Ask the Workout Window: Bankruptcy Complexities Galore

In each issue of The RMA Journal, veteran workout leader Jason Alpert gives advice on thorny workout challenges. Have a challenge you would like Jason to address? Send your question to WorkoutWindow@rmahq.org.   

QUESTION: Our financial institution has deep relationships with our customers,  providing consumer products to individual business owners and commercial loans to their companies. Recently, a  commercial banker received a notice of bankruptcy from our consumer department, as the individual consumer, Mr. John Galore, filed a chapter 13 personal bankruptcy. Mr. Galore owns Kitchens Galore, a contractor and supplier for kitchen remodels in our local market. We financed a $2 million owner-occupied showroom/warehouse property owned by a single-asset entity and a $750,000 unmonitored line of credit to Kitchens Galore for working capital. Mr. Galore provides unlimited and unconditional guarantees for both loans. 

Personally, Mr. Galore has a HELOC on his residence with our bank totaling $1.4 million. He also has a mortgage on a mountain cabin of $600,000 (purchased two years ago), three car loans totaling $100,000 (purchased over the last three years), and a boat loan of $65,000. Additionally, he has multiple business and personal credit cards with balances totaling $165,000. Our commercial team receives Mr. Galore’s annual tax returns and pulls credit reports annually. He requested an increase in Kitchens Galore’s line of credit, but we declined, given that Kitchens Galore didn’t have much additional collateral to pledge and we weren’t willing to exceed our real estate lending limits to cross-collateralize the showroom/warehouse. His credit score at the time had fallen to 645, which is not an event of default. 

We also recently found out from our consumer lending team that he was consistently past due on the car loans, boat loan, and credit cards. The company did well during the pandemic; however, revenues, margins, and liquidity have all declined over the past 18 months, and he is on track to break even on a cash flow basis this year. We know the guarantor’s bankruptcy is an event of default, and we are in the process of engaging our workout team and legal counsel. What else should we do?  

JASON: In today’s environment, where banks actively compete to increase wallet share from their customers—both on a commercial and consumer basis—scenarios like the above are not uncommon. While regulations sometimes silo different departments, communication and collaboration between bank groups are crucial. In fact, timely consumer payments and/or the increasing leverage might have raised red flags before Mr. Galore felt the need to file personal bankruptcy.  

First, the bank should align its approach to the consumer and commercial loans. Since the consumer loans are in bankruptcy and the commercial loans are paid as agreed but in default due to guarantor’s bankruptcy, the bank should ensure it has appropriate counsel and staff to manage the consumer bankruptcy. Second, the commercial loans should also be moved to the workout group and assigned legal counsel (which could be same as for the consumer side). The loss of the guarantor’s backing (given Mr. Galore’s bankruptcy filing) will likely lead the bank to fully exit the relationship unless the underlying business is strong enough that the bank is comfortable with an essentially nonrecourse loan (unless another family member or friend is willing to provide a substitute guarantee). In the case of an exit, the bank should make sure that its counsel engages with the customer’s counsel to avoid violating the automatic stay of the personal bankruptcy. 

Third, leverage the guarantor default to pick up any credit enhancements, term out the line of credit, and cross-collateralize or cross-default the two commercial loans to facilitate an orderly exit from the bank (shortening maturity, increase the rate, etc). Finally, the borrower may want to consider a sale-leaseback of property to deleverage the business (which could lead to a payoff of the real estate loan and, if cross-collateralized, the line of credit). However, I cannot stress this enough: Be sure to have outside legal counsel with bankruptcy experience fully engaged to handle the complexities of both the commercial restructuring and the consumer bankruptcy. Since the deal involves consumer collections the attorney should have experience with both commercial and consumer debt collection. Additionally, the bank should ensure that its internal systems do not inadvertently send collection correspondence to someone in bankruptcy. This happens all too often, and a system should be developed to prevent it and ensure both sides of the bank are aligned. 

Jason Alpert is managing partner at Castlebar Holdings, a distressed debt fund and financial institution advisor. Jason led and managed workout and special asset teams at major financial institutions for two decades. He is on the editorial advisory board of The RMA Journal and is an adjunct professor at the University of Tampa. Email Jason at jason@castlebarholdings.com or reach out to him at 813-293-5766.    

Disclaimer: The Workout Window is not intended nor is it to be considered legal advice. As The Workout Window stresses, consult with legal counsel and your institution’s management to be sure you are acting within the parameters of your institution’s policies and banking law.  

Please note: Sending a Workout Window question indicates you approve of the question’s publication, without attribution to you, and its use in the development of scenarios, practices, and advice that could be included in the Workout Window or other RMA content, properties, and platforms.