Bankruptcy Not Only Option to Solve Debt Problems.

DESPITE the overall booming economy in Los Angeles, the area has its share of struggling businesses, many of them small and privately owned. When debt becomes unbearable, many of these businesses simply close their doors or file for bankruptcy.

One of the best business-saving options is often overlooked: loan workouts. For small businesses facing temporary or relatively minor financial problems, this debt restructure strategy can keep a business operating until its financial situation improves.

A loan workout with a lender may result in a new loan agreement with lower interest rates, monthly payment amounts or other new loan terms. One of the most important keys to a successful workout is to contact the lender early with a workout plan, before the lender starts sending threatening payment demand letters.

Waiting until the lender has already redflagged an account makes chances of renegotiating the loan slim. Putting off contact with the lender implies that the business owner did not adequately anticipate current financial problems, leaving the lender with little confidence that the business will be successful in weathering the storm.

Small-business owners should not view a workout as a means to buy time in the hopes that financial troubles will miraculously disappear. Lenders will usually see right through this ploy. Workouts should only be considered when the business is strong enough to realistically pay back the renegotiated loan in a timely manner.

A lender will typically only consider revising original loan agreements when the small-business owner provides a convincing argument why doing so would be worthwhile for the lender. For that, small-business owners must thoroughly prepare for a strong presentation before the lender's management.

The small-business owner needs to assemble a workout presentation package that includes documentation showing the lender how the owner was able to identify the situations that caused the financial problems, and solutions that will resolve the underlying problems. The package should include a short-term (three to six months) cash-flow projection; a business plan under the proposed new loan terms, showing how the business will be able to meet its future financial obligations; and new management methods or marketing efforts designed to increase operational efficiency or increase sales.

The company's accountant can help prepare the financial documents needed in the workout package. The business owner should also consider retaining a loan consultant (many are retired bank loan officers) to help prepare the presentation to ensure that the package contains the kind of information that lenders look for in workout plans. Once the materials are assembled, the borrower should arrange a workout meeting with the lender.

Sometimes, a thorough financial investigation will show that the lender's actions actually led to the company's financial problems. If this is the case, the business owner can negotiate a new loan from a stronger position. Lender's that realize a small business has a legitimate "lender liability" claim will be much more willing to negotiate.

Lender impropriety may be present if the lender tried to:

* Control aspects of the business;

* Add new conditions to the loan after the business had accepted the original terms;

* Improperly use acceleration and demand clauses in the loan documentation in an attempt to ensure compliance or punish the business;

* Fail to provide adequate notice before changing the way it did business (or called a loan due without giving a company time to find a substitute lender);

* Stall the loan process so an unreasonable amount of time passed and the business suffered as a result.

Because lenders know borrowers are usually in a vulnerable position, during workout negotiations, they may try to extract unwarranted concessions. A lender, for example, may insist that any new loan documents include an arbitration clause that waives the company's right to a jury trial, or a release by the borrower of any lender liability for other claims against the lender. If the lender asks for a release or a waiver of important rights, the business borrower must consider the consequences of the concession (i.e., forfeiting the right to sue for an existing lender liability claim in the future).

In loan workouts, almost everything is negotiable: loan length, interest rates, payment schedules and technical loan covenants (i.e., debt-to-equity ratios). Each loan workout is different. A small business may need an entire set of new loan documents or, if the changes are minor, amendments to existing loan agreements may suffice.

The business owner should be prepared to pay renewal or rollover fees to the lender for changes in the loan terms. Some lenders require borrowers to pay the lender's attorney's fees incurred during the workout.

Often, the written documents of a workout are just as comprehensive as the original loan documents. Business owners must make sure that all of the lender's oral promises or commitments made during the negotiations are documented in writing in the loan papers. Without written documentation, these oral promises may be worthless when the business owner later tries to hold the lender to them.

Not all workout discussions are successful. If negotiations fail but clear lender misconduct is present, the borrower and its legal counsel must determine whether it is worth the time and money to fight the lender in court. Caution: because it takes considerable time and money to bring a lender to court on lender liability claims, suing the lender should only be used as a last resort.

By contacting their lenders early and having a program in place that will keep a loan performing, businesses are more likely to convince their lenders to go along with a workout plan, especially if non-financial factors are strong within the company. These factors include the management team's honesty, integrity, long-term business planning ability, track record and competency. All play an important role in a lender's decision-making process.

A. Barry Cappello is managing partner in the Santa Barbara law firm of Cappello & McCann.

Entrepreneur's Notebook is a regular column contributed by EC2, The Annenberg Incubator Project, a center for multimedia and electronic communications at the University of Southern California. Contact James Klein at [phone] with feedback and topic suggestions.