For management at these plants, having a plan to deal with dwindling cash flows and reserves is critical to avoid shutting down and surviving until better times.
A plant’s ebbing cash flow will impact its relationships with creditors such as vendors, banks and employees. It can also test the equity owners, as the financial strains will impose greater burdens on them and may expose divergent goals. This is particularly true where owners wear other hats such as that of a supplier. The specific nature and scope of the financial difficulty will determine which creditor or creditors will be the focus of the plant’s operational renewal. The process of realigning reasonable expectations, however, remains fundamentally the same.
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Declining cash flows may prevent the plant from meeting all of its contractual obligations in a timely fashion. To work through these issues, the plant must convince creditors that a realignment of these obligations is in everyone’s best interests. The primary line of reasoning is that a termination of the creditor’s relationship with the plant or commencement of a collection action will result in a far smaller return. As a result, it is in the best interest of all those involved, including the creditor, to receive payment according to a more relaxed timetable or in an amount less than originally expected.
The most critical factor determining whether a plant can weather the current economic climate is early recognition of the challenges and putting a comprehensive plan in place. The plant’s resources may be needlessly wasted attempting to impose last-minute solutions. The plant may obtain short-term concessions from creditors. This may provide the plant immediate relief. However, it will typically fail to address the fundamental issues driving the dwindling revenues. It may even exacerbate such problems by causing the plant to incur additional obligations such as interest and attorneys’ fees. The current environment calls for resolutions that are broader in scope, more farsighted and permit the plant to continue operations rather than shut down. Such resolutions may include the implementation of a uniform plan to extend contractual commitments to conserve operating capital with a wider array of the plant’s creditors.
One critical class of creditors is vendors. Those who supply the goods and services essential to the plant’s continued operations often are the first to feel the impact. In a time of financial distress, payments to these suppliers may be untimely and infrequent. This is a product of necessity as it is a way to informally fund operations. If the financial problem is quickly resolved, such vendor financing may be sufficient. The current and near-term economic conditions, namely high-priced inputs and oversupply caused by infrastructure problems, counsel that such a resolution will be rare or only temporary.
If delaying payment of obligations to vendors fails to trigger the operational renewal, banks are often the next class of creditors to be addressed. The deteriorating condition may trigger a default under the loan documents such as a missed payment or very often a breach of financial covenants. Indeed, banks draft the default provisions broadly to enable quick action on their own financial interests. Diligent banks will learn of the operational concerns before a payment default occurs through financial reporting required under the loan documents. The recent publicity surrounding the difficult issues facing the ethanol industry will condition banks to have their antennas tuned for such distress.
Once aware of potential problems, banks usually proceed with a two-pronged approach. First, they will conduct a review of the plant’s assets securing the loan. The analysis will assume that the assets will be sold at an orderly liquidation value, significantly less than fair market value. The bank uses this picture of the asset values to establish the available approaches to ensure payment of the loan or otherwise maximize its recovery. Second, the bank will demand that the plant provide it with a plan and supporting financial information, such as projections, to resolve the operational issues. Provided an arrangement can be reached with the bank, it will permit the plant to continue to operate under close monitoring. If the bank perceives that the continued operations will further deteriorate its financial position, the bank will likely act quickly to attempt to enforce its rights, particularly against the assets.
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