Breathing room

The scrap metal recycling industry is particularly susceptible to economic forces, and in Los Angeles that includes in particular the slowdown in growth in Asia, particularly China. The business model of many scrap yards requires sourcing agents to bring scrap metal to the yard (or the yard uses its own trucks to carry the metal in from an outside site), and then the metal is processed and shipped to purchasers. In Los Angeles County, scrap yards obtain a significant amount of scrap as a result of residential and commercial construction. Many purchasers are involved in that same type of construction, either domestically or internationally.

Sources of pressure

In 2016, the scrap metal industry faced significant economic pressures. The recent increase in residential construction in Los Angeles County has created an increased supply of scrap as buildings are torn down. Demand for scrap, however, is down. This is not only because of economic slowdowns in countries such as China, where demand for scrap has decreased alongside the decrease in construction activity, but also because metal scrap prices are measured against the U.S. Dollar, and the dollar has been at eight–year highs against many currencies, including the euro. International buyers may find it less expensive to acquire scrap from local suppliers than acquire it from scrap yards in the United States.

This decrease in demand is having a predictable effect upon scrap prices. Since 2011, the price per pound for nonferrous metals has decreased approximately 40 percent, with copper and nickel decreasing even more, and iron decreasing in price by approximately 60 percent. The tendency of some business owners holding a commodity that fluctuates in value is to hoard that material during periods of low prices, waiting for prices to increase.

All of these factors create a challenging business climate for scrap yards. Add to this any of the numerous possible “shocks” that a business can receive, such as an unexpected lawsuit or a secured lender’s foreclosure action, and that can create an emergency situation where breathing room is necessary, otherwise a scrap yard could be forced to sell its inventory in unfavorable market conditions, harming its long-term prospects.

In that situation, counsel with experience in loan workouts and business reorganization can provide significant assistance, enabling companies to negotiate for extra time to pay their secured lenders, respond to litigation demands, make payments on heavy machinery leases or, at the very least, provide a credible threat to any lender attempting to foreclose on its assets: that a company is prepared, as a last resort, to commence a Chapter 11 case in which the debtor will seek to pay its debts over an extended period of time, on terms more favorable to the company.

Opportunities in reorganization

A Chapter 11 reorganization can provide the breathing room a company needs to reorganize its affairs. A company is generally permitted to carry on its ordinary business—buying and selling scrap metal in this case—and employing all of its employees, so long as the business is capable of paying its ongoing expenses. Expenses that existed as of the commencement of the case can then be paid over time, pursuant to a plan of reorganization that the company and its attorneys prepare and file with the court.

Scrap metal recycling operations that typically pay cash up front for deliveries of material will have no difficulty in using and selling the scrap inventory that is on-site at the commencement of the case. For scrap yards that pay for goods some time after they are actually delivered to the yard, those creditors might have administrative claims or even a right to reclaim scrap metal delivered to the yard prior to the bankruptcy case. The treatment of different creditors in a bankruptcy case is complex, though the overriding principle is that the company will be permitted to carry on business as usual, acquiring and selling scrap metal, and creditors will be paid in the priority that the Bankruptcy Code requires.

Commencement of a Chapter 11 case has other benefits to a scrap metal recycler in particular. The price of metals can fluctuate so much that an additional six months, or longer, of time to come up with a plan to pay debts can be enough for commodity prices to rebound and for debts to be more feasibly paid off. Scrap yards also typically own or lease heavy equipment, and to the extent this equipment is no longer needed, the Bankruptcy Code allows the company to sell that machinery or terminate a long-term lease for it, even if the contract otherwise states the company cannot terminate the lease.

Buying time

While commencing a Chapter 11 bankruptcy case is never taken lightly, it can be an effective tool to implement a restructuring plan and to assist a company that needs time to set its affairs in order—to obtain a break from litigation or foreclosure, to terminate leases or to sell assets that are no longer desired and to come up with a plan to pay its debts. In a cyclical industry such as scrap metal, that extra time can be gold.

Steven Werth is an associate at California-based SulmeyerKupetz PC, a business, financial restructuring and litigation firm. He can be contacted by email at swerth@sulmeyer law.com or by phone at 213-617-5210.