Joseph D. Meddings, Certified Turnaround Professional
As a commercial lender, it is unlikely that you will get to go through a full career without having one of your customers either commit or be a victim of fraud. While the situation can certainly be stressful and anxiety-ridden, here are four things you can do to get some help. Remember, trying to manage a situation like this on your own successfully is unlikely at best, and potentially career threatening at worst.
Find out what the damage is.
It is impossible to formulate an effective strategy for dealing with the fraud at hand if you don’t know the full scope and magnitude – therefore, your first goal is to figure out how bad your collateral position has been compromised. You can and should have a meeting with management to make sure that they have told you everything that they know, but you also need some outside expertise to help quantify the damage. The quickest way to get that type of independent, third party information is to get a field exam done as soon as possible. Concentrate on accounts receivable and inventory during the exam, and include the extra step of customer verification on accounts receivable and a full physical count of the inventory. Although not typically in the normal field examination scope, have the examiner test count the machinery and equipment against the fixed asset software and/or accounting records. Finally, take the additional step to have an appraisal completed to round out the information.
Keep in mind that while your customer may have suffered a significant loss, your collateral may be just fine.
Hire a specialized attorney.
You are going to want to tighten up the credit facility after you have digested the findings. While you could use attorneys that work on regular deals, I would suggest that the potential complexity of a fraud case demands that you hire an attorney that specializes in workouts.
It is important not to overreact and seize collateral where there is no legal right – doing this can cause even more damage if it is challenged in Court and reversed. Potential damages could be rewarded, or the fraud perpetrator could be left in control to continue the fraud while you stand by hopelessly watching.
Fortify your collateral position.
As a lender, you are already programmed that more collateral is better than less collateral. Assuming that the fraud has not damaged the company beyond repair and it will survive, fortify your collateral position with additional assets or guarantees. This is a key and reasonable request from a lender who has just found out that its client can’t protect and report on the lenders collateral base.
Get some additional protection.
Depending on the scope of the fraud and the involvement of senior management and/or ownership, it will probably benefit you to hire a turnaround consultant to assist with the day to day management of the company and protection of the collateral – this is true whether the company will survive or has been fatally damaged.
The key to correcting any loss from fraud is to generate positive cash flow from the operations, asset liquidations or equity injections. A turnaround consultant can assist the company in creating and implementing projections that quickly get the company to breakeven and beyond, and to eventually fill the hole created by the fraud.
Once a plan forward is agreed to by the lender, turnaround consultant and customer, then documenting that in a forbearance agreement is important. Mandating additional collateral, independent 3rd party oversight, projected 13-week cash budgets and control of collateral proceeds are all worth thinking about. Depending on the severity and complexity of the fraud, you may consider more active measures such as the removal of the management team and the appointment of a Chief Restructuring Officer (“CRO”).
Make the hard decisions.
None of this will be easy, including the decision on whether to continue lending to a customer that has been impacted by fraud. You could face internal challenges to not make the potential loss worse by bringing in “high priced talent” to help you navigate the unknown. You will most certainly face external challenges from the customer stating that they found and eliminated the issue, and that they don’t need the additional expense. The easy decision is to roll the dice and see what happens – the hard decision is to make sure you have the help around you that you need and proactively mitigate losses.
Joe Meddings, CTP is the President and CEO of Hollis Meddings Group, a strategic advisory firm that assists companies that are experiencing operational or financial distress. Hollis Meddings Group specializes in family or closely held organizations with $10 million to $500 million in revenues. Joe is a member of the Turnaround Management Association (“TMA”), and sits on several Boards including the Connecticut Chapter of the TMA.