Using a Virtual Data Room to Manage Bankruptcy Scenarios28 February, 2009
Over the last year, the number of corporate bankruptcies has surged considerably due to financial turmoil and tight credit conditions. Among publicly traded companies, bankruptcy filings in the US increased by 74 percent in 2008 when compared with 2007, according to figures from BankruptcyData.com.
Also, the total assets of the companies filing for bankruptcy rose dramatically, to a record $1.16 trillion from just $70.5bn in 2007. This increase can be partly attributed to the collapses of several financial institutions, including Lehman Brothers, which had $691bn in assets at the time of its downfall. The size of the companies filing for bankruptcy protection, combined with the recent changes enforced by Congress, are making bankruptcy and restructuring processes more complex. One result of this added complexity is that virtual data rooms (VDRs), already in frequent use in M&A transactions, are increasingly being utilised to facilitate bankruptcy and restructuring processes, allowing companies to host and manage thousands of documents online in an electronic format.
Over the last year, the number of corporate bankruptcies has surged considerably due to financial turmoil and tight credit conditions. Among publicly traded companies, bankruptcy filings in the US increased by 74 percent in 2008 when compared with 2007, according to figures from BankruptcyData.com. Also, the total assets of the companies filing for bankruptcy rose dramatically, to a record $1.16 trillion from just $70.5bn in 2007. This increase can be partly attributed to the collapses of several financial institutions, including Lehman Brothers, which had $691bn in assets at the time of its downfall. The size of the companies filing for bankruptcy protection, combined with the recent changes enforced by Congress, are making bankruptcy and restructuring processes more complex. One result of this added complexity is that virtual data rooms (VDRs), already in frequent use in M&A transactions, are increasingly being utilised to facilitate bankruptcy and restructuring processes, allowing companies to host and manage thousands of documents online, in an electronic format.
Their use also enables businesses to assess the key documents relevant to a restructuring process and in a secure environment. Furthermore, the number of VDR providers is increasing, the products have improved and the prices are coming down, all of which could be pointing to a boom in the use of virtual data rooms in 2009. However, there are still a substantial number of companies relying on paper-based bankruptcy procedures, indicating that there may be awareness issues.
Accelerating and facilitating the restructuring process
In a bankruptcy or restructuring situation, companies must deal with complex procedures and deadlines as well as managing an abundance of documents that need to be reviewed by several parties, sometimes spread across the globe. “These might be the creditors, the committees, the banks, the advisers, bankruptcy attorneys, or court-appointed trustees – all of whom need to be informed in detail through those documents, while preserving the confidentiality of that information, because you are sharing the information outside the boundaries of your firm,” explains John Badger, the vice president of Marketing & Product Management at Pandesa Corporation. The workflow associated with that process can be a tremendous logistical challenge and often creates difficulties, especially in such a rapidly changing business environment. “Insufficient, incomplete and inaccurate records are a frequent problem for companies which have gotten into trouble, and just as frequently are one of the root causes of the difficulty. Without good and complete information it is hard to navigate a challenging environment,” asserts Anthony H. N. Schnelling, a managing director at Bridge Associates LLC. However, this can be mitigated by making use of VDRs. He continues, “VDRs provide a single location for housing information and making it readily accessible to selected users.”
With immediate, timely access to pertinent documentation, all parties can share critical information required for tight deadlines via a web access portal. Unlike a physical data room, it is generally the case that several people can simultaneously view documents in the VDR at any time of day, simply by using a login and password. In addition, VDRs allow for a more logical and efficient structuring of the documents gathered, thereby making the information more accessible.
Furthermore, most providers have concentrated on improving that accessibility of late, and now offer a range of electronic tools for use within the VDR, such as the ability to search by word and/or concept. “You need to be able to find things across the entire universe of your documents in a rapid and efficient manner, not only by searching document titles,” insists Paul F. Hartzell, senior vice president of DataSite at Merrill Corporation Ltd. “When was the last time you titled a document ‘Look in here for the problems’?” In addition, virtual collaboration between the different parties involved in the restructuring has been facilitated by improved editing and tracking tools.
The ability to undertake a full text search and to communicate easily with other parties can actively assist in speeding up the due diligence period, and consequently galvanises the whole bankruptcy process. In addition, a streamlined, well-organised environment enables the people involved to concentrate on restructuring the business, rather than wasting time in other areas. “Outsourcing the capture, hosting and management of the data to a VDR provider allows the professionals in a process to focus on case dynamics, as opposed to being burdened with the administrative nightmare of information gathering and presentment,” says Brandon Farley, managing director of Bowne Virtual Dataroom.
Furthermore, restructuring a troubled business often includes disposing of some of its less vital assets, which can also be supported by a virtual data room. “Once the restructuring is decided upon, the VDR can be used to divest certain units of a business, so as to optimise a portfolio which fits into the company’s strategy,” points out Alexandre Grellier, CEO of Data Room Services. “Flexible access to the relevant documents for the involved parties at any time makes a fast and complex restructuring process possible.” In the case of a §363 sale of a debtor’s assets, for example, the seller and its advisors can convert all the necessary documentation into a digital format and upload them into the VDR.
Once this has been completed, an interested party can draft, edit and execute a sales agreement completely within the virtual room.
VDRs are also useful tools for reducing the time, and therefore costs associated with contract reviews. They can also present new opportunities by opening investment channels. “By offering online access to their information, which expands the locations and number of potential participants, clients can expand their lender, investor and buyer universe without added expense,” observes Fred Mather, executive vice president Global Sales at IntraLinks. He also explains that through the acceleration of the bankruptcy process, a VDR can not only support a company in recovering from a difficult situation faster, but also enable the reduction of certain risks, commonly found in such environments. “VDRs can help minimise risk during bankruptcy and restructuring by shortening deal timelines and therefore leaving less time for market factors to disrupt a deal,” Mr Mather adds.
Limiting risks, reducing costs
A threat that goes hand-in-hand with bankruptcy is the potential for litigation. Keeping track of who accesses what data and which types of documents are consulted is essential in a bankruptcy situation, but a challenge to achieve in a paper-based environment. Litigation surrounding the availability of critical information can often lead to a prosecution, notes Mr Hartzell. “On the risk management side, you are preparing for when both sides say ‘prove it’. Prove that these documents were made available, prove that these documents were accurate – in other words that there were truthful – prove that the people who are charged with evaluating this have done so thoroughly. When you are buying a VDR, you are buying a framework that allows you to generate this proof,” he adds. With a virtual room in place, all documents are captured and indexed in a single online database, simultaneously guaranteeing both availability and proof.
Furthermore, it is easy to control access to information. User rights for viewing, printing or accessing documents can be defined by the VDR manager and can change depending on the situation. “VDRs, if properly set up, manage and monitor risks by providing accurate record-keeping of what is available, who gets access and what sort of access each user is given. There is also the ability to create discrete categories of information according to differing needs of differing stakeholders,” observes Mr Schnelling. Indeed, this monitoring ability goes further than simply offering protection from potential litigation. “The transparent tracking of all user activities also avoids any misuse of information,” adds Mr Grellier. “With today’s technology, it is possible to track all documents that have been added, removed or deleted in the lifecycle of the data room. As such, it offers fewer angles to attack the transaction post closing. Also, all the information can be kept by the seller so that they are well prepared for future issues.”
The security of the information disclosed is evidently enhanced, particularly in comparison with a paper-based environment in which printed documents often have to be sent to multiple external parties by mail. “In some cases, there is also the ability, even after a document has been downloaded, to digitally shred it, if you decide afterwards you did not want that piece of information to get out. This really helps you communicate effectively and fluidly while being able to maintain the security over those documents,” says Mr Badger. Of course, the ability to easily distribute documents to different parties involved is not just a matter of risk. VDRs also have a direct impact on the costs involved in a bankruptcy process and, for a distressed business, making such savings can be very valuable.
From the buyer’s point of view, those savings break down into two types: travel and scheduling costs, both of which are eliminated by the adoption of a VDR. “The review of information can be simultaneous for all users in a VDR, compared to an often linear timeline in a paper-based process, expediting the document review,” suggests Mr Farley. “Coupling the shorter review cycle with the relative elimination of travel to the physical hosting site translates into significant time and cost benefits.” These cost benefits, which can be in the region of thousands of dollars, can also encourage more parties, which may have been deterred by a paper-based environment, to get involved in the process.
On the seller’s side, it is often very expensive to rent a physical data room and have someone monitor it while people are assessing the documents. When using a VDR, this is another cost that can be eliminated. In any restructuring process, a large amount of documents need to be printed and reviewed by several parties. On average, a virtual data room will contain 25,000 pages that need to be reviewed by at least 10 people, with the total number of pages produced for a single deal easily reaching 200,000 to 250,000 copies. With virtual rooms, the double cost of duplication and dissemination fall to almost nothing. “For all parties involved, time and cost savings during a restructuring or bankruptcy engagement are paramount,” argues Mr Mather. “VDRs enable professionals to focus on high-level strategy by reducing the administrative resources needed to gather and distribute information during a traditional, offline process.” Furthermore, according to Merrill Corporation, some preliminary research indicates that VDRs can actually reduce the overall carbon footprint of a bankruptcy by as much as 95 percent, compared to the old, paper-based method.
Use of VDRs in 2009
This array of benefits, coupled with an increase in bankruptcies to be expected this year, is likely to make the use of VDRs increasingly common in the coming months. “We have seen an increase in bankruptcy and reorganisation deals over the past two years. As corporate default rates are expected to rise in the coming months, there will be increasing pressure for distressed companies to manage, restructure and maximise distressed assets,” says Mr Mather. Indeed, this tough economic environment is likely to make the use of VDRs jump dramatically in the medium term.
According to Mr Hartzell, virtual data room adoption may increase by around 50 percent in the next 18 months, surging from the 40 percent adoption rate achieved over the last five years. If that happens, 60 percent of bankruptcy cases would be using VDRs by 2010. “Restructuring engagements over the next year or so will accelerate the adoption curve, because the people who demand VDRs are on the trustee side of bankruptcy proceedings,” says Mr Hartzell. “Effectively, we are entering the fourth phase of VDR adoption. Their initial use began with bulge bracket investment banks, followed by their corporate clients who were regularly involved in M&A, followed by private equity firms during the recent boom. Now, in this fourth wave, the complex legal nature of executing restructurings will drive further use of VDRs.”
With today’s difficult and rapidly changing markets, information needs to circulate in a more accessible, faster and cheaper manner, especially in a bankruptcy scenario, argues Mr Grellier. “Either the company needs to be protected from its creditors to survive or, if this is too late, the insolvency administrator needs to sell parts of the company very quickly to cover costs. Consequently, the usage of VDRs is the only sensible way to conduct due diligence in such complex scenarios and receive the best outcome for everyone.” Furthermore, VDRs can be adapted to meet a variety of purposes, not just M&A or bankruptcy processes, points out Mr Farley. “VDRs are used by our strategic partner BMC Group in 100 percent of their restructuring engagements, and we find that when companies and professionals are new to the concept of leveraging technology to improve a process, they become converts who apply the efficiency to other applications of corporate life.”
The forecasted surge in VDR adoption and the subsequent decline in physical data room usage, predicted by most experts, will almost certainly have another consequence – the improvement of current VDRs. “We believe the accelerating shift to a paperless environment model will make the use of VDRs simpler, more common and increasingly economical,” says Mr Schnelling. VDR providers look set to be in a favourable circle – in which the increasing use of VDRs will lead to further developments and consequently encourage more companies to adopt VDRs – in time replacing physical data rooms.
But is this likely to happen soon? A few experts believe there is still some convincing to be done, regarding the benefits delivered by VDRs. Some small companies, for example, are put off VDRs because physical data rooms are actually cheaper for them, although it is the case that VDR prices are steadily declining. Also, there are still concerns regarding the security of information gathered and presented in electronic formats. VDRs are designed to avert potential fraud by utilising several monitoring and security devices, but some companies still fear that an ill-intentioned person might be able to slip through the net. Equally though, this risk still exists in a monitored physical data room.
As such, most analysts agree that the main battle is not necessarily reassuring companies regarding VDRs’ cost and benefits. Their biggest challenge remains an awareness issue. “People, when they drill processes and approaches, are used to doing things in a particular way, and it doesn’t really occur to them to go out and innovate if they have got their standard way of doing things. Unlike M&A intermediaries, for whom VDRs are a standard tool, the lawyers, accountants and other advisors who focus on bankruptcy today are often not aware of VDRs – so it may not even enter the discussion. Once it does, I think it will become standard operating procedure. It is just a matter of getting the word out,” says Mr Badger.
While they are still more common in M&A transactions, VDRs can be used in a variety of situations and processes – including restructurings and bankruptcies. The extent of the financial crisis and the number of distressed companies that have been affected by it has increased the need to respond quickly, efficiently and cheaply to the challenges that arise. VDRs give those companies a framework in which they can do that without distracting them from their priorities. From that perspective, VDRs provide welcome benefits amid the cost and confusion of the current global turmoil.