance with the provisions of the Copyright, Designs and Patents Act 1988 or under terms of a licence issued by the Copyright Licensing Agency Ltd, 6–10 Kirby Street, London EC1N 8TS, United Kingdom (www.cla.co.uk, email: licence@cla.co.uk). Applications for the copyright owner’s written permission to reproduce any part of this publication should be addressed to the publisher.

DISCLAIMER

This publication is intended as a general guide only. The information and opinions which it contains are not intended to be a comprehensive study, or to provide legal advice, and should not be treated as a substitute for legal advice concerning particular situations. Legal advice should always be sought before taking any action based on the information provided. The publishers bear no responsibility for any errors or omissions contained herein.

Table of contents

Foreword

Richard Tett

Freshfields Bruckhaus Deringer LLP

Introduction

1. Turnaround managers and their role in corporate rescue

2. The decline curve: warning signs and the slide into crisis

3. Crunch point: when time and money are in short supply

4. Basic requirements for a successful turnaround

5. Assessing enterprise value and business viability; consensual compositions

6. Addressing the underlying business problems

7. The turnaround business plan

8. Management credibility and stakeholder management

9. Negotiating the financial restructuring: La Seda de Barcelona

10. The operational turnaround: La Seda de Barcelona

11. International and cross-border complexities

12. Turnaround and non-performing loans

13. Exiting the leadership role

14. Risks and rewards

15. Conclusion: the role of turnaround management in seeking to reconcile debtor and creditor interests

Appendix – Guidelines and Policy Recommendations, an excerpt from Best Practices in European Restructuring: Contractualised Distress Resolution in the Shadow of the Law

About the author

Index

Foreword

Richard Tett

Freshfields Bruckhaus Deringer LLP

It was a delight to be asked to write the foreword for Turnaround Management: Unlocking and Preserving Value in Distressed Businesses. Turnaround transactions and turnaround management can end up being more about balance sheet restructurings than true business turnarounds. While a financial restructuring is often crucial to the survival of a business, it is not the same as turnaround management. Some people talk unkindly of ‘desk top jockeys’ who are excellent financial modellers, but with limited experience away from their computer screens in the office. As this book shows, such a comment cannot be said about Alan Tilley and his work in turnaround.

Alan has the proverbial dirt- and oil-engrained hands from years of ‘bottom up’ management and turnaround experience. Alan had a decade at Arthur Andersen and two decades in ‘normal management’ before coming to turnaround in the mid-90s. Since then, he has not looked back and has 25 years of operational turnaround experience across many industries and countries including the United Kingdom, France, Spain, Portugal, Germany, Italy, Switzerland, Scandinavia, Eastern Europe and the United States. He also generously gives of his time to contribute to trade bodies, most notably TMA UK, TMA Europe and TMA International, for which he won the TMA Global Chairman’s award for outstanding service in both 2008 and 2014. He was UK turnaround manager of the year in 2010 and won similar awards from TMA International in 2011 and TMA Europe in 2015.

Turning to the book itself, as the chapter titles indicate, it distils Alan’s deep knowledge and experience for the reader. The book follows the logical sequence of the lifecycle for a turnaround. It starts by asking what is a turnaround manager, and proceeds through early warning signs into how to achieve a turnaround. Alan addresses the crucial issue of stakeholder management and management credibility, before considering how the turnaround manager can effectively exit the role. The book concludes with the interesting question of reconciling the debtor’s and the creditor’s interests, and the turnaround manager’s role in that.

It follows from the above that this book will provide valuable information for turnaround managers and for professionals working on financial restructurings (which naturally often include turnarounds). Accordingly, I commend it warmly to the reader – both to read and to keep as a resource for future situations.

October 2018

Introduction

In successful businesses, stakeholder interests are closely aligned and generally lead to harmonious working for mutual benefit. In such enterprises, shareholders, funders, directors, management, employees, customers and suppliers all have a common interest in success. However, once a business falls into financial difficulty, with cash and credit lines under pressure, this mutual alignment changes to protection of self-interest.

This is not a sudden event, rather an incremental and downward spiral. During this process opportunities exist for the management to navigate out of the financial difficulties by changing operations and policy. But if opportunities are ignored or missed, the business can come closer to an insolvency event that could trigger the need for insolvency protection.

This period of decline close to insolvency, the so-called ‘zone of insolvency’, is one of intense pressure for all parties. How they react will determine the fate of the business.

It is in the zone of insolvency that the opportunity exists to engage the services of a turnaround manager to assess business viability critically, to stem cash outflows, to bring operational stability, to identify a course of action to reposition the business, and to bring both situation-specific, conflict-free experience and credibility to the operational and financial restructuring process.

This book explores the complexities of the various processes that occur at this stage of decline, with an emphasis on the processes leading to successful turnarounds. It is based on the author’s 25 years of experience as a turnaround manager, and more than 50 cases in various jurisdictions in North America and Europe.

Cases may be mentioned by name where they have been in the public domain. But in other cases, where turnaround has been achieved without publicity, confidentiality and anonymity are respected.

It is not intended to be a jurisdiction-specific guide, but it does by necessity cover situations where outcomes are driven by local factors.

The book also covers a timespan when insolvency legislation in most countries has been evolving to facilitate greater value preservation, sometimes driven by circumstances highlighted by and lessons learned from the cases themselves.

Underpinning the book is the author’s belief that distressed but live companies where a viable entity exists have greater value than ones tainted with the stigma of insolvency, and that insolvency, while necessary in some cases, is value destructive and wasteful of time and money when time and money are in short supply.

The term ‘turnaround manager’ is generally considered to emanate from the United States following the introduction of the concept of Debtor in Possession (DIP) in Chapter 11 of the US Bankruptcy Reform Act 1978.

Bankrupt companies filing for court protection from creditors would appoint a turnaround manager to guide them through the process. The appointment was often a condition of DIP funding from the DIP lender bank. Management in the ordinary course of business remained with management, with court approval needed only for more significant transactions and subsequent approval of the exit plan.

Similarly, companies in workout but not in Chapter 11 could be granted forbearance or waivers on breach of covenant from the banks, on condition of the appointment of a turnaround manager while they restructured outside of bankruptcy.

A members’ association, the Turnaround Management Association (TMA), was established in the United States in 1987 and it introduced an exam and experienced-based professional qualification, that of Certified Turnaround Professional (CTP), in 1993.

TMA was subsequently established in Europe in 2001, in the United Kingdom and France, and then rolled out across the continent under the umbrella of TMA Europe. Now, there are chapters in most countries of the European Union. Chapters also exist in Asia/Pacific, Africa and South America.

More recently, and under CTP governance, the European Association of Turnaround Professionals (EACTP) was established in 2012 as a professional body for European turnaround managers that recognises turnaround expertise and provides a format for training aspiring professionals. Similar CTP associations promoting turnaround management expertise have been formed in Japan, Australia and South Africa.

With some of the headline trans-Atlantic restructurings of the early 2000s, such as WorldCom, Global Crossing, Enron, Clark Material Handling and Nukote/Pelikan Hardcopy, US professionals challenged the established insolvency-based restructuring processes in Europe and organised restructurings outside European bankruptcy.

This was achieved by ring-fencing the European subsidiaries and keeping them liquid, thus avoiding tripping an insolvency trigger, and then restructuring both operations and the balance sheet consensually.

US turnaround management boutiques subsequently established operations in Europe and have since grown to become mainstream providers of broad-based restructuring advice.

Insolvency obstacles in certain countries were navigated around by innovative processes such as forum shopping to more favourable jurisdictions, thus shifting the European centre of main interest (COMI).

For instance, Schefenacker and Collins & Aikman both shifted their restructuring from Germany to the United Kingdom to restructure under English law. European professionals and governments reacted to these developments by changing legislation to be more accommodating of pre-insolvency or more debtor-friendly techniques.

France introduced the concepts of ‘mandate ad hoc’, ‘conciliation’ and ‘sauveguarde’, early stage pre-insolvency processes that are generally managed under supervision of turnaround professionals. Italy reacted to the Parmalat bankruptcy in 2004 with more debtor-friendly legislation, first for large companies and then for all companies.

Parmalat was then restructured under a turnaround manager with much-modified insolvency laws for large corporates – the ‘Prodi Law’, which was then amended as the ‘Marzano Law’.

With Italy, at the time of writing, having more than €140 billion of corporate non-performing loans in its banking system, the Italian government continues to introduce legislation designed to encourage consensual turnaround and speed up and facilitate restructuring.

Germany, meanwhile, introduced so-called ‘ESUG’ procedures to become more flexible and to counter the trend of forum shopping out of the country.

Spain reacted to the La Seda de Barcelona restructuring, which used a UK scheme of arrangement to cram down hold-outs that were preventing a restructuring, by introducing its own cram-down legislation.

The Netherlands has introduced new legislation with a version of the UK scheme of arrangement with a lower cram-down threshold, while Eastern European countries have, one by one, adapted legislation often based on the US model.

In 2015, the European Union issued a directive requiring all member states to introduce legislation facilitating pre-insolvency processes. Progress in adopting the requirements of the directive varies within jurisdictions. Research continues assessing its effectiveness.

An extensive review project undertaken by Co.Di.Re, a grouping of academic experts from leading Italian and German universities part-funded by the European Union, published its first draft report in July 2018. A summary of major conclusions and recommendations is included in the Appendix on page 187.

Significant in the conclusions is the benefit of early intervention, the value preservation achieved by avoiding court-based or formal insolvency processes and the benefit of independent, conflict-free professionals as advisers or supervisors, including recognition of the benefit of operational as well as financial restructuring, and the benefit of the appointment of a chief restructuring officer (CRO).

The United Kingdom, which had fallen behind other EU states in adapting its legislation, is currently considering introducing legislation along the lines of the EU proposal. Draft documents have been prepared and consultation is being carried out.

While legislation is delayed because of parliamentary time restrictions related to Britain’s exit from the European Union, it is firmly expected that a pre-insolvency moratorium period will emerge, enabling time under qualified and, to be hoped, non-insolvency-conflicted supervision for a restructuring to be agreed consensually.

Following the financial crisis of 2007/8 and the demise of Lehman Brothers many of the West’s banks experienced enormous financial pressures. Some had to be rescued by state support.

In the United Kingdom two leading banks, RBS and Lloyds, were particularly affected. The financial crisis also affected many of their clients and the response of the banks’ workout teams to their distress shines much light on some fundamental issues affecting turnaround and secured creditor behaviour.

The ways in which RBS and Lloyds reacted should certainly be better understood by management of companies in distress. Moving from a commercial lending department of a bank to a workout group is a seminal relationship change for a company. The friendly bank manager looking for more business now becomes a workout banker looking to recover money and minimise potential losses.

This is new territory for most corporate business executives. Whereas they may be quick to hire outside help on an IT or tax problem, too often they are slow to admit the need for help in distress, commonly being in denial of the distress itself. And, too often, when and if they accept the need for help, they are guided to outside advisers from a bank or creditor recommendation, oblivious to the conflict of interest that this brings.

In short, in such situations too little help comes too late, often from the wrong and conflicted advisers.

The activity of RBS’s workout group, Global Restructuring Group (GRG), following the financial crisis attracted great criticism from affected customers and politicians. It has been subjected to a review by the UK Financial Conduct Authority (FCA).

The report was published in 2018, some eight years after the issues were first brought to light and was critical of much of the conduct of GRG for charging punitive fees and interest rates on businesses without due consideration to the longer-term viability of customers.

Many people believe that GRG’s actions forced viable businesses into insolvency.

The report acknowledged what all people in the commercial world recognise – that while successful turnaround might be of mutual benefit to a lender and a customer, a return to financial health is not always possible and businesses will, at times, fail.

When businesses are no longer viable, actions will be necessary to minimise the bank’s loss. This is fair enough, but failure to evaluate viability properly can lead to an outcome that is terminal for the business and at the loss of a customer to the bank, not to mention the loss of jobs, losses to unsecured creditors and the trickle-down effect that all of this has on other business.

Indeed, a significant cause of business distress is the bad debts in unsecured supplier companies that result from a customer insolvency.

R3, a UK body representing restructuring professionals has reported that up to a third of all UK business failures happen as a result of the insolvency of a customer, leading to both a bad debt causing a cash crisis and a loss of a customer, reducing sales.

GRG’s actions will have caused financial distress outside its own customer base.

The FCA report goes deeper and is critical of the bank’s attitude to turnaround. It cites a failure to support SME business in a manner consistent with good turnaround practice. It goes on to say that GRG did not place appropriate emphasis on turnaround in its staff objectives, instead focusing on pricing.

The FCA report into GRG also commented on inadequate management of conflicts of interest in its relationship with West Register, another part of the bank engaged in property investment. This led to an environment where case strategy was influenced by the perceived or actual interests of that investment arm, with a reduced focus on customer-led recovery and turnaround.

While being damning of GRG’s failure to embrace better value preservation through turnaround, RBS was itself in deep distress at the time. But for government support, it was insolvent, which doubtless affected its decision-making.

Indeed, it was being monitored by the Asset Protection Agency (APA), an agency set up by the government to monitor the management of £286 billion of risky loans underwritten, effectively insured, by the APA to assist the bank in restoring stability.

Although APA had no influence on the pricing decisions GRG made, it did, according to RBS, influence the decisions on whether to pursue turnaround or insolvency, thus adding the government agency as a party to the aggressive recovery process.

So, the message for a business manager of a distressed company cannot be clearer. In distress, each stakeholder, including government agencies, looks to protect its own self-interest. It is therefore incumbent on the debtor to enter the discussions with the best, most experienced, independent and conflict-free advisers possible to promote its case for viability and support as the best means of preservation of value. It cannot depend on the secured creditor to be sympathetic to its position, nor insurers or advisers too close and too beholden to the bank to be conflict-free.

Too cosy relationships between banks and professional advisers have been exposed in other cases.

Lloyds Bank inherited a situation on its purchase of HBOS in which a bank workout officer and a turnaround and insolvency adviser had colluded fraudulently to divert funds from viable businesses that were subsequently put into the insolvency process. Both the bank officer and the advisers were imprisoned. Lloyds is subject to large sums in financial compensation.

Subsequent enquiry has looked at whether the extent of the fraud and criminality was known at HBOS board level in 2003, well before the financial crisis hit that caused its own crisis and subsequent sale to Lloyds. If it turns out that it was, it will only reinforce the suspicion that creditors acting in self-interest and preservation will bend the concept of integrity to and beyond the limits of the standards required of them as directors.

In the United Kingdom, PwC has also been engaged in an alleged conflict-of-interest case following its appointment, first in an advisory capacity as a condition of a Lloyds Bank loan extension that subsequently led to an insolvency administration, in which PwC was appointed administrator, and which led to the disposal of the business both at an alleged undervalue and to a Lloyds group company.

The allegations were prominently trailed in the press and in the Tomlinson Report commissioned by the then UK Business Secretary, Sir Vince Cable, to investigate possible damage to businesses by the banking industry following the 2008 financial crisis.

The case will not be heard in court as the plaintiff has agreed not to pursue the case on a ‘drop hands’ basis, lacking the funds for lengthy court proceedings. However, it exposes the dangers of conflict and lack of independence.

PwC is not alone among the Big Four accountancy firms in being subject to adverse press and business comment on conflict of interest in acting as an auditor opining ongoing concerns, a restructuring adviser and an insolvency practitioner.

A potential break-up of the large UK accountancy firms’ business models, particularly as pre- and post-insolvency advisers, as happened in USA following the Enron scandal and Arthur Andersen’s subsequent demise, which presaged the Sarbanes-Oxley legislation, cannot be totally discounted.

And it should be a siren warning to shareholders and company directors that people who may appear to be independent professional advisers with only the client’s interest at heart may, in fact, be human beings torn by all the pressures of internal conflicts of the pursuit of financial gain that their organisations demand.

There is a great value to be put on capable, conflict-free and independent advice in a crisis.

The activities of some bank workout groups and the breadth and range of services of the large accountancy practices pose important questions in the process of business recovery. How does the law in the UK permit such apparent conflict of interest and alleged abuse of process to happen, and how do the laws and professional standards permit and condone such conflict of interest?

Relationships between funders and professional advisers who are both turnaround and restructuring advisers and insolvency advisers has become too close. Government and professional institutions are probing around the edges of this abuse and change may result.

But it also raises another question; how is it that business managers who have risen to lead and manage their own businesses can, at times of distress, be so unaware of the pitfalls of conflict of interest between their position as shareholder or in debtor management and the interests of the creditor? Where do they go to seek independent, unconflicted professional advice?

This is a void that can be filled by independent turnaround management, free of conflict of interest other than to work on behalf of the debtor to guide them through the complexities of turnaround and restructuring within the constraints of commercial reality and insolvency laws.

In the United Kingdom there are shortcomings in legislation that enable abuse, a deficiency in ethical practice between secured lenders and advisers practising both pre- and post-insolvency advisory work, and a naivety among business leaders regarding the conflict of creditor and debtor interests in distress.

No doubt similar shortcomings of legislation and ethical practice exist in other countries, but the message is the same. For business managers entering the zone of insolvency, make sure that you have the best and most conflict-free advice that covers the legal, financial and commercial issues of turnaround and restructuring.

In addition, make sure you take the time to understand the basic principles of turnaround and restructuring, and have some knowledge of the pitfalls that can affect the unwary.

In this book I set out to address the processes and, by practical example, demonstrate both the traps to avoid and the positive steps that can be taken to maximise chances of success.

Of prime concern for a business director and manager involved in a turnaround is the responsibility he or she has to a changing constituency. While the business is solvent and profitable a director has a fiduciary duty of loyalty to his or her shareholders and a duty of care to other stakeholders.

That balance changes as the business falls deeper into the zone of insolvency. The primary duty moves from the shareholders to the creditors, and within the creditor community there are rankings of preference.

There are also other statutory