Agribusiness Bankruptcies, Failures and Fraud –

BFF’s?

Karen Boyer U.S. Bank National Association

Mike Stewart Faegre Baker Daniels

Randy Humphreys Glenwood Management, LLC

Breia Schleuss, Moderator Faegre Baker Daniels

Agribusiness Bankruptcies, Failures and Fraud – BFF’s?

Agribusiness BFF: Recent Examples

► AgFeed Industries ► Anderson Seed ► Aurora Foods ► Austin Packaging ► Cascade Grain Products ► Choice Genetics ► C&K Market ► Eastern Livestock ► Fresh & Easy ► Gateway Ethanol ► Grabanski Grain ► Groeb Farms ► Hawkeye Renewables ► Hereford Biofuels ► Hostess

► International Garden Products ► Interstate Bakeries ► LeNatures ► MF Global ► Mid-America Agri Products ► Pacific Ethanol ► Peregrine Financial Group ► Pierre Foods, Inc. ► Pilgrims Pride ► Stamp Farms / Northstar Grain ► Universal Cooperatives ► VeraSun ► Walterman Implement ► White Energy ► Wisconsin Rapids Grain

Agribusiness BFF: Common Themes

Agribusiness BFF: Common Themes

WE HAVE A CAPITALIST SYSTEM,

AND BUSINESS FAILURES HAPPEN.

BUT THERE’S A DIFFERENCE BETWEEN STRAIGHT BUSINESS FAILURE AND FRAUD.

Agribusiness BFF: Common Themes

WARNING SIGNS OF FINANCIAL DISTRESS: ► Deteriorating financial performance

► Declining profitability ► Leverage ► Liquidity constraints

► Stretching of trade payables ► Industry or economic downturns ► Competitive environment ► Loss of key customers ► Weak financial systems and reporting

Agribusiness BFF: Common Themes

WARNING SIGNS OF FINANCIAL DISTRESS (continued): ► Unanticipated costs

► Commodity prices ► Energy prices ► Food prices

► Changing consumer preferences ► Labor costs ► Management weakness ► Turnover in personnel

NOTE: Some things are outside of management’s control.

Agribusiness BFF: Common Themes

WARNING SIGNS OF FRAUD: ► Payroll taxes not paid, tax returns not timely filed

► Aging of trade payables, multiple supplier rotation, overdrafts

► Aging of accounts receivable; special discounts, allowances and terms; growth of (ineligible) receivables

► Untimely posting of credits, returns and other allowances

► Inventories – growth, turn, obsolete inventory, valuation, the importance of physical inventory inspection

► Cash flow issues, lack of detailed projections, lack of information

Agribusiness BFF: Common Themes

WARNING SIGNS OF FRAUD (continued): ► Lack of transparency

► Mismatched metrics – receivables, inventories and payables, profit and expenses, agings and sales

► “Top Secret” projects

► Litigation

► Turnover in accounting firms

Agribusiness BFF: Common Themes

THE “FRAUD TRIANGLE”

Pressure / Motive -need for liquidity

Perceived opportunity

Rationalization / Lack of management integrity / Ego

There’s a difference between premeditated fraud and fraud resulting from desperation.

Agribusiness BFF: Common Themes

FINANCIAL STATEMENT FRAUD: ► Inappropriate revenue recognition

► Understand costs and expenses

► Inadequate loss reserves

► Overstated or nonexistent assets

► Related party transactions

Agribusiness BFF: Common Themes

COLLATERAL FRAUD: ► Hiding the nature of the collateral ► Preventing another party from knowing its rights ► Double-billing and fictitious accounts – receivable verifications ► Pre-billing ► Credit memos, rebilling, dilution ► Double-pledging ► Conversion of collections – look for decrease in turnover and increase in dilution ► Failure to account for receivable collections in borrowing base ► Out of sequence invoices, repetitive numbers ► Real estate fraud ► Shipping and invoice testing – review of original documents

Special Considerations in the Agribusiness Context

Special Considerations in the Agribusiness Context

► Commodity price volatility ► Hedging errors ► Contract counterparty risk ► Overcapacity resulting from supply / demand imbalance ► Weather ► Liquidity crises ►Production cycles ► Food safety recalls

Special Considerations in the Agribusiness Context

►Statutory liens and trusts (PACA, PASA, Producer Liens, Food Security Act, Milk Producer Liens, etc.)

Note: These protections can still leave the contract counterparty holding the bag.

►Warehouse liens, claims by farmers to grain in storage, and rights of

state and federal licensing agencies

► Never a perfect time to liquidate an agribusiness company

► Managing outstanding contracts in a liquidation scenario ► Demand for adequate assurance of performance ► Ability of third party to enforce ► Risk of termination ► In or out of court

► How can a lender liquidate a food company

(Food Safety Modernization Act issues)?

Special Considerations in the Agribusiness Context

Special Considerations in the Agribusiness Context

► Borrowing base calculations may not be sound

► The problem with lending against “contract equity”

► The problem with collateral that eats and grows

► Unsophisticated players can defraud sophisticated players, and vice versa

Agribusiness BFF: Lessons Learned

Lessons Learned

► The importance of early detection of problems

► Greater flexibility the earlier you start

► The problem of the debtor’s non-recognition of a problem – waiting for a “miracle cure”

► Review of documentation, liens and collateral

► Understanding the priority of claims and ability to obtain additional security

► Establishing goals and strategy

Lessons Learned

► Identify structural issues (e.g., fraudulent conveyance issues, other secured lenders, affiliates)

►Perform a liquidation analysis (sets a baseline for negotiations). Consider how you would liquidate.

►Determine scope of debtor’s problems (temporary? legal? environmental? labor?)

►Evaluate company’s projections and management (realistic? competent?)

►Determine how to avoid further erosion