Working Together: A Previously Successful Business’s General Counsel and Distressed-Debt Counsel

By: Donald L Swanson

Answers to these two questions can get tricky:

1. When should a previously successful business engage distress-debt counsel?
2. What is the role of the business’s general counsel once that happens?

Second Question: Role

Here’s the answer to the second question first: 

• The business’s general counsel needs to remain involved, after engagement of distressed-debt counsel, with an agreed division of labor between the two counsel. 

General counsel should not merely “turn over” the client to the distressed-debt counsel.  Here’s why:

• typically, debtor’s general counsel has (i) a wealth of knowledge about the business and the business owners and their goals and strengths and issues, and (ii) the trust of the business owners; and
• distressed-debt counsel will need to lean into both of those benefits to adequately and zealously represent the debtor.

First Question: Timing

As to the first question, there is frequent-and-huge problem of businesses waiting too long to engage distressed-debt counsel: i.e., waiting until debtor’s decline into failure is entrenched and irreparable.  To illustrate: “There’s a replevin hearing on Thursday,” is not a good comment for debtor’s first discussion with distressed-debt counsel.     

This waiting too long problem seems to arise from a linear view of legal representation: i.e., this linear view sees a clean break between general counsel’s representation and the distressed-debt counsel’s representation. 

It’s illustrated by a time line that looks like this:

—>General Counsel role—>Bankruptcy Counsel role—>

Answer to Both Questions

Rather than waiting too long and then displacing general counsel with distressed-debt counsel, the better approach is to:

• get distressed-debt counsel involved as soon as debtor’s distressed debt issues become serious; and
• get into a combined representation mode, with debtor’s general counsel and distressed-debt counsel each playing a different-and-complementary role.

Many of my debtor representation cases have the debtor’s general counsel—i.e., debtor’s trusted advisor—directly involved, so that we can provide joint efforts and joint representation at all times, to both (i) educate me, and (ii) help me educate the debtor.

Alternative Means of Joint Representation

There are a variety of ways general counsel can be formally involved in such a joint representation—and get paid:

• One way is for general counsel to represent a party that’s related to the debtor, such as one of the debtor’s owners, an older (or younger) generation of family members involved in the business, or an affiliated entity; and
• Another way is to be a co-counsel with distressed-debt counsel in representing the debtor, each having a different role in a specified division of labor.

[Note: once a bankruptcy is filed, any joint-representation of the debtor needs to be approved by the bankruptcy court up-front, with a specific division of labor, and the Bankruptcy Code’s fee application process needs to be followed by both counsel.]

Timing & Limitation

Back to the timing issue:

• Distressed-debt counsel needs to be engaged early-on in the distressed-debt situation;
• The initial engagement of distressed-debt counsel can be a limited one—e.g., a Zoom meeting every Friday afternoon—to keep abreast of and evaluate debtor’s ongoing situation and progression; and
• This way, distressed-debt counsel can evaluate options, consider strategic alternatives, and (most importantly) be informed and prepared when bad- or worse-case scenarios begin to materialized.

Additionally, small and middle market businesses need to take a page from the monster bankruptcies—like General Motors.  Those bankruptcy debtors didn’t simply wake up one day and decide that a bankruptcy filing is needed tomorrow.  No.  They:

• saw the bankruptcy necessity coming for many months;
• retained distressed-debt counsel to prepare for that eventuality;
• planned for the bankruptcy filing for many months; and
• then executed the well-planned and well-thought-out bankruptcy strategy when the time for such action finally arrived.

Terminology

An important note on the foregoing discussion is this: all references are to distressed-debt counsel—not to bankruptcy counsel. 

Here’s why: a primary goal is always to avoid filing bankruptcy—whenever possible.

So, instead of promptly jumping into a bankruptcy filing, distressed-debt counsel can use the bankruptcy possibility in a dual manner:

1. To provide a backstop for out-of-bankruptcy negotiations—i.e., showing what would happen, if a non-bankruptcy resolution cannot be reached; and
2. To provide a remedy—i.e., actually filing bankruptcy, if out-of-bankruptcy negotiations don’t succeed.

Conclusion

It’s tricky: transitioning a distressed-debt counsel onto the professional team of a previously-successful business.

But for such businesses, its important to:

• engage distressed-debt counsel early-on in the distressed-debt situation; and
• find a way for distressed-debt counsel to work with (rather than displace) debtor’s general counsel.

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