As the current economic downturn continues, we are likely to see more involvement by so-called “turnaround” consultants with struggling businesses. A turnaround consultant will assist a company with business restructuring advice in order to enhance performance (mainly profitability and cash flow).
It is an accepted and sound workout approach for lenders to request that their troubled borrowers retain turnaround consultants to help right the ship by cutting expenses, developing strategies to enhance revenues and to report on the borrower’s financial progress in a meaningful and timely way to the lender.
Lenders, however, need to proceed with caution when making retention of a turnaround consultant a condition of a forbearance or other workout arrangement. A lender should not mandate or require a borrower to hire a particular consultant. Rather a lender should give a borrower a list of three (3) or more names of possible consultants acceptable to the lender, while also giving the borrower an opportunity to suggest any other qualified turnaround consultant the borrower may prefer. It is then the borrower’s task to interview and retain the consultant of its choice.
It is important for a number of reasons that the borrower be the party hiring the turnaround consultant:
- A turnaround consultant is employed by and hired by the borrower. The consultant’s duty is to the borrower. While a lender will negotiate with the borrower for the right to speak directly with the consultant and to request specific financial reporting (such as 13-week cash flows) prepared by the consultant, the lender is not financially responsible for paying the consultant, and the consultant does not report to or obey the lender’s directives. This boundary must be respected to avoid potential issues. If the lender were to hire the turnaround consultant directly, then that consultant would report to the bank, but would then not be in the proper position to suggest the appropriate business restructuring strategies for the borrower. Thus, the primary purpose of the turnaround consultant would be thwarted.
- If the boundaries in the turnaround consultant relationship are not respected, the consultant could also be deemed an agent of the lender and the lender may be considered responsible for any poor decisions or other failed strategies implemented by the consultant. This has the potential for significant liability for a lender. Control or instrumentality liability can expose a lender not just to liability to its borrower, but also to other creditors of the borrower who may claim the lender overstepped its role by controlling the actions of the borrower to the detriment of the other creditors. This danger is particularly present in the event of a bankruptcy filing by the borrower.
- If the lender limits the selection of a consultant for a borrower to a single consulting company, the lender may also face liability claims for negligent referral or recommendation if the consultant is unable to successfully restructure the borrower’s operations. The borrower could then claim that the lender knew or should have known about the consultant’s deficiencies and blame the lender for the damage caused to the borrower’s business. Similarly, the ordinary lender-borrower relationship is not a fiduciary one, meaning the lender can act in its own self-interest and is not required to act in the best interests of the borrower. By imposing a specific consultant on a borrower, the lender may be deemed a fiduciary in its relationship with the borrower which is a prescription for liability.
In a lender-creditor relationship, boundaries are important and must be observed. Not doing so opens the door to potential lender liability claims. Turnaround consultants can provide critical business restructuring advice and strategies and set a borrower back on the right track. Lenders should be cautious though and always provide a borrower with a number of suggested choices for turnaround consultants who have successfully helped borrowers manage forbearance or workout situations with lenders.
This communication is for informational purposes only and should not be construed as legal advice on any specific facts or circumstances.