Articles Tagged with Sales

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An asset based loan (“ABL”) is often the financing of choice for retail borrowers – and for good reason. In its simplest form, an ABL is a credit facility, usually in the form of a revolving line of credit, the availability of which is based exclusively on the value of a company’s “eligible” assets.  In the retail context such eligible assets are, for the most part, the company’s accounts receivable and inventory.  There are numerous advantages of an ABL over a traditional loan: an ABL is typically easier to obtain since it is based on a company’s assets and not cash flow; an ABL provides ready cash to support liquidity needs; an ABL often includes flexible borrowing and repayment terms and less restrictive financial covenants; and, particularly beneficial to retailers, an ABL commonly accounts for seasonality and allows more borrowing during periods of slower sales.  The borrower in the ABL is required to submit a “borrowing base certificate” on a monthly or even weekly basis, which details the current inventory levels (and accounts receivable), deducts certain amounts such as letters of credit, applies the applicable borrowing percentage (usually a percentage of the net orderly liquidation value (“NOLV”) of their inventory), and the result is the amount of cash available.  In addition to borrowing base certificates, the company is also subject to field examinations and inventory appraisals conducted at least once a year, if not more often, which determine the percentage applied to their borrowing base calculation.

iStock-184621155-1024x682When retail sales are booming, the company and the ABL seemingly work like a well-oiled machine: inventory is rapidly converted to cash, which is then used to pay the loan and fund purchases of new inventory, which, in turn, increases the amount the company can borrow at any time, commonly known as the “borrowing base”. A difficulty arises, however, when one of these necessary steps is obstructed – which is exacerbated in the bankruptcy context.  There seems to be an inherent conflict between the fluid nature of retail inventory flow and the fixed nature of a borrowing base.  It would certainly be maddening if American Express restricted my credit limit on a weekly or daily basis depending upon what was, or was not in my closet at any given time.

When the amount you can borrow depends upon your inventory levels, the retail company is incentivized to keep inventory levels high through new inventory purchases, which, in turn, often requires drawing cash from the credit facility.  This vicious circle illustrates what is colloquially referred to as the “ABL Trap”.  Even when it may be in the company’s best interest to reduce or hold off on inventory purchases, the selling of inventory without replenishment will lower its borrowing base and increase the risk of an overadvance – that is, when the amount borrowed exceeds the calculated availability.

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On December 1, 2016, something extraordinary happened. No, it was not president-elect Trump visiting another Carrier air conditioning factory in Indianapolis. It was an event that made no headlines and caused no stir.  The Federal Rules of Bankruptcy Procedure were silently amended to remove all references to “core” and “noncore” proceedings.

So what’s the big deal?

Besides eliminating one of the last tools I possessed to sound smarter than my non-bankruptcy colleagues, the change reflects the final chapter in a 34-year saga regarding bankruptcy court jurisdiction and the constitutional authority of bankruptcy judges.

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The biggest trend in Chapter 11 bankruptcies over the past 10 years is to sell assets through a “Section 363 sale,” named for Section 363 of the Bankruptcy Code, which describes the standards for sales in bankruptcy court.   Previously, in most Chapter 11 cases, the debtor would propose a Chapter 11 plan.   In successful cases, the Chapter 11 plan would be approved by creditors and by the court.   If a debtor was selling substantially all of its assets, the sale would be part of the Chapter 11 plan.

With greater and greater frequency, debtors and their buyers have eschewed the more laborious Chapter 11 Plan process, opting to consummate the sale transaction by way of a simple motion under Section 363 of the Bankruptcy Code.   In order to obtain court approval of a Chapter 11 Plan, a debtor must first obtain approval of a disclosure statement, must then obtain sufficient votes from creditors, and finally, must meet other stringent Bankruptcy Code requirements.   This takes time, generally at least 3 months.  It is also expensive, and the outcome is uncertain.

In contrast, a motion to sell assets free and clear of liens under Section 363 can be accomplished upon regular notice—21 days in Southern California—and sometimes on even shorter notice if the Court allows it.   In addition, the paperwork is much less onerous and thus less expensive for the bankruptcy estate.

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