Your client Green Goo has referred to you a new client The Third Man Inc., another public company playing in the sustainable sewage space. The Third Man has made a disastrous investment in the Vienna sewer system, and cash is draining fast. In fact, bankruptcy is a real possibility.
“Our 10-Q is coming up,” Third Man’s General Counsel says to you. “What do we need to say about our current financial situation?”Designing the appropriate disclosure for a company in financial distress is never easy. The situation will likely be fast-moving, fluid and unclear (e.g., will the company close on a new financing package it is discussing with key lenders?).
There is no one-size-fits-all solution here, but we offer the following checklist of some issues that a company could consider when confronting potential bankruptcy.
MD&A

Recall that Item 2 of Part I of Form 10-Q requires Management’s Discussion and Analysis (MD&A) disclosure that includes the information required by Item 303 of Regulation S-K. Item 303 requires that management discuss and analyze the registrant’s financial condition, changes in financial condition, and results of operations. Item 303 specifically requires management to identify known trends or uncertainties that have had (or may reasonably be expected to have) a material impact on the company’s liquidity, capital resources or results of operations. In addition, Instruction 3 to Item 303(a) calls for discussion of “material events and uncertainties known to management that would cause reported financial information not to be necessarily indicative of future operating results or of future condition.”

Possible topics for discussion in MD&A accordingly might include:

• the ability and intent of the company to continue as a going concern based on its current liquidity and capital resources;
• the facts and circumstances that would lead the company to declare bankruptcy;
  a detailed discussion of the company’s secured and unsecured debt, including:
  • maturity dates;
  • key financial covenants and other material terms;
  • the company’s ability to make interest and principal payments;
  • the company’s ability to borrow further funds under its credit facilities;
  • the company’s ability to refinance its debt, and the status of refinancing negotiations; and
  • the status of any defaults and forbearance agreements;
• the company’s ability to access the capital markets to obtain additional debt or equity financing;
• a detailed discussion of why the company is not able to generate sufficient liquidity to fund its operations and debt obligations, and the company’s view as to how these factors will or will not change in the future;
• the impact of economic and market conditions on the company and its industry, and the future outlook for the company and its industry in the context of these conditions;
• potential downgrades to the company’s credit ratings and the impact that might have on liquidity;
• the effect of the company’s liquidity issues on its relationships with suppliers, customers, employees, shareholders and other important third parties; or
• extraordinary transactions being contemplated by management to address the company’s liquidity and capital resources issues, such as a merger or a divestiture of key assets.

Risk factors

You also may want to have a look at the company’s package of risk factors, and ask yourself whether any need to be revised. Potential bankruptcy-related risk factors might cover:

• the consequences of the company declaring bankruptcy if it cannot continue as a going concern;
• the consequences of a default under the company’s secured and unsecured debt, including the inability to comply with financial covenants, make interest and principal payments, and enter into forbearance agreements with lenders;
• the company’s limited ability to access the capital markets to refinance its debt or obtain additional debt and equity financing;
• the adverse effect of the company’s indebtedness on its financial condition and operations;
• the effect of the company’s liquidity issues on its relationships with suppliers, customers, employees, shareholders and other important third parties;
• the effect of potential further downgrades on the company’s credit ratings;
• potential delisting of the company’s stock; or
• any limitations on the ability of the company to pursue a strategic restructuring, refinancing or other transaction which may be needed to stave off bankruptcy.

The bottom line: this is tricky stuff, and the stakes are high. (See, e.g., this SEC enforcement action relating to allegedly misleading disclosures in the months preceding a company’s bankruptcy.) So, if your client is circling the drain, let’s talk.