Outline for February 9 IACR Lunch Presentation

Presented By:

David Hunt, Vice President - Special AssetsFirst Merchants Bank

Robert Leasure, PresidentLS Associates LLC

Michael O'Neil, Partner and Practice Group ChairTaft Stettinius & Hollister LLP

Ethics and Turnaround Situations

1. Usual Disclaimers Regarding Personal Views, Not Institutional.

2. Ethics for Different Stakeholders A. Borrower Probably Most SignificantB. Guarantor IssuesC. Joint Representation of Borrower and Guarantor

3. Statutory or Voluntary Ethical GuidelineA. Guidelines for Consultants/Advisor

(i) Turnaround Management Assoc.(ii) Assoc. Insolvency & Restructure Advisors

B. AICPA Code of Professional Conduct for AccountantsC. Rules of Professional Conduct for LawyersD. Bankruptcy Code is Most Onerous

(i) 11 USC §327(ii) 11 USC §101(14) “disinterested”

E. General Guidelines for BanksF. The Borrower: Let Your Conscience be Your Guide?

4. Lawyer and ConsultantA. Engagement LetterB. Need for Candor

5. For LendersA. Helen Chaitman’s 10 (really 9) Commandments to Avoid Lender LiabilityB. Steven Fried’s 10 Commandments of Commercial LendingC. Fair Credit Act/Fair Debt Collection Practice Act, Consumer Finance

Protection BureauD. IN “Lender Liability” Statute of Frauds 32-21-1-1

6. Criminal ImplicationsA. Need for Additional CounselB. Much More Likely to See Receiver or TrusteeC. Bank File Suspicious Activity Report (“SAR”): What is Next?D. Sentencing Guidelines: Impact of amount of losses

3.A.(i) Turnaround Management Association

Canon I

General Obligations and Professional Boundaries

A member shall maintain and advance knowledge of the practice of turnaround and crisis management and corporate renewal, respect the practice and contribute to its growth.

E.S. 1.1 Professional Boundaries:A member bound by this Code of Ethics is one who is engaged in the practice of providing managerial services and consultation services to businesses, debtors, creditors and other interested parties with respect to troubled businesses, organizations and associations. While such services include a wide range of issues and problems, a member must take care not to perform services that require a license, unless the member is so licensed to perform such services.

E.S. 1.2 Standards of Excellence:A member shall strive to improve his or her professional knowledge and skill. Within his or her practice, a member shall demonstrate a consistent pattern of reasonable care and competence.

E.S. 1.3 Conduct:A member shall uphold the law in the conduct of his or her professional activities.

E.S. 1.4 Human Rights:A member shall uphold human rights in all of his or her professional endeavors.

E.S. 1.5 Continuing Education:A member shall seek out and participate in educational programs to enhance his or her professional knowledge.

Canon II

Obligations to the Client

A member shall serve his or her client independently, competently and in a professional manner. A member should exercise unprejudiced and unbiased judgment on the client’s behalf.

E.S. 2.1 Professional Responsibilities:(A) A member shall undertake to perform the engagement to the best of his or her ability; (B) A member shall not proceed with an engagement unless the client has agreed with the objectives, scope and approach to be employed and has agreed to the fee structure; (C) A member shall not undertake an engagement which cannot be fulfilled in a timely manner because of his or her commitments.

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E.S. 2.2 Independence:A member’s duty is solely to the client and he or she should strive to remain independent of other affiliations that could compromise his or her judgment or result in the appearance of compromise. Prior to accepting an engagement, a member shall disclose to his or her client all financial relationships which may cloud, or give the appearance of clouding, his or her judgment. If the client is the troubled business or organization, disclosure shall be made of any past referrals from, prior work for, or an ownership interest in, any owner, creditor or customer of the client and any party offering financing to, or seeking to purchase an interest in the client. A member shall avoid conflicts of interest and the appearance of conflicts of interest.

E.S. 2.3 Competence:A member shall not undertake an engagement for which his or her firm does not have the technical capability.

E.S. 2.4 Candor and Truthfulness:(A) A member shall not intentionally or recklessly mislead existing or prospective clients about the results which can be achieved through the use of a member’s services; (B) A member shall not offer solutions nor make recommendations that are unrealistic or impractical. The nature of proposed actions, and the potential ramifications of those actions, should be communicated to the client.

E.S. 2.5 Integrity:(A) A member shall not disclose confidential information about his or her clients or otherwise take advantage of such information; (B) A member shall not serve a client using proprietary information developed for a previous client without obtaining the previous client’s consent.

E.S. 2.6 Contingency Fees:A member may accept a performance bonus or other contingency fee.

E.S. 2.7 Ownership:(A) TMA recognizes the difficulties involved with respect to equity ownership of a troubled company client; (B) If a member owns or obtains a direct or indirect financial interest in a client, such interest must be disclosed to creditors and stockholders of the client on a timely basis, must be negotiated prior to the assignment and additional equity ownership should not be negotiated during the course of an engagement; (C) If an equity interest in a troubled business client results in the member gaining control of the client, the conditions and circumstances whereby the interest is obtained should be set forth in writing and agreed to prior to commencement of the engagement. Equity interests held by parties affiliated with the member shall be aggregated with the member’s direct interest to determine whether or not the member would control the client. The member should insist that the client obtain legal counsel to represent the client with respect to negotiating and documenting the equity interest to be obtained by the member.

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Canon III

Obligations to the Profession and to Colleagues

A member shall uphold the integrity and dignity of the profession.

E.S. 3.0: Responsibility to Colleagues:

E.S. 3.1: Each member has a responsibility to further the profession by acting with integrity and supporting the objectives and programs of the Association.

E.S. 3.2: A member shall not refer a client to a colleague in exchange for monetary consideration from that colleague or in any way share in any fee received by such colleague. For this purpose, "colleague" shall not include a member’s partner, a shareholder or employee of such member’s firm, or an independent contractor that has an exclusive, written contractual relationship with a member or such member’s firm that predates the referral.

E.S. 3.3: A member referring a client to another member shall not make any commitments on behalf of the member receiving the referral or misrepresent the qualifications of the member receiving the referral.

E.S. 3.4: A member shall not misrepresent his or her credentials or capabilities in the pursuit of engagements.

E.S. 3.5: A member shall not disparage or make false statements about another member competing for an engagement.

E.S. 3.6: A member shall not give the impression that membership in the TMA bestows any credentials or in any way guarantees minimum qualifications.

E.S. 3.7: A member shall represent that he or she subscribes to this Code of Ethics.

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3.A.(ii) Association of Insolvency & Restructuring Advisors

Code of Professional and Ethical Conduct

AIRA members have a responsibility to perform professional services in a manner consistent with this Code of Professional and Ethical Conduct, developed by the Board of Directors, according to each of the following standards:

COMPETENCE•Maintain an appropriate level of professional competence by ongoing development of their knowledge and skills. •Perform their professional duties in accordance with relevant laws, regulations and technical standards; including, but not limited to, technical standards issued by authoritative bodies as designated in the bylaws. •Accept only those assignments for which they possess, or can reasonably acquire, the necessary competence to complete—applying their knowledge and skill with reasonable care and diligence, without assuming a responsibility for infallibility of knowledge or judgment.

CONFIDENTIALITY•Refrain from disclosing confidential information acquired in the course of their work, except when authorized, unless legally obligated to do so. •Inform subordinates as appropriate regarding the confidentiality of information acquired in the course of their work and monitor their activities to assure the maintenance of confidentiality. •Refrain from using or appearing to use confidential information acquired in the course of their work for unethical or illegal advantage, either personally or through third parties.

INTEGRITY•Be honest and candid within the constraints of client confidentiality. •Avoid actual or apparent conflicts of interest and advise all appropriate parties of any potential conflicts. •Not knowingly misrepresent facts. •Refrain from any activity that would prejudice their ability to carry out their duties ethically. •Recognize and communicate professional limitations or other constraints that would preclude responsible judgment or successful performance of an activity. •Refrain from engaging in or supporting any activity that would discredit the profession. •Observe the principles of objectivity and due care.

OBJECTIVITY•Be impartial, intellectually honest, and free of conflicts of interest. •Communicate information fairly and objectively.

DUE CARE•Discharge their professional responsibility with competence and diligence. •Adequately plan and supervise the performance of professional services.

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•Obtain sufficient relevant data to afford a reasonable basis for conclusions or recommendations in relation to any professional services performed.

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3.B. AICPA Code of Professional Conduct

2.000.020 Ethical Conflicts

01. An ethical conflict arises when a member encounters one or both of the following:

a. Obstacles to following an appropriate course of action due to internal or external pressures.

b. Conflicts in applying relevant professional and legal standards.

For example, a member suspects a fraud may have occurred, but reporting the suspected fraud would violate the member’s responsibility to maintain the confidentiality of his or her employer’s confidential information.

02. Once an ethical conflict is encountered, a member may be required to take steps to best achieve compliance with the rules and law. In weighing alternative courses of action, the member should consider factors such as the following:

a. Relevant facts and circumstances, including applicable rules, laws, or regulations

b. Ethical issues involved

c. Established internal procedures

03. The member should also be prepared to justify any departures that the member believes were appropriate in applying the relevant rules and law. If the member was unable to resolve the conflict in a way that permitted compliance with the applicable rules and law, the member may have to address the consequences of any violations.

04. Before pursuing a course of action, the member should consider consulting with appropriate persons within the organization the employs the member.

05. If a member decides not to consult with appropriate persons within the organization that employs the member, and the conflict remains unresolved after pursuing the selected course of action, the member should consider either consulting with other individuals for help in reaching a resolution or obtaining advice from an appropriate professional body or legal counsel. The member also should consider documenting the substance of the issue, the parties with whom the issue was discussed, details of any discussions held, and any decisions made concerning the issue.

06. If the ethical conflict remains unresolved, the member will in all likelihood be in violation of one or more rules if he or she remains associated with the matter creating the conflict. Accordingly, the member should consider his or her continuing relationship with the specific assignment or employer.2.100 Integrity and Objectivity

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2.100.001 Integrity and Objectivity Rule

01. In the performance of any professional service, a member shall maintain objectivity and integrity, shall be free of conflicts of interest, and shall not knowingly misrepresent facts or subordinate his or her judgment to others.

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3.C. Rules of Profession Conduct

Rule 1.1 Competence. A lawyer shall provide competent representation to a client. Competent representation requires the legal knowledge, skill, thoroughness and preparation reasonable necessary for the representation.

Rule 1.3 Diligence. A lawyer shall act with reasonable diligence and promptness in representing a client.

Rule 1.4 Fees. (a) A lawyer shall not make an agreement for, charge, or collect an unreasonable fee or an unreasonable amount for expenses. (b) The scope of the representation and the basis or rate of the fee and expenses for which the client will be responsible shall be communicated to the client, preferably in writing, before or within a reasonable time after commencing the representation.

Rule 1.7 Conflict of Interest: Current Clients. (a) Except as provided in paragraph (b), a lawyer shall not represent a client if the representation involves a concurrent conflict of interest. (1) The representation of one client will be directly adverse to another client; or (2) There is a significant risk that the representation of one or more clients will be materially limited by the lawyer’s responsibilities to another client, a former client or a third person or by a personal interest of the lawyer.

(b) Notwithstanding the existence of a concurrent conflict of interest under paragraph (a), a lawyer may represent a client if: (1) the lawyer reasonably believes that the lawyer will be able to provide competent and diligent representation to each effected client; (2) the representation is not prohibited by law; (3) the representation does not involve the assertion of a claim by one client against another client represented by the lawyer in the same litigation or other proceeding before a tribunal; and (4) each affected client gives informed consent, confirmed in writing.

Rule 3.4 Fairness to Opposing Party and Counsel. A Lawyer Shall Not:

(a) Unlawfully obstruct another party’s access to evidence or unlawfully alter, destroy or conceal a document or other material having potential evidentiary value. A lawyer shall not counsel or assist another person to do any such act;

(b) Falsify evidence, counsel or assist a witness to testify falsely, or offer an inducement to a witness that is prohibited by law;

(c) Knowingly disobey an obligation under the rules of a tribunal except for an open refusal based on an assertion that no valid obligation exists;

(d) In pretrial procedure, make a frivolous discovery request or fail to make reasonably diligent effort to comply with a legally proper discovery request by an opposing party;

(e) In trial, allude to any matter that the lawyer does not reasonably believe is relevant or that will not be supported by admissible evidence, assert personal knowledge of facts in issue except when testifying as a witness, or state a personal

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opinion as to the justness of a cause, the credibility of a witness, the culpability of a civil litigant or the guilt or innocence of an accused; or

(f) Request a person other than a client to refrain from voluntarily giving relevant information to another party unless:

(1) The person is a relative or an employee or other agent of a client; and

(2) The lawyer reasonably believes that the person’s interests will not be adversely affected by refraining from giving such information.

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3.D. Bankruptcy Code §§327 and 101(14)

11USC §327: Employment of professional persons

(a) Except as otherwise provided in this section, the trustee, with the court's approval, may employ one or more attorneys, accountants, appraisers, auctioneers, or other professional persons, that do not hold or represent an interest adverse to the estate, and that are disinterested persons, to represent or assist the trustee in carrying out the trustee's duties under this title.

(b) If the trustee is authorized to operate the business of the debtor under section 721, 1202, or 1108 of this title, and if the debtor has regularly employed attorneys, accountants, or other professional persons on salary, the trustee may retain or replace such professional persons if necessary in the operation of such business.

(c) In a case under chapter 7, 12, or 11 of this title, a person is not disqualified for employment under this section solely because of such person's employment by or representation of a creditor, unless there is objection by another creditor or the United States trustee, in which case the court shall disapprove such employment if there is an actual conflict of interest.

(d) The court may authorize the trustee to act as attorney or accountant for the estate if such authorization is in the best interest of the estate.

(e) The trustee, with the court's approval, may employ, for a specified special purpose, other than to represent the trustee in conducting the case, an attorney that has represented the debtor, if in the best interest of the estate, and if such attorney does not represent or hold any interest adverse to the debtor or to the estate with respect to the matter on which such attorney is to be employed.

(f) The trustee may not employ a person that has served as an examiner in the case.

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101(14) The term “disinterested person” means a person that—

(A) is not a creditor, an equity security holder, or an insider;

(B) is not and was not, within 2 years before the date of the filing of the petition, a director, officer, or employee of the debtor; and

(C) does not have an interest materially adverse to the interest of the estate or of any class of creditors or equity security holders, by reason of any direct or indirect relationship to, connection with, or interest in, the debtor, or for any other reason.

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3.E. Common-Sense Lender Ethics

Missed Opportunities: The “Golden Rule” of Turnaround Situations

Lender “should” recognize that the debtor is the REAL expert when it comes to understanding its own business.

May require lender to resist the natural urge to show debtor “who’s in charge”.

Opportunity to maximize collateral disposition and loan recovery for lender’s compliance.

Higher cost/longer resolution time horizons for lender’s non-compliance.

Breach of lender’s trust…a game changer!

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5.A. Helen Chaitman’s 10 (Really 9) Commandments to Avoid Lender Liability

1. Thou Shalt Note Make a Sudden Move

2. Thou Shalt Not Tell a Lie (or Fudge the Truth)

3. Thou Shalt Honor Thy Commitments

4. Thou Shalt Not Run Thy Borrower’s Business

5. Thou Shalt Not Bail Thyself Out on Thy Brother’s Money

6. Thou Shalt Keep Thine Own Files Clean

7. Thou Shalt Transfer a Troubled Loan to a Workout Officer

8. Thou Shalt Confer With Thy Workout Counsel

9. Thou Shalt Think Carefully Before Suing on a Deficiency

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5.B. Steven Fried’s 10 Commandments of Commercial Lending

1. Follow the Money. Understand where your money goes from the time it leaves your hands until your loan gets repaid.

2. The Three M’s of Credit. Management, Management, Management

3. All Bad Loans are Made During Good Times. A bad loan is a loan when, at the time it was made, deviated from long-standing, successful underwriting standards.

4. The Collateral is Never There When You Need It. This Section has nothing to do with loan fraud or diversion of collateral. Placing too much reliance on collateral as a source of repayment to justify other weaknesses in a commercial loan is a fools’ promise.

5. People Are Going Broke Today That Have Never Been Broke Before. A requestor’s successful experience thirty years ago does not guaranty similar success in the future. Although no one can accurately predict the future, lenders must give it their best shot to be successful.

6. Yes or No. Say yes or no to the loan request by definitely not “I can only lend you 50%.” A cardinal principal of lending is to either grant a loan request in full or deny the request entirely.

7. Asking Questions is Note a Sign of Weakness. There are really two distinct situations that fall under this heading; questions of co-workers and questions of borrowers. For either possibility, not asking questions is dumb and dumber.

8. Murphy’s Law Applied to Lending. There is not a single business I can think of where, since its inception, it has not hit a bump in the road. A minor hiccup can be expected somewhere in the relationship and, when it happens, does not instantly turn your borrower into crook or a deadbeat. If it’s not a hiccup but a major sea change---skip the Commandment number 10!

9. Lending is Not a Profession for People Who Need to be Liked. Definitely with respect to borrowers and even with respect to co-workers, it is sometimes necessary to say no!

10. Your First Loss is Your Best Loss. When a borrower experiences significant difficulties that should have been handled or should have been anticipated but were not; it’s time to cut your losses.

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5.C. Regulatory Influences on Lender Ethics (To Name a Few)

FAIR DEBT COLLECTION PRACTICES ACT

The FDCPA has been in place since 1977

Provides certain protections to consumer from certain debt collection practices including false or misleading representations, and unfair practices such as harassment.

It also allows the consumer to dispute the validity of the debt and allows the consumer to bring legal action against a debt collector who violates the Act.

Provides debtor the right to demand that t third-party debt collector cease further contact, provided that the demand is received in writing. (Note: After demand is received, debt collector or creditor may contact the debtor to advise of intent to take a specific action, such as filing a lawsuit).

The FDCPA covers personal, family and household debts, such as credit cards, auto loan, medical bills and residential mortgage. The FDCPA does NOT cover business debt.

Offshoots of the FDCPA include:

Equal Credit Opportunity Act: (Prohibits discrimination on the basis of race, color, religion, national origin, sex, marital status, age, receipt of public assistance, or good faith exercise of any rights under the Consumer Credit Protection Act. The Act also requires creditors to provide applicants, upon request, with the reasons, underlying decisions to deny credit.)

Fair Credit Reporting Act: (Governs the collection, assembly and use of consumer reporting information and provided the framework for credit reporting in the U.S.)

Servicemembers Civil Relief Act: (Established to help military personnel fulfill their financial obligations or assert their legal rights while they are actively serving our Nation. Protections include: (i) a six percent cap on interest on debts incurred before being called to active military duty; (ii) Prohibiting negative reports to credit bureaus solely for exercising SCRA rights, and (iii) Limits on foreclosure or other default judgments.

Dodd Frank – Consumer Financial Protection Bureau: (Regulates consumer banking products, such as credit cards, payday loans and mortgage rules, in an attempt to stop predatory lending. The CFPB’s mandate is to protect consumers against unfair, deceptive, or abusive acts or practices).

BANK SECRECY ACT

The Bank Secrecy ACT (BSA) requires financial institutions to keep records and file reports on certain transactions. These reports are submitted to the U.S. Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN). FinCen collects and analyzes the information to support law enforcement investigative efforts and to provide

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U.S. policy makers with strategic analyses of domestic worldwide money laundering developments, trends and patterns.

The BSA’s reporting and recordkeeping provisions apply to banks, savings and loans, and credit unions as well as other financial institutions, including casinos and money services businesses.

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6.C. Suspicious Activity Report (SAR)

A form filed by financial institutions to report detailed information about transactions that are or appear to be suspicious.

Such reporting by banks is critical to the United States’ ability to use financial information to combat terrorism, terrorist financing, money laundering and other financial crimes.

The purpose of a suspicious activity report is to report known or suspected violations of law or suspicious activity observed by financial institutions subject to the regulations of the BSA.

A SAR must be filed within thirty (30) days of the initial determination for the necessity of filing the report.

Federal law provides protection from civil liability for all reports of suspicious transactions made to appropriate authorities, including supporting documentation.

Banks should maintain appropriate arrangements to protect the confidentiality of SARs and may lose their safe harbor protection of SARS are not maintained in a confidential manner.

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6.D. Federal Sentencing Guidelines

There are more specific fraud guidelines that apply in more specific cases. §2B1.1.     Larceny, Embezzlement, and Other Forms of Theft; Offenses Involving Stolen Property; Property Damage or Destruction; Fraud and Deceit; Forgery; Offenses Involving Altered or Counterfeit Instruments Other than Counterfeit Bearer Obligations of the United States(a)       Base Offense Level:(1)       7, if (A) the defendant was convicted of an offense referenced to this guideline; and (B) that offense of conviction has a statutory maximum term of imprisonment of 20 years or more; or (2)       6, otherwise.(b)      Specific Offense Characteristics(1)       If the loss exceeded $5,000, increase the offense level as follows: Loss (Apply the Greatest) Increase in Level

(A) $5,000 or less no increase

(B) More than $5,000 add 2

(C) More than $10,000 add 4

(D) More than $30,000 add 6

(E) More than $70,000 add 8

(F) More than $120,000 add 10

(G) More than $200,000 add 12

(H) More than $400,000 add 14

(I) More than $1,000,000 add 16

(J) More than $2,500,000 add 18

(K) More than $7,000,000 add 20

(L) More than $20,000,000 add 22

(M) More than $50,000,000 add 24

(N) More than $100,000,000 add 26

(O) More than $200,000,000 add 28

(P) More than $400,000,000 add 30.

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