When a business loan is “classified,” meaning that there is some doubt about repayment in full of all principal and interest, the credit will be moved to that bank’s workout department and the borrower’s business life will take a major change for the worse. Each financial institution uses its own methods and nomenclature, but the workout department’s name generally includes one or more of the following terms: special assets, corporate recovery, troubled credit, etc.
While in rare cases the troubled credit can be rehabilitated and administration of the loan returned to the good side of the bank, for most borrowers it is a one-way door into the workout group and out the back door of the bank. Following are seven ways the lives of the borrower and its management team may be affected.
- The borrower will likely be subjected to constant requests for information by the workout banker, often in formats not familiar to the borrower’s controller or usual outside accountants.
- The borrower will face increased costs of funds, as the interest rate is increased to account for the bank’s perception of additional risks.
- The borrower will have to pay increased professional fees, as the borrower will be responsible for the bank’s outside counsel (and perhaps other professionals), and the borrower itself will need special counsel for the workout and may need additional outside accounting help as well.
- The constant distraction of responding to inquiries from the bank and various professionals means that the management team will be devoting less time to sales, marketing, product improvement and the like. Instead, the focus will be on cost cutting and turning assets into cash.
- The various perks that company management and key customers obtained in the past will be among the first line items excised from the budget. Season tickets, means and style of travel, and other employee perks will be reduced.
- As word leaks out that the borrower and the bank are divorcing, competitors will exaggerate the story and insist that the borrower is on the verge of collapse. This will be especially challenging if key employees from the borrower jump ship to a competitor and work against the borrower’s success.
- Payments made with respect to subordinated debt (whether third party lenders or friends and family capital) will be reduced or likely even halted. Particularly given the highly leveraged balance sheets that seem to have become the norm, halting or reducing such payments may have a ripple effect and bring about litigation with other stakeholders.
Unless the business is irretrievably broken, the borrower can often refinance with a different lender, albeit on more onerous terms than the borrower enjoyed previously. Depending on the size of the borrower and the size of the credit, the refinance or sale (or liquidation) could take months or years. In any event, the borrower’s owners and management team must understand that their lives will be changed profoundly when their long time banker requests a meeting and brings a new player whose business card includes one of the dreaded euphemisms described above. When that person enters your life, you must run, not walk, to the best restructuring lawyer you can find.