My friends and colleagues who finance non-investment grade companies have had good times since the Great Recession of 2009, but the volatility of August 2019 brought back memories of Bear Sterns and the call on liquidity for everyone that followed after that bankruptcy. While many readers have experienced downturns, workouts and liquidations, some new to the business have not, and it feels like a good time to review the lessons of the past.

As I reflect back on various interactions in the past with companies that could not maintain adequate liquidity, I recall each of the management teams with which we (and a number of other lessors) worked. In this article, I am going to contrast two different types of managers we can encounter during a period of economic stress, and some of the things that a creditor can experience during these times. I use fictitious names “Rob” and “Paul” to describe the hypothetical managers who either are or represent a lessee or borrower.

Proactive Paul

Your borrower Paul sends you an email asking for a time to talk about his business. Paul is clear in his agenda and he describes what he needs to happen in order for the company to maintain an adequate cash balance. He tells you his plan with the degree of forbearance he needs and what he is asking other creditors to do as well as what is already in the works with his equity investors and/or other substantial debt holders. You ask Paul for a detailed monthly cash operating forecast and you get it the same day.

In this scenario, there is uncertainty as to the ultimate fate of his company and your economic outcome but you have a situation where you get all the information you ask for and more. In addition, you believe in the integrity of the information you receive. Here it is relatively clear to you that your ability to bend (modify your payment terms) is likely to maximize your total recovery. You consider options such as payment deferral, reduced payments and granting the ability to sell certain assets. In the worst case, you ultimately take a loss, but you have been treated as fairly as possible along the way and feel like you would do business with Paul again. In the best-case scenario, you limit your downside and protect or negotiate more compensation for your ability to be flexible when your client needs it. You contribute to helping bridge your client to a healthy position.

Reactive Rob

You get notice from someone on your accounting team that ACME Corp.’s payment did not go through. You call your contact Rob, get his voicemail and leave a message. By the end of the day you have not heard back from Rob, so you send an email with a friendly tone and request to catch up and hear how things are going. Two days later, no response from Rob. You report internally to your team and speculate about how things might be going for ACME. Someone on your team has something judgmental to say about Rob. You take it in but neither pile on nor make excuses for him.

In the scenario I am describing, you are trying to gather facts. You need to understand whether you are going to experience an imminent liquidation, a long workout period or whether payment will resume. You are dealing with someone who, whether consciously or unconsciously, is more motivated to restrict information than to share it. You are on the outside and once the payment is late, and there is no communication, the pressure starts building. After several failed attempts to get meaningful information, you know you are likely in for a much more significant project.

In a Rob-like situation, some creditors may spend more or less time sitting still and watching the outcome unfold. So many things can happen: Rob may insist that all creditors give him time. Rob may figure out that he needs to file Chapter 11 but may have lost valuable time and precious remaining cash on the path to this decision. Rob may be intellectually or emotionally incapable of filing Chapter 11 or otherwise navigating his way through a liquidity crisis. You might see your client bleed out abruptly, or over months. Your contact Rob could walk from the company at any moment during this time.

The Work in a Workout

If you have a workout with a borrower like Paul, life will be relatively easy or at least logical and manageable. If you have a borrower like Rob and you have a meaningful position at risk, approach the workout with the preparation and energy that you would with a new investment opportunity. Try to get direct dialogue with a controlling shareholder as soon as practical. If you can’t get dialogue with a controlling shareholder, or there is no controlling shareholder, try to connect with a director who understands the company’s liquidity and obligations. If the equity investors in the company are not prepared to address the company’s liquidity, the creditors need to be assertive. You need to quickly figure out if you are facing a Chapter 7 liquidation or if there is enough of a business for someone to put new money in or if there is a strategic buyer who would value the business or key assets. Don’t assume because you are “only a lessor” that you don’t have a key role to play. If you own critical assets, you may be in a more significant position to influence the outcome than even a much larger first lien lender. Prepare for the worst by understanding your likely best outcome if you have to repossess. Then be creative in searching for possible solutions that are likely to generate better results. Consider exchanging full or partial forbearance for having equity investors bridge the company in a fair and proportionate way. Talk to the senior creditors to understand their tolerances – what they can and can’t do. There will be scenarios where it will make sense to sit still and do nothing for periods of time but make your choice to be passive an active decision.

Which of Our Clients Will Be Next to Default?

Here is an exercise for lessors that are significant suppliers of financing to their customers: Ask yourself which companies in your portfolio do you have the least amount of faith in to manage their way through a liquidity crisis. Where are the “Robs” hiding? Ask those companies now for updated financial statements and a call to hear about the outlook for the business. Think ahead about your alternatives in a default for each of these and who the most likely funders or suitors for the business are. Remember that during a liquidity crisis, the excitement and energy required by us as creditors is inversely proportionate to our level of preparedness and the aptitude of our client