Jeff Sklarz is the New Haven, Connecticut-based attorney representing the unsecured creditors’ committee in the JNET Communications (parent company of ServiCom) bankruptcy case.
I talked to him on Monday about the JNET bankruptcy and I’m combining what he told me with some information I dug up myself to help you better understand what’s going on.
Chapter 11
Jeffrey M. Sklarz (Source: Green & Sklarz LLC)
JNET Communications, which is registered in Delaware and headquartered in New Jersey, filed for voluntary Chapter 11 bankruptcy in the Connecticut Bankruptcy Court on October 19. (A voluntary Chapter 11, as you have no doubt guessed, is when the company itself files for bankruptcy relief. It is also possible for creditors to band together and file an involuntary Chapter 11 petition against a defaulting debtor.)
Under US bankruptcy law, Sklarz explained:
…a Chapter 11 gives a business time to…restructure to attempt to continue in business in some way. And I use the term “continue in business” broadly, it could envision a true restructuring, where there’s a deal cut with all your creditors and you continue doing business in the same or substantially similar form. It can be a sale of assets to a new owner to facilitate the continuation of the line of business but with a different owner.
One of the most powerful aspects of US bankruptcy law, he said, is called the “automatic stay” which says that;
…when you file bankruptcy all creditor action, attempts to collect debt and whatnot, must stop and you have to go through the bankruptcy court.
The automatic stay applies to all creditors — including employees.
In the case of JNET Communications, they are currently:
…attempting to sell their businesses so that…basically, employees can have jobs. They’re attempting to sell their businesses to attempt to rescue some value for employees and other creditors.
And although Todd Riley, the former site manager at ServiCom here in Sydney (and a man who is, as far as I can see, doing everything humanly possible to save the local ServiCom operation) told the Post that companies such as General Motors, Delta Airlines and Macy’s had “all sought bankruptcy protection at some point in a bid to restructure their debts,” Riley’s own stated goal is to ensure the sale of the Sydney ServiCom center goes through, so it seems clear he understands JNET is not likely to emerge from Chapter 11 unscathed.
As David Skeel, a professor of corporate law at the University of Pennsylvania Law School told ABC news at the time of the GM bankruptcy, the most important element necessary for an eventual exit from Chapter 11 is a source of financing, and in the case of GM, it had one — the government.
Skeel also noted that while the US government doesn’t keep statistics on how many firms emerge from Chapter 11, “the bigger the company, the more likely they are to re-emerge.”
And finally, in what could be a reference directly to ServiCom (but isn’t, because it’s a statement made in 2009) Skeel noted:
[C]ompanies with bricks-and-mortar assets have a better chance than a Silicon Valley-type firm whose key asset is its employees, Skeel said. “As folks like to say, their most important assets walk out the door at the end of every day. And most of them don’t stick around for a long bankruptcy. With GM, the assets aren’t going anywhere. Those plants aren’t going to run away.”
Priority creditors
Employees owed wages have what’s called a “priority unsecured claim.” This, says Sklarz, means “they get paid ahead of certain creditors, but they also get paid behind certain creditors.”
Secured creditors — those with “rights and collateral” — get paid first.
In the case of the call centers, there is little physical collateral — the offices and equipment are leased. The only real collateral, says Sklarz:
…are the accounts receivable. And that’s what’s sold to Coral [Capital Solutions], but then there’s other companies that claim an interest in those accounts receivable that would come behind Coral.
At a meeting for ServiCom employees held on December 10, Riley said:
What I was able to do last evening was, go back to our accounts receivable and identify that there was close to 4 million dollars U.S. that is owed out from our clients over the next 30 and 60 days. What we need to do is we need to expedite with our clients, which we are doing right now, to ensure that they move those…payments up the ladder sooner than later, so we have that working capital that goes into the factoring group, then it turn gives it to the banks, then in turn the bank, the Trustee, will then give it to ServiCom to deploy for each individual.
This is basically true, but the $4 million is a bit misleading. To understand why, you have to understand how factoring works.
Factoring
Coral Capital Solutions is the factoring firm that, according to this 2015 press release, JNET has been dealing with since 2011.
Factoring — also called “alternative financing” or “accounts receivable financing” — works like this:
Say you own a business and you are owed $1,000. Your client has 60 days — two months — to pay that invoice, which is a long time to wait for money.
So instead of waiting for it, you decide to sell the invoice — at a discount — to a factoring firm. (The discount is calculated by applying a factoring fee, which you can read more about here. That fee is usually between 1% and 5%. Riley told the ServiCom workers the factoring firm dealing with JNET earns “$50,000 or $60,000 or $70,000” on every $4 million worth of invoices, which would indicate the fee is somewhere between 1.3% and 1.8%. But we don’t have to get this deep into the weeds right now.)
In the example above, say you sold that $1,000 invoice for $750. The factoring company will give you most of that on the day the receivable is purchased (the exact amount of the advance depends on your particular agreement) providing you the capital to make payroll, pay light bills, etc. In this case, let’s say the factoring company pays you $700.
But it will hold some money in reserve (in this case, $50) to be paid when the debt is actually collected.
In the case of JNET, of course, the dollar amounts are much higher (that press release cited above states that between 2011 and 2015 JNET financed “nearly $250 million” with Coral Capital), but the basic premise is the same — whatever Coral Capital paid JNET for those $4 million worth of invoices, it would have advanced much of it at the time of purchase and that money would have gone into JNET’s coffers right away. Coral Capital will be holding some money in reserve, to be released when it collects on those final invoices. That money (the “cash collateral”) will be paid to JNET’s creditors in the order outlined by Sklarz.
Riley told the ServiCom workers on December 10 that the new owner (a really “cool cat” in his estimation) told him that the deal to sell the Sydney center (along with two other JNET properties) fell through because the factoring group “was unwilling to take their monies and put it into the payroll to get people paid.”
If I understand this correctly, he’s saying that the new owner wanted the factoring company to release the reserve before it had collected those unpaid invoices. If that’s the case, it’s within Coral Capital’s rights, under the terms of its contract with JNET, to refuse to do so.
But why that would derail a serious buyer is an eye-brow raiser. If the new buyer is as “passionate” and “concerned” and “wanting to make things happen” as Riley told ServiCom workers he was, why would he get hung up on the question of past wages? Why wouldn’t he simply begin paying wages and let the bankruptcy court handle the wages owed?
Case study
As it happens, we can get a good look at the deal Coral Capital had with JNET Communications because the factoring company features JNET (unnamed but easily identifiable) as a factoring success story on its website. I copied the information because I suspect it won’t be there much longer. As noted above, JNET, which was formed in 2003, began doing business with Coral Capital in 2011. The “turnaround” discussed below then, presumably began in 2011:
A Construction and Infrastructure Call Center Leveraged Accounts Receivable Loans
Industry: Telecommunications: Construction & Infrastructure Call Centers
Situation: The Company was looking for working capital support to manage their turnaround including options such as Accounts Receivable Loans and Purchase Order Financing.
The Call Center giant was formed with two subsidiaries through the acquisition of two separate businesses. One subsidiary operates call centers in the United States and Canada, deriving revenues from outbound marketing calls and inbound customer service and help desk calls. The other provides installation and construction services to the cable industry throughout the United States.
The Deal: Coral Capital Solutions replaced the existing Accounts Receivable Lender, added PO financing with letters of credit, and negotiated inter-creditor agreements with two separate banks to maintain term loan and inventory financing for the client, thereby adding substantially to working capital availability.
The Result: The unique combination of accounts receivable financing and PO financing worked out. Now that they can source from overseas suppliers that require Letters of Credit, the Company has been able to expand its product line. It is now competing for larger orders with nationwide retailers.
Unsecured creditors
Sklarz says that, technically, the creditors’ committee represents general unsecured creditors — not secured creditors or employees (who, as we’ve established, are priority unsecured creditors):
My constituency is more of the trade creditors — like vendors and suppliers, like, there’s a janitorial company that’s owed a lot of money up in Canada.
In fact, as the Cape Breton Post reported on November 2, there are four general unsecured creditors in Cape Breton:
- Advanced Janitorial Services Ltd ($62,507.73)
- Cape Breton Screaming Eagles ($5,590)
- Connors Basics Office Products Ltd. ($3,805.71.)
- ECBC ( $43,292.68 and $12,659.02.)
But while it’s not necessarily the role of the five-member creditors’ committee to “look out for employees,” Sklarz says they’re “trying to.”
Timeline
I asked Sklarz how long it will take to resolve the bankruptcy case and he told me:
[C]ertainly by the end of next week if not the end of this week we’ll know what’s happening. Because either…somebody’s going to step in and restart the businesses or they’ll just have to liquidate. Because every day the call centers are closed, there’s less value.
Sklarz says they’re expecting to see filings this week concerning each of the separate call centers — the one in Sydney and the one in Machesney Park, Illinois.
And finally, Sklarz told me:
From the creditors’ committee standpoint, our view right now is…we’ll support, anything that provides jobs for folks and gets them paid their back pay. Everybody on the creditors’ committee feels terrible about what’s going on and is willing to do whatever they can to assist…
We certainly have [the employees] forefront in our mind, both me as counsel and the various individual creditor committee members, because everybody is pretty distraught and disgusted as to what’s happened.
Featured image from Investor Training Academy via YouTube
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