Speakers:

David S. Kupetz, Partner, SulmeyerKupetz

Steven J. Green, Co-founder and President, Kibel Green

AVOID LEGAL AND BUSINESS MISTAKES WHEN YOUR COMPANY, CLIENT OR CUSTOMER IS IN

FINANCIAL DISTRESS

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David S. Kupetz, a member of SulmeyerKupetz, specializes in troubled transactions, crisis avoidance consultation, workouts, restructurings, reorganizations, bankruptcies, receiverships, assignments for the benefit of creditors and other non‑bankruptcy insolvency proceedings. He represents debtors (in restructurings and workouts and in chapter 11 reorganization cases), secured creditors, unsecured creditors' committees, assignees for the benefit of creditors, buyers/sellers of businesses/assets in distressed circumstances and other entities in insolvency and bankruptcy situations. A sampling of clients represented by Mr. Kupetz includes: Care Enterprises, Inc. (debtor in possession); Ocean Pacific Sunwear, Ltd. (debtor in possession); County of Los Angeles (creditor); General Electric Capital Corporation (secured lender); Litton Industries, Inc. (creditor); Boston West, LLC (Boston Markets) (debtor in possession); ExxonMobil Corporation (creditor); Honda Trading Co. (creditor); CKE Restaurants (creditor); San Diego Television, Inc. (debtor in possession); South Bay Pizza, Inc. (debtor in possession); Transgo Corp. (unsecured creditors’ committees); Aura Systems, Inc. (out-of-court unsecured creditors’ committee); Snow Valley, LLC (debtor in possession); Gardenburger, Inc. (debtor in possession); eStyle, Inc. (debtor in possession); American Home (debtor in possession); No Fear Retail Stores, Inc. (debtor in possession); and Ventura Port District (chapter 9 debtor). His many articles on bankruptcy‑related subjects have been published in The Business Lawyer, Commercial Law Journal, IDEA: The Journal of Law and Technology, Journal of Bankruptcy Law and Practice, The Annual Survey of Bankruptcy Law, The Urban Lawyer, The Banking Law Journal, Los Angeles Lawyer, California Lawyer, Commercial Law Bulletin, Los Angeles Daily Journal, The Secured Lender, The Journal of Private Equity, The Journal of Corporate Renewal, Public Law Journal, Federal Lawyer and many other publications. Mr. Kupetz served as the author of Collier Commercial Bankruptcy Forms for many years and currently is the author of the Collier Handbook for Creditors' Committees. Mr. Kupetz is a frequent lecturer on reorganization and other insolvency topics. Mr. Kupetz was admitted to the California bar in 1986. He obtained his legal education at the University of California, Hastings College of the Law (J.D., 1986).

333 South Hope Street 35th Floor Los Angeles CA 90071 (213) 617-5274 dkupetz@sulmeyerlaw.com www.sulmeyerlaw.com

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Steven J. Green is Co-founder and President of Kibel Green. With more than 30 years of experience in business leadership, finance, operations, and turnaround management, Steve Green is a nationally recognized authority in these fields. He co-founded Kibel Green in 1984 and continues to serve as its President. Known for his creative strategic thinking and strong leadership in assisting companies through periods of transition or turnaround, Steve has led or participated in hundreds of operational transitions and major reorganizations, resulting in dramatic improvements to profitability and cash flow. He has also overseen numerous transactions involving acquisition, sale, or financing. Prior to co-founding Kibel Green, he served as President and led successful turnarounds at four mid market companies. Steve holds an MBA from the University of Southern California (USC) and a BS in business from Northeastern University. He serves on the Advisory Council to USC's Entrepreneurship Program and lectures at the USC graduate and undergraduate business schools. He is a frequent speaker on a variety of operational and financial topics. He also holds a California Real Estate Broker license. Steve is a past member and officer of Young Presidents' Organization (YPO) and a current member of World Presidents' Organization.

2001 Wilshire Blvd., #420 Santa Monica, CA 90403 (310) 829-0255 sgreen@kginc.com www.kginc.com

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MAJOR TOPICS

•  Five critical mistakes management makes and proactive approaches for addressing problems before they before fatal

•  Avoiding common legal errors •  Mistakes made by creditors when trying to collect from a company in

distress and suggestions for enhancing recoveries •  Information and specific examples involving companies in distress

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AGENDA

A.  Introduction B.  Characteristics of companies C.  Topics:

1.  Restructuring debts consensually 2.  Avoiding personal liabilities 3.  Avoiding cash crises 4.  Avoiding preferences and fraudulent conveyances 5.  Seeking new capital or sale early

D.  Q&A E.  Conclusion

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Key Characteristics of a Company That May Have Distress in the Future?

A.  Bank line(s) of credit: 1.  Default 2.  Due in next 12 months

B.  Too much debt C.  Losing money or negative EBITDA D.  Litigation:

1.  Litigation among ownership 2.  Major litigation judgment against company 3.  Threatened litigation from creditors

E.  Ownership continues advancing more money to fund company F.  Sharp decline in revenues G.  Loss of major customers or vendors H.  Considering bankruptcy

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Restructure Excess Debt on Consensual Basis Excess debt:

•  Destroys future growth and value •  Stresses cash flow of a business •  Creates conflicts among management and ownership

A company with excess debt:

•  Accounts payable in excess of 30 days past due is more than 50% of total

•  In next 12 months, large amounts of debts (lenders, other debts) are due

•  Defaults with lender(s) exist or are projected to exist •  Major litigation has occurred or is threatened to occur by creditors •  Debts of a company keep rising

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Restructure Excess Debt on a Consensual Agreement

Best practices:

•  Begin early the planning and negotiations process •  Develop financial plans and proposals •  Create a clear vision of the future •  Identify and analyze options for company and for creditors •  Provide credible communication and information to the creditors •  Review existing legal documents

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Restructure Excess Debt on a Consensual Agreement

Types of results include:

1.  Capital structure that works 2.  Return to focus on normal business operations 3.  No repayments for an extended period of time 4.  Repayment program for part of the debt (discount) and return to

normal terms with current debts 5.  Reduction of debt based upon one-time payment 6.  Reduction of debt and new debt is received 7.  Ownership retains all equity

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Restructure Excess Debt on a Consensual Agreement

Requirement: A team with experience and able to dedicate time to this project

•  Management •  Legal counsel •  Restructure/turnaround experts

Case Studies: 1.  Music company 2.  Retail chain with significant IP rights

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Restructure Excess Debt on a Consensual Agreement Plan Plan

Jan-14 Feb-14

Cash 1,311,878 5,530,334

Accounts receivable, net 10,863,827 10,934,809

Inventory, net 18,705,341 18,868,852

Intangible assets, net 11,920,552 12,889,955

Total Assets 57,391,072 58,333,961

Accrued Liabilities (AP, AE, Royalties) 21,516,922 15,007,895

Prior Senior Debt 14,871,500 - New Senior Debt - 22,803,355

Subordinated Debt 40,881,669 15,000,000 ** Contingent Note

Total Liabilities 84,915,338 60,148,298

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Avoid Liability and Recognize Issues Involving Corporate Governance, Fiduciary Duties, and Potential Personal Exposure

•  Corporate directors owe a fiduciary duty to the corporation and its shareholders •  Directors have the duties of care and loyalty and the obligation to act in good

faith •  When a corporation is insolvent, the fiduciary duties of directors and officers

also extend to creditors •  Insolvency

o  Two primary alternative tests: (1) Balance sheet test weighing assets against liabilities; and (2) ability to pay debts as they come due test

o  Third potential test – inadequate capital test – whether insolvency is reasonably foreseeable

o  Actual point of insolvency determined in hindsight and may be uncertain

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Avoid Liability and Recognize Issues Involving Corporate Governance, Fiduciary Duties, and Potential Personal Exposure

•  Under the internal affairs doctrine, the law of the state of incorporation generally governs internal affairs issues, including director and officer liability

•  Delaware law

o  Creditors have standing to bring derivative claims for a breach of fiduciary duty against directors of an insolvent corporation

o  Creditors stand in the position normally occupied by shareholders

•  California law

o  Directors' and officers' duties to creditors are imposed under the trust fund doctrine

o  "All of the assets of a corporation, immediately on its becoming insolvent, become a trust fund for benefit of all of its creditors." Berg & Berg Enterprises, LLC, 178 Cal. App. 4th 1020, 1040 (2009)

o  Application of the trust fund doctrine has generally been limited to situations involving (i) self-dealing by directors, or (ii) preferential treatment of creditors (particularly insider creditors)

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Avoid Liability and Recognize Issues Involving Corporate Governance, Fiduciary Duties, and Potential Personal Exposure •  Protection of the business judgment rule

o  The business judgment rule establishes a presumption that directors' decisions are based on sound business judgment if directors are disinterested and act in good faith after reasonable inquiry

o  If directors are able to demonstrate that they exercised their good

faith business judgment, they will be insulated from liability from negligence relating to their decisions

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Avoid Liability and Recognize Issues Involving Corporate Governance, Fiduciary Duties, and Potential Personal Exposure •  Other Areas of Potential Personal Liability

o  Mistake of using trust fund money (payroll taxes, sale tax, etc…) o  Mistake of floating checks (disbursing checks without cash to cover- can cost a

distressed company critical suppliers – and can result in criminal prosecution) o  WARN Act

§  Employers with 100 or more employees may be required to give 60-day notice of mass layoffs

§  If advance notice not given, company can be held liable for paying equivalent wages for notice period and if company cannot pay officers and directors can potentially be held personally liable

o  False Representations §  making false statements to obtain further credit (even for one last

shipment) can result in personal liability and, in some cases, criminal charges against officers or employees involved

•  Best practice is for directors and officers to obtain advice and guidance when their

company is experiencing signs of financial distress

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Manage Cash Flow to Give Company Time – Avoid Cash Crises •  Cash flow management is very different than managing to profits

o  Most companies are not good at projecting and managing cash flow

o  Focus on growth could create cash issues

•  Symptoms of cash flow issues

o  CEO and CFO express concern about cash o  No cash flow projections or projections are unreliable o  The amount of assets and liabilities vary a lot from month to

month o  Products or services are not meeting sales demands or are not on-

time o  Excess debts – see section above – money is being used to pay

debts verses operations

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Manage Cash Flow to Give Company Time – Avoid Cash Crises •  Best Practices

o  Build and use 13 week cash flow projection – Case study see attachment

o  Develop full set of financial projections: cash flow, income statement and balance sheet

o  Manage the balance sheets to create cash. o  Organize team to project and manage cash flow

1.  Management 2.  Restructure/Turnaround experts 3.  Other resources

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For Discussion Purposes Only-Fundamental Numbers and Assumptions Provided by Management

ACMECash FlowWEEK BEGINNING: ENDING: SourcesOtherA/R InternationalA/R Domestic

Total sources

Raw Material/ Comp.-Curr

Uses-OperatingPayrollAMEXBroker CommissionsUtilitiesHealth InsuranceInsuranceTaxes / BOEMarketingRentFrieghtOther

Total Operating Uses

Net Activity from Operations

Uses-Non-OperatingBank Interest-10.75%Default Interest - 2%Old A/POtherPlaintive LitigationLegal / Consultants

Total Non-Operating Uses

Net activity

Beginning cash book bal

Ending cash (per books)

Actual Actual Actual Actual Actual Actual Actual Actual Actual Actual Actual Actual Projected 1 2 3 4 5 6 7 8 9 10 11 12 13

12/28 1/4 1/11 1/18 1/25 2/1 2/8 2/15 2/22 3/1 3/8 3/15 3/22 1/3 1/10 1/17 1/24 1/31 2/7 2/14 2/21 2/28 3/7 3/14 3/21 3/28 Total

12,000 13,500 15,000 16,500 18,000 19,500 21,000 22,500 24,000 25,500 27,000 28,500 30,000 273,000 540,000 567,000 595,350 625,118 656,373 689,192 723,652 759,834 797,826 837,717 879,603 923,583 969,762 9,565,011

1,169,095 1,064,059 1,014,757 594,365 690,575 436,666 916,767 673,848 574,624 1,606,108 1,205,587 985,675 800,238 11,732,364

1,721,095 1,644,559 1,625,107 1,235,982 1,364,949 1,145,358 1,661,418 1,456,183 1,396,450 2,469,325 2,112,190 1,937,759 1,800,000 21,570,375

- 954,962 718,597 580,038 83,470 476,950 693,800 219,005 548,614 1,045,072 840,233 498,702 769,231 7,428,674

418,495 1,156 408,175 4,222 431,490 936 419,831 1,084 432,255 - 468,745 3,398 435,000 3,024,787

- - - 599,289 - - - 695,545 - - 77 - 822,000 2,116,911

167,205 24,825 1,253 3,797 2,500 142,402 225 5,495 - 154,626 - 5,400 - 507,728

36,983 - - 1,464 - 30,389 - - 43,951 - - - 45,000 157,788

1,575 13,175 121,279 - - - 123,856 - - - - 121,793 381,677

- 52,635 166,148 14,398 - 14,096 18,379 103 96,983 - 15,594 17,846 396,180

- 2,532 4,407 - 46,917 1,594 438 - 15,023 725 2,008 39,600 10,000 123,243

99,766 60,485 75,686 14,276 256 27,927 86,738 662,277 7,198 74,908 407,301 53,000 100,000 1,669,818

- 157,878 - - - 162,370 - - - 157,878 - - 478,127

21,345 18,142 13,451 4,495 11,208 15,290 13,094 17,178 12,809 18,771 11,948 15,529 18,000 191,259

21,984 29,552 50,546 111,915 4,863 47,648 96,093 89,718 17,202 55,987 21,838 21,085 50,000 618,431

767,353 360,380 840,945 753,855 497,235 442,652 758,652 1,471,400 625,420 462,896 927,511 277,651 1,480,000 9,665,950

953,741 1,284,179 784,162 482,127 867,714 702,707 902,766 (15,218) 771,030 2,006,430 1,184,679 1,660,108 320,000 11,904,425

610,507 - - - - 633,667 - - - 652,972 - 1,897,146

111,944 111,944 - - 223,889

-

37,900 20,000 254,000 311,900

-

571,181 270,783 68,404 55,087 154,155 120,598 52,759 27,918 46,423 175,561 344,109 379,205 250,000 2,516,183

1,293,632 270,783 106,304 55,087 154,155 866,209 52,759 27,918 46,423 848,533 598,109 379,205 250,000 4,949,118

(339,891) 58,434 (40,739) (152,998) 630,089 (640,453) 156,208 (262,140) 175,993 112,825 (253,663) 782,200 (699,231) (473,367)

1,724,400 1,384,509 1,442,944 1,402,205 1,249,207 1,879,295 1,238,843 1,395,050 1,132,910 1,308,903 1,421,728 1,168,064 1,950,264 1,724,400

1,384,509 1,442,944 1,402,205 1,249,207 1,879,295 1,238,843 1,395,050 1,132,910 1,308,903 1,421,728 1,168,064 1,950,264 1,251,034 1,251,034

sample for steve of 13 weekCFW 1of1 3/26/20141:45 PM

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Avoid or Minimize Risk of Preferences and Fraudulent Transfers •  Clients need to be made aware when dealing as creditors with companies that

may be on the edge of bankruptcy that they may be required to return payments they receive from the company within 90 days prior to the bankruptcy case

•  Preference risk applies to vendors contemplating a compromise of a delinquent

account, parties in litigation entering into a settlement agreement, a lender negotiating a workout, and others simply conducting business with financially stressed entities

•  There is nothing improper about accepting a potentially avoidable preferential

payment – rather, the preference provisions are designed to ensure equality among creditors (although it generally feels unreasonable to a creditor who was already owed money by the debtor to also be pursued for recovery of a preference)

•  Creditors should be aware of the primary defenses and practical strategies for

reducing potential preference liability

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Avoid or Minimize Risk of Preferences and Fraudulent Transfers •  Elements of a preference – the following elements must be established in order to

recover a preferential payment under Bankruptcy Code § 547:

o  A transfer of an interest of a debtor in property; o  Made to or for the benefit of a creditor; o  For or on account of an antecedent debt; o  Made while the debtor was insolvent; o  Made within 90 days before the filing of the bankruptcy petition (or within

one year if the creditor is an insider of the debtor); and o  That resulted in the creditor receiving more than it would have received in a

hypothetical chapter 7 liquidation case

•  Fully secured creditors generally need not be concerned about preferences because prepetition payments do not provide them with more than they would receive upon liquidation of their collateral – however, the grant or perfection of a new security interest may be subject to avoidance as a preference

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Avoid or Minimize Risk of Preferences and Fraudulent Transfers •  Defenses – the three most common defenses are the following:

o  Contemporaneous exchange for new value (prevents recovery of a payment when the transfer was intended by the debtor and creditor to be a contemporaneous exchange for new value given to the debtor and when such exchange was in fact substantially contemporaneous);

o  Subsequent new value (this prevents a trustee from avoiding a

transfer where the creditor subsequently provided new value to the debtor); and

o  Ordinary course of business defense (either the payment was

received in the ordinary course of business between the parties or on terms ordinary for their industry)

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Avoid or Minimize Risk of Preferences and Fraudulent Transfers

•  Avoiding common mistakes: o  Application of incoming payments

A.  A common mistake of creditors conducting business with a financially distressed entity is to apply incoming payments to the oldest outstanding invoices

B.  If the creditor suspects the debtor is in financial distress and wishes to minimize the risk of preference liability, it should have new payments applied to the goods or services provided at the time of payment – this will allow a creditor to assert the contemporaneous exchange for new value defense

o  Restricting Credit A.  A common mistake of creditors is to restrict credit upon discovering that

debtor is experiencing financial difficulty B.  Payment received after creditor begins restricting credit terms may be

viewed by a bankruptcy court as outside the ordinary course of business between the creditor and the debtor

C.  Instead of tightening or more strictly enforcing credit terms, if possible, creditors should require advance payment or COD payment in order to eliminate the antecedent debt element and/or avail themselves of new value or contemporaneous exchange defenses

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Avoid or Minimize Risk of Preferences and Fraudulent Transfers •  Settlement Agreement and Workouts

o  Payment received within the preference period in connection with settlement agreements and workouts may be subject to preference attack since the settling parties are generally compromising an antecedent debt and it may be that no new value is being provided to the debtor

o  Some courts have agreed with the argument that a settlement

agreement constitutes a contemporaneous exchange for new value when the settlement releases the debtor from contingent claims (thus providing new value)

o  A settlement agreement should be explicitly drafted to state that new

value is being exchanged and that the parties intend that the exchange be substantially contemporaneous

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Avoid or Minimize Risk of Preferences and Fraudulent Transfers •  Earmarking doctrine

o  A required element for a preference is that the transfer involves an interest of the debtor in property

o  The earmarking doctrine insulates transfers that are provided by and

earmarked for the creditor by a non-debtor third party, such as lender independent of the debtor, or an affiliate or insider of the debtor

o  If a creditor can establish that all of the elements of the earmarking

doctrine are satisfied, it can protect a payment received within 90 days before the bankruptcy case from preference recovery

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Avoid or Minimize Risk of Preferences and Fraudulent Transfers

o  Guidelines for structuring transaction to fall within the earmarking doctrine:

A.  The debtor and the non-debtor third party should enter an agreement providing that the new funds will be used solely for the purpose of paying the existing creditor's antecedent debt;

B.  Under the agreement, the debtor should not have control over the disposition of the funds or any ability to comingle the funds (and the funds should be identifiable and traced to the existing creditor);

C.  The existing creditor should maintain records showing that the agreement has been performed according to its terms; and

D.  The transaction needs to be structured in a manner where it does not diminish the debtor's estate (i.e., an unsecured debt is not replaced with a secured debt)

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Avoid or Minimize Risk of Preferences and Fraudulent Transfers

o  In defending a preference, it is helpful to have some knowledge regarding the bankruptcy estate and anticipated distribution to creditors (if there's not a complete defense to a preference, frequently a settlement can be negotiated and, in some instances, the settlement might involve the waiver of a claim in return for the dismissal of the preference action)

•  Fraudulent Transfers

o  Another tool for recovering pre-bankruptcy payments or a avoiding other transfers

o  Constructive Fraud (reasonably equivalent value not received) o  Actual Fraud (intended to hinder, delay or defraud creditors)

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Seek Out New Capital or Consider a Sale Transaction as Early as Possible

•  Always better to have enough time to do an orderly transaction

o  Valuation o  Probability for success much better

•  Symptoms

o  Company knows it needs new capital or conduct some transaction in next 12 months

o  Lender or others large debts are due in next 12 months o  Company has failed in prior attempts for new capital or sale o  Not a good vision and plan for the future value creation

- Why should a new lender or capital provide money, or pay good value?

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Seek Out New Capital or Consider a Sale Transaction as Early as Possible

•  Best practices

o  Determine the amount of new capital required in next 12 months and then 3 to 5 years

- Debt restructuring may reduce capital need o  Get an assessment of capital markets or potential to sell company

- Retain financial advisor or get outside perspective o  Develop the Value Creation Plan (business plan) to go to market o  Organize team to complete transaction

§  Management §  Investment Banker §  Restructuring/turnaround expert §  Legal

•  Case studies: One that waited and one that got organized early