The ripple effect Featured

7:00pm EDT January 29, 2008

While your business may seem to be far removed from the problems of Wall Street and increasing foreclosures, you’ll most likely feel the impact here in Northeast Ohio sooner rather than later.

“Business owners need to consider how the overall economic slowdown will affect them over the next three to nine months,” says Shawn M. Riley, managing partner of the Cleveland office and chair of business restructuring at McDonald Hopkins LLC. “They need to anticipate the impending challenges and become knowledgeable about their legal rights and alternatives if they find themselves in a crisis.”

Smart Business asked Riley how difficult he thinks matters will get in the near term and what companies should consider if they end up facing restructuring or bankruptcy.

What impacts will the subprime mortgage crisis and the drop in home values have on business restructurings and bankruptcies?

As homeowners see their mortgage rates reset, they will be forced to spend more of their monthly income on housing. This will crimp spending on durable goods, automobiles, appliances and remodeling. Already, some of the manufacturers of these products are seeing downturns. Chrysler, Ford and General Motors predict that 2008 will be down from 2007 and certainly from 2006. This will have a ripple effect through the economy. Consider, for example, the manufacturers of auto parts. As their orders from automakers decline, they will need to start thinking about the cuts they will have to make. They might target areas such as cleaning and janitorial services, supplies, etc. Then, what we’ll probably see, especially in the second half of 2008, is an increase in the number of businesses that file bankruptcy or that are in some type of distress — for example, with their own loan agreements. They may need to go out and raise more capital, sell the company as a stand-alone, combine with another company, or liquidate.

What other macro-economic factors will impact business restructurings?

The increase in oil prices will have a definite impact in Northeast Ohio. In addition, the inflation rate is driving the cost of goods higher and, when coupled with the decline in wealth resulting from reduced home values, consumers are spending less. This feeds the cycle of economic slowdown.

Will Northeast Ohio fare better or worse than the rest of the nation?

Unfortunately, I think it will fare worse in the near term. Manufacturing drives much of our local economy — particularly auto manufacturing — so we may bear a disproportionate part of the slowdown. All evidence from media reports indicates that Cuyahoga County and Northeast Ohio have among the highest foreclosure rates in the nation. The good news is that if we feel the pain first, we may begin recovering sooner than other parts of the country. If that is not the case, we should still be OK because as demand for automobiles and other goods begins to rise again throughout the country, demand for parts manufactured in Northeast Ohio will begin to rise again, as well.

How will the 2005 changes to the Bankruptcy Code affect business restructurings?

Before the code changed, bankruptcy was often considered a viable way to save a business and then turn it around. Today, it is still an alternative, but all parties — owners, lenders and trade creditors — see it as ‘less attractive.’ In the past, there were no limits on how long a company could stay in bankruptcy. Now, they have 18 months to complete the process. These shortened deadlines make the process more difficult.

There are other disincentives, as well. Historically, companies could offer senior management bonuses to stay and complete the reorganization process. Now, there are very severe limitations on that, so there is a very real risk of losing management. Another disincentive is the new deadline that a company has to make decisions about buildings [e.g., leases, stores], which is 210 days from filing. This creates a lot of pressure to make decisions about assets rather quickly.

The result of all this is that companies may be more reluctant to use the bankruptcy process and may try to get more creative in exploring alternatives. For example, the owners or lenders might decide it is best to sell the business to a competitor that can absorb the overhead and run the company better. Some companies do end up deciding bankruptcy is the best solution. A benefit is that it is a comprehensive process that resolves all issues once and for all.

What is your advice for companies that decide to move forward with bankruptcy?

If you don’t have the process completed within 18 months, another involved party — such as a lender, creditor or union — can come forward with its own plan. So move quickly or you run the risk that others will take charge.

SHAWN M. RILEY is the managing partner of the Cleveland office and chair of business restructuring at McDonald Hopkins LLC. Reach him at (216) 348-5773 or sriley@mcdonaldhopkins.com.