in theMoney

Middle

Money

Middle

April 26, 2004

Supplement to the Los Angeles Daily Journaland San Francisco Daily Journal

Trials, transactions and theinsider’s guide to the

practice of law.

COVER STORY

Who says bigger is better? Four bankruptcy partners atPachulski, Stang, Ziehl, Young, Jones & Weintraub are let-ting the Enrons and Kmarts of the world pass them by. Ledby partner Thomsen Young, these lawyers created a firmwithin their firm to ensure Pachulski Stang keeps a lock onthe middle market.

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Small companies that dream big hope oneday to take on the Microsofts and Wal-Marts of the world.

But not all of them make it, and somewind up declaring bankruptcy.

As companies that wanted to be big but woundup bust look for insolvency counsel, they’returning to one firm that has made a point ofattracting not only the K-Marts and Enrons of thebankruptcy world but also small and midsizeclients with between $50 million and $250 millionin annual revenue.

Bankruptcy firm Pachulski, Stang, Ziehl,Young, Jones & Weintraub, with 85 attorneysand offices in insolvency hot spots like Delawareand New York, often handles large-companybankruptcies, helping ailing corporate titansrearrange hundreds of millions in debt.

But recently, the firm decided to focus ondrumming up business among middle-marketcompanies, rather than outgrowing themcompletely.

Last April, four top Pachulski Stang attorneysformed a “firm within the firm” to seek smallercompanies in what it calls the middle-market niche.Although the group is in its infancy, it has helpedcompanies in bankruptcy such as Health Care ofthe Redlands, Country Home Bakers, GingissFormalwear and Sega GameWorks.

Pachulski Stang has grown from two lawyersat its founding 20 years ago to attorneys in fouroffices nationwide. Throughout this period,Pachulski Stang worked to establish itself as anationwide specialty firm capable of handling thebiggest corporations’ bankruptcies, competing forbusiness with regional and national bankruptcyshops.

As part of that effort, Pachulski Stang added35 lawyers in the last few years. It opened its SanFrancisco office in 1996, its Delaware office in2000 and its New York office in 2002, in eachcase expanding into markets ripe with bankruptcyprospects.

The firm’s New York and Delaware officesgave it greater access to large troubled companiesthan the California offices alone could. Largecompanies frequently incorporate under Delawarebusiness laws and file for Chapter 11 protectionin Delaware Chancery Court, which has areputation for being more predictable andbusiness-friendly.

By Draeger Martinez

in the

Catching a 20-pound bass is nice, but four lawyers at Pachulski, Stang, Ziehl,Young Jones & Weintraub say they eat perfectly well pulling medium-sizedfish from the bankruptcy pond. Leaving the larger troubled companies to

their firm compatriots, these attorneys are frying ‘middle market’ fish.

From left, Hamid Rafatjoo, Sam Maizel Jeffrey Pomerantz and Thomsen Young have formed agroup in Pachulski Stang to seek companies in the middle-market niche.

Photo by Robert Levins

As middle-market partner Jeffrey Pomerantzputs it, “the bench there has a sophistication thatallows them to administer the proceduresefficiently.”

“And with some of the judges there,” Pomerantzsays, “you know what you’re going to get whenyou come before them.”

Laura Davis Jones, who heads the firm’sDelaware office, says the firm’s recent majorclients include Exide Technologies, whichaccording to its Securities and ExchangeCommission filings posted $141 million in lossesfor fiscal 2003 on revenues totaling $2.36 billion;Sleepmaster Mattress, which posted a $7.32million loss on $86 million in sales during thesecond quarter of 2001; and online grocer WebvanGroup Inc., which posted a $241 million loss inthe first quarter of 2001.

However, Pomerantz and other attorneys began

to worry in the late 1990s that the firm had begunoverlooking middle-market companies.

The signals we got from prospects were that,if you had a $50-million-per-year company,” hesays, “you didn’t want to give it to Pachulskibecause now they’re a national firm and they’llput their ‘B team’ on it.”

“But that’s not the case,” Pomerantz says. “Wehave senior attorneys who would want to do thatbusiness, who don’t want to travel so much, andwho would like to handle middle-marketcompanies here in Southern California.”

Pomerantz says the firm was especially wellpositioned for middle-market work because ofits San Francisco office. The northern Californiaoutpost allowed Pachulski Stang lawyers to attractBay Area dot-com bankruptcies, he says.

The middle-market group’s leader, Thomsen“Tom” Young, says that, as Pachulski Stang grew,

some attorneys worried that landing larger andlarger clients would mean leaving middle-marketclients behind. Young didn’t want that to happenbecause he considers the middle-market home tothe firm’s longtime bread-and-butter clients. Hebelieves that, when other growing bankruptcyfirms have abandoned the middle market, theyhave seldom recaptured it.

“It’s like the dinosaur and the small mammalsthat succeeded them: There are lots of small firmswaiting around, waiting to grow and competingfor those accounts,” Young says. “They’ll pitch[to prospective clients] that they’ll put their namepartners on the account, not some low-levelassociate. And once they have that space, theyusually don’t give it back.”

Young says that he talked with name partnerRichard Pachulski about establishing a “firmwithin the firm” to handle middle-market clients.The move meant changing some firm policies toaccommodate the group. Young says the changesoccurred gradually during the group’s first fewmonths in practice.

The firm came up with a new billing procedurefor clients of the middle-market group. Althoughpartners charge $400 an hour, the same as otherfirm partners, the total bill for a middle-marketclients is often less than for larger clients, even ifpartners have billed the same amount of time.

The firm uses rate caps and blended rates thatemphasize the lower fees of associates, $300 to$350 an hour, Young says. The billing innovationsare generally not available to larger clients, firmattorneys say.

“It would mean less money for the firm, butnot so much less that the firm would actually losemoney,” Young says.

He adds that most larger clients have not askedabout receiving financial accommodations, but tosecure one new big-bankruptcy case,Metropolitan Mortgage and Securities Co. inSpokane, Wash., the firm offered blended rates.

“We also developed a whole new network ofreferral sources to nurture our middle-marketportfolio,” Young says. “There would be differentaccounting firms, turnaround firms, investment

Smaller FryCOVER STORY

bankers and so forth who dealt with clients inthis market.”

Yet while the middle-market group can chargeless than its big-bankruptcy brethren, Pomerantzsays that he and his colleagues enjoy the samefinancial rewards as other Pachulski Stangpartners. Their salaries and profit participationremain the same, and middle-market partners donot face penalties if they’re unwilling to travel asfrequently as colleagues working on largerbankruptcies, for instance.

“The size of the company does not alwaysdictate the size of the revenues [from itsbankruptcy],” Pomerantz says. “Some big clientsmight yield revenues in the mid six-figures, whilesome middle-market cases can yield seven-figurerevenues.”

According to Pachulski, the smaller debts in amiddle-market bankruptcy do not make matterseasier than a larger bankruptcy; if anything, theymake the problems more difficult.

“It’s ironic but true that it nearly costs a creditoras much to handle a $5 million credit as with a$50 million credit from a bigger company,”Pachulski says. “If a middle-market companyowes $10 million to a bank and a larger company,say an Enron, owes the bank $150 million, thebank is more willing with the larger company towork things out.

“With a middle-market company, there’s agreater temptation for them to say, ‘Let’s justliquidate it. Let’s get this $10 million off ourbooks.’”

The group has four dedicated partners: Young,Pomerantz, Hamid Rafatjoo and Sam Maizel. Butno associates are specifically assigned to workon middle-market companies.

Rafatjoo says that the midsize bankruptciesinterest him because they typically involve manyof the same problems as big bankruptcies, but thesmaller companies have fewer resources availableto solve their problems.

“When bankruptcy comes into play, they wantthe same kind of representation for theirproceedings [as bigger companies],” Rafatjoosays. “We believe that the expertise we canprovide will help them in the short and the longterm, maybe more so than a firm that will chargeclients $150 per hour and not really do a lot forthem.

“These usually are good people hit by hardtimes, and you can take a lot of satisfaction fromhelping them plan their comeback.”

Rafatjoo says that his colleagues in PachulskiStang have provided the group excellent supportas they pursue middle-market clients.

“Often, when a firm reaches a certain size or acertain status level, they avoid the small casesbecause they think that will prevent them frompursuing the big clients,” Rafatjoo says.

Young says the hardest obstacle the group hasfaced is marketing its services effectively andchanging the attitudes of prospective clients.

“We were identified by other professionals asonly being interested in, or able to, handle big

firms and not mid-market companies,” he says.“Competitors would talk this up as a reason

not to hire us, and it’s an uphill battle to challengethat,” Young says. “Changing what goes on inpeople’s heads can be very difficult, and that isour current objective.”

Pomerantz notes that running and building aninsolvency practice takes plenty of legwork.Although the work typically provides little to norepeat business — once a company goes throughbankruptcy, generally it either turns its operationsaround or fails for good — Pomerantz says theteam has identified some ways to generate busycaseloads.

One of the group’s chief sources iscreditors’ committees, whichtypicallycomprise a company’s unsecuredcreditors such as suppliers and

landlords. Once interested creditors form acommittee, they are empowered to weigh in onbankruptcy proceedings.

“They investigate what got the company whereit is and what the plan is for its recovery, or atleast to maximize value. The committee doesn’trun things directly, but they do have a very strongvoice at the bankruptcy court,” Pomerantz says.

Young says that, each time the group handles abankruptcy, it keeps all of its records ofrepresentation and the parties involved incomputerized format. Sometimes, creditors in onecase turn out to be creditors in other cases, whichtips off the group to further middle-marketopportunities.

“We also get referrals from turnaroundoperators, from accountants and fromnonbankruptcy lawyers,” Pomerantz says.

He adds that the firm’s reputation in handling abig bankruptcy sometimes makes goodimpressions on middle-market companiesconsidering a bankruptcy filing.

Mark Syrstad, CEO of middle marketbankruptcy client Gingiss Formalwear, says heinterviewed two other bankruptcy firms beforedeciding to bank on Paculski Stang’s reputationand track record.

“We felt our deal was pretty complex and thatsimply attaching the name Pachulski Stangimpressed people who might have beenproblematic,” Syrstad says.

Since the middle-market group formed, it hastaken nine months to get up to speed, Young says.Allowing the group to set its own pricing structureand referral network has paid off, as has the firm’sdecision to dedicate senior attorneys to this clientbase, rather than giving middle-market casessporadically to its lawyers.

Young says that the group has not tallied asolid figure for its middle-market book ofbusiness but that its goal for the group is $5 millionin annual revenues. He declines to say how muchrevenue the firm as a whole generated, but headds that the middle-market group has brought12 bankruptcies for the firm to handle in its firstyear.

“So far, we’ve focused this effort from ourL.A. office, and we hope to eventually replicatethis effort in New York and San Francisco,”Young says. “I think if you went to any largemanufacturing company about branding, theywould tell you the same thing, that you spendyears and lots of money to build one brand.You can’t just turn on a dime to build anotherone.”

Pomerantz, who joined the firm in 1992 andbecame a shareholder three years later, saysthe middle-market practice group evolved outof a market opportunity that the firm noticed afew years before he arrived.

“In the late 1980s and early ’90s, the firmwas trying to distinguish itself from other L.A.bankruptcy boutiques. Another firm namedStutman Treister & Glatt kind of abandonedthe middle market, and we decided to targetthat market,” Pomerantz says.

Kenneth N. Klee, a name partner withinsolvency boutique Klee, Tuchin, Bogdanoff& Stern, agrees in part with Pomerantz.

“I think it is fair to say that Stutman did abandonthe middle market when they focused more onbecoming a national firm,” says Klee, who alsoteaches bankruptcy law and negotiating businessdeals at UCLA’s law school.

Klee also thinks of Pachulski Stang“primarily as a national firm.”

“I’d be surprised if their middle-marketbusiness is more than 5 percent of the overallfirm revenues over the last five years,” he says.

Robert Greenfield, who chairs StutmanTreister’s executive committee, says that, whilehis firm has added national clients, it neverabandoned the middle market.

“We don’t have any attorneys who strictlyhandle middle-market cases. Our people areexperienced with middle-market cases andnational ones, and they work on both based onwhose expertise could best serve the client,”says Greenfield, whose firm has 35 lawyers inall. “We pride ourselves on being the mostexperienced bankruptcy firm around, and wehave more great lawyers from top to bottomthan anyone.”

Greenfield says he knows Pachulski Stangto have a good reputation among both middle-market and larger clients, though he was notaware of that firm’s middle-market group.

With the middle-market group rounding outits first year, Pomerantz says its work has onlybegun.

“We’re trying to do a lot of word-of-mouthmarketing, and people are still surprised thatwe offer [middle-market service],” Pomerantzsays. “There are maybe 10 other firms in L.A.that would compete for mid-market clients, andsome clients maybe don’t want to take the effortto check out all 10.

“And they might look at us, a national firmand hence probably more expensive, and say,‘We don’t need a Rolls Royce solution to ourChevy-level problem.’”

Reprinted with permission from the Daily Journal EXTRA. ©2004 Daily Journal Corporation. All rights reserved.Reprinted by Scoop ReprintSource 1-800-767-3263

Young named four firms he considersnotable competitors for his group’s middle-market practice: the Newport Beach office ofIrell & Manella; Levene, Neale, Bender, Rankin& Brill in Los Angeles; SulmeyerKupetz, inLos Angeles; and Winthrop Couchot, inNewport Beach.

“I would consider them to be more of anational firm, as opposed to a regional,predominantly middle-market firm like we are,”says Paul Couchot of Winthrop Couchot.“They’re a very good firm. We have a healthyrespect for them and what they’veaccomplished, and we have a good relationshipwith the lawyers there.”

David Kupetz of SulmeyerKupetz offers noopinion on the size of Pachulski Stang’s clientsbut echoes Couchot’s positive impression ofthe larger firm.

“I think they have a good reputation, handlingcases in and out of state,” Kupetz says. “Forus, we don’t concentrate on just the middle-market or the big cases. We try to tackle anycase we can where we can bring value to theprocess, and if it’s cost-effective and we’re notconflicted out.”

The bankruptcy lawyers at Pachulski Stangaren’t the only ones innovating to meet themiddle market. Joe Coleman, a real estatepartner in Snell & Wilmer’s Irvine office, saysthat, as with bankruptcy law, middle-marketopportunities have grown in the real estate field.

Coleman adds that, because large firms havebeen moving away from a real estate focus,firms with lower rates are moving in to fill thevoid.

The majority of real estate developers fit hisfirm’s middle-market profile, he says.

“Most real estate lawyers in our office try tokeep their rates below $400 an hour. We don’tuse blended rates that much but we do oftencap fees at a specified amount,” Coleman says.

Blane Prescott, a partner in the consultingfirm Hildebrandt International, says that manylaw firms miss out on opportunities presentedby the middle market because they assumebigger clients automatically lead to higher firmrevenues.

“Those [big] clients tend to have in-housecounsel and a large volume of work, and theytend to parse out their work so that often a lawfirm is doing a very small piece of the work,”Prescott says. “On the other hand, middle-market clients don’t have in-house counsel asoften, and while they’re fee-sensitive, they tendto not extract fee discounts like big companiesdo. So if you’re careful about picking clients,the middle market can be as profitable or moreso than big companies.”

Although he doesn’t consider himself a fullmember of the firm’s middle-market group,Pachulski says he’s happy to serve as theirconsultant and sounding board.

“There’s a sensitivity in all bankruptcy casesto the costs of restructuring, but more so in amiddle-market case because the pie is so muchsmaller than with a big company,” Pachulskisays. “Often, you’re dealing with at least asmany operational problems as with financialproblems, and you have to look at how manyresources to bring to bear. A middle-marketcompany often can’t afford much forspecialized attorneys or accountants, and there’sonly so much time that creditors are willing tospend to regain their stakes.”

Pachulski adds that the middle-market grouphas handled cases generated from the firm atlarge as well as cases the group started fromscratch.

“We don’t want to get across that these casesare different from our bigger clients; we mayhave fewer resources on these cases, but they’requality attorneys,” Pachulski says. “They’vedone so many middle-market cases that theycan handle them very efficiently. They don’tspend much time trying to re-invent the wheel.

The margin of error on middle-market casesis much lower, and if you’re not careful, youcan drown the client in Chapter 11 fees.”

Ideally, a company in bankruptcy is able tonegotiate an outcome that all parties can livewith, rather than proceed to litigation,Pomerantz says.

The thing that attracted me to bankruptcy lawis that it’s dynamic and it’s not as win-lose,zero-sum game as trial work,” Pomerantz says.“Working from the debtor’s side especially, youhave the ability to bring people together, getbehind the politics involved and bring everyonetogether.”

A current case in point for Pomerantz: SegaGameWorks, a chain of restaurant/video arcadesthat recently filed for bankruptcy under Chapter11. Pomerantz, who is representing thecompany’s creditor committee, says he wantsto find a winning solution for everyone.

“GameWorks has 19 locations, 16 that theyown and three that they manage under jointventures. The problem they face is that theirrevenue has declined over the last few years,”Pomerantz says. “They’ve tried to cut theiroverhead expenses, but it hasn’t been enough tooffset the falling revenue, so they’ve been tryingto get rent concessions from the landlords. Theleases include portions for the build-out expenses,so they can’t afford the rents.”

Pomerantz says that the company won’t beviable without some kind of deal from its

landlords. The creditor committee is weighingseveral options, including sell ing offGameWorks or closing its least-profitablelocations.

The company indicates that it might not bean easy fix; a lot of them are making money butmaybe not enough to carry the overhead,” suchas the corporate headquarters and its financialand legal departments, Pomerantz says.

Pomerantz added that the company’s annualrevenue is $64 million for fiscal 2003, whichended March 30, 2003, but that projectionsindicate falling revenue for fiscal 2004.

Pomerantz, like Young and Rafatjoo, are themiddle-market group’s generalists, unlike SamMaizel.

Maizel came to the firm seven years ago,after practicing bankruptcy law for the federalDepartment of Justice. His governmentexperience focused on representing theMedicare program and other health careagencies, which he says prepared him torepresent middle-market clients in the medicalfield.

“There are a lot of hospitals and medicalgroups and health plans that fall right into thatmiddle-market range, and that’s the field of lawI’ve always covered, so that makes me a goodfit,” Maizel says. “Middle-market companiesthat expand too quickly or unwisely, or thatchose the wrong locations to expand in, can beexactly the kind of client we want to represent.”

He cited one of his clients, Health Care ofthe Redlands, as a good example of hisspecialty. Although the medical group operatesin just four Northern California counties, with100,000 premium-paying members it usuallygenerates between $10 million and $20 millionper month.

“A group that size typically doesn’t haveaccess to the biggest accounting firms or lawfirms,” Maizel says. “In this particular group’scase, they’re also nonprofit, and that limits theirresources, too. And before you know it, theyget into trouble.”

Pomerantz says that the group’s currentchallenges come from starting new clientrelationships and balancing their needs withthose of long-standing clients.

“Our firm has a commitment to this,” he says,“and we will continue to mine our contacts andcontinually increase our name recognition andour number of contacts.

“You don’t necessarily see the resultsovernight, and you need to keep people buyinginto what we’re doing here. We don’t exactlyhave a make-or-break point mapped out of acertain number of months or years to make thiseffort successful.”