Exploring the Worst Case Scenario: On Bankruptcy

Had a conversation recently with the CEO of a large MLS who desires anonymity. But who he is is unimportant since the topic is the point.

We were talking about the big lawsuits (Sitzer, Moehrl, REX, PLS) and the worst case scenario that could come from them. Specifically, the commission lawsuits of Sitzer and Moehrl are the real big OMFGs. As longtime readers know, I’ve estimated potential damages from Sitzer/Burnett to be about $6 billion and damages from Moehrl could be as high as $376 billion.

There are but five defendants in both of those cases: NAR and the four Corporate Defendants — Realogy/Anywhere, HomeServices of America, RE/MAX and Keller Williams. Obviously, even the Missouri-only case might lead to instant insolvency for some of these five defendants, but the Moehrl judgment would absolutely make all five insolvent. There just aren’t many companies that can pay a $376 billion judgment or $75 billion if divided five ways.

Naturally, no one has any idea what the actual result of any lawsuit would be. But we were discussing worst case “what if?” scenarios so it was worth exploring what would happen IF the worst came to pass. The MLS CEO thought everyone would just declare bankruptcy to put off having to pay such a ridiculous sum, and wanted to know what would happen in bankruptcy.

Thought I would entertain you with that little nightmare.

Please keep in mind that I do not advocate for any of this, nor do I wish to see a multibillion judgment. I am not your lawyer, and you should speak to competent counsel for anything real. I am also years out from being current with bankruptcy law so I am likely to get a lot wrong. This is education and entertainment only.

Having said that, I happen to love bankruptcy law. I know, it’s a weird trait, but it is what I focused on in law school, and if life had turned out differently, there’s a pretty good chance that I’d be doing cross-border insolvency stuff right now. So I might have a decent idea as to what is likely to happen in a worst case scenario. Let’s explore it together.

Bankruptcy, Generally

The first thing to note is what bankruptcy actually is. What the purpose is. What its goals are. Most of us just think of bankruptcy as “company is out of business” but that’s not actually true.

Bankruptcy is about imposing order on a fucked up chaotic situation.

The first step in a bankruptcy (usually, unless we get to talking about strategic bankruptcy which is a whole different subject) is insolvency. That simply means a company, a person, a city, an entity of some kind, cannot meet its financial obligations right now.

If you have assets of $1m and debts of $2m, but those debts are longterm mortgages and such, that doesn’t mean you’re insolvent. You’re meeting your obligations on a timely basis by making your payments. But if suddenly, you need to pay back all $2m, then you’re insolvent since you can’t actually pay the $2m you owe.

So if a company gets insolvent for whatever reason, what usually happens is a scramble to get paid. It’s like a bank run, but on the company. And in the normal course of business, companies often have preferred partners or vendors or some such that they know they have to stay on good terms with. They’ll often decide to pay Important Supplier ABC while stiffing the random-ass one-time contractor, for example, because they need Important Supplier ABC if they’re ever going to come back healthy.

So without bankruptcy laws, you just get a mad dash to get your claims/debts paid before somebody else; you get anger, rancor, violence… just a bad, bad scene all around.

The point of bankruptcy law then is to stop the madness, get everybody to take a time out, give the debtor time to figure out what’s going on, and then have the court divvy up the pie.

The four key concepts then are:

  1. Pause
  2. Gather all of the debtor’s assets
  3. Gather all of the debtor’s liabilities (debts, payroll, suppliers, etc. etc.)
  4. Divide up the loot according to objective fair (depends on who you are, but still…) rules

After that’s all done, then all of the debts are wiped clean (with exceptions, of course, like student loans) and the debtor can have a fresh start. This cancellation/forgiveness of the debts is why the debtor wants to go through the pain and humiliation of bankruptcy at all.

Liquidation vs. Reorganization

One of the first inquiries/decisions is whether to liquidate the company or reorganize it.

You liquidate the company if there’s no chance that the company is ever coming back from the dead, more or less. FTX, the crypto-ponzi scheme, is probably not coming back as a going concern… so you liquidate in that case.

Most of the time, we hear about reorganization, the so-called Chapter 11 bankruptcies. Here, the idea is that you have a good solid company with a fundamentally sound business, but it just hit a rough patch maybe due to the economy, due to bad decisions on the part of management, or some unforeseen situation. Like losing a bigass lawsuit and getting slapped with a huge judgment. So after the whole gathering debts, dividing up the money, and canceling debts… the company can get back to business and perhaps get back on its feet.

In our case, all five defendants are good solid companies with a long track record of success. If they get hit with a giant judgment, that isn’t a flaw with their core business model; that’s a temporary problem that needs to get fixed. Chapter 11 makes all the sense in the world then. So that’s what I expect will happen.

Nonprofits and Bankruptcy

Fact is, most of us reading don’t care all that much about the four corporate defendants. They’re great companies, with a strong business, with decent balance sheets, good cash flows, etc. They have to deal with the giant legal judgment, but once they can figure that out, they will go back to doing business and making money. As for-profit companies, the courts know what to do, the lawyers know what to do, and the managers know what to do.

Where things get a bit trickier is when we start looking at NAR, the one not-for-profit defendant. What happens if NAR is hit with a $100 billion judgment, which it cannot possibly pay (because nobody can pay a $100 billion judgment with the snap of a finger)?

Nonprofits can voluntarily file for bankruptcy protection, either Chapter 7 liquidation or Chapter 11 reorganization. And then you enter a world that most nonprofit executives and directors, and I’m going to suggest that virtually no one I know in the world of REALTOR organizations has ever entered: operating a nonprofit through bankruptcy.

I found this wonderful Guide for Nonprofit Organizations: Bankruptcy Issues put out by The Law Project from the Chicago Lawyers’ Committee for Civil Rights. If you are in any kind of a leadership role in REALTOR organizations, and especially if you’re a NAR Director (there are over 900 of you), you are going to want to skim this and have your attorney brief you further. There’s a ton of really good advice in there. But I’d like to focus on two issues.

The Board’s Fiduciary Duty

Again, read the Guide and ask your attorney, but as a general matter, in a bankruptcy — especially a Chapter 11 reorganization, as the nonprofit’s staff and Board are usually left in charge (“debtor-in-possession” is the term) — the Board of Directors will be shifting its fiduciary duty from the organization and its members to the creditors of the organization. This is an analogue of the for-profit world, where the Board has to put the interests of the creditors ahead of the interests of shareholders (who are all likely to have their claims extinguished).

Plus, you’re in bankruptcy. Which means that the court will appoint a U.S. Trustee to monitor and oversee your efforts to reorganize. (Please note that the U.S. Trustee is a program of the Department of Justice, with whom NAR is currently locked in litigation.)

Two consequences flow from this immediately.

One, the Board is going to have to get intimately involved with financial and operational details. Because the top task for the debtor (which the Trustee will enforce) is to figure out exactly how much money it has and where and exactly how much money it owes and to whom. From the Guide:

The board cannot create the nonprofit’s books and records. Keeping the books is the entity’s responsibility. However, the board can require – and in a financial crisis, must insist – that those records are complete and current. If there is a silver lining to a financial crisis for a nonprofit, it is that the entity often comes out of the crisis – if it survives – with much tighter financial controls and with a far more financially literate staff and board.

In a financial crisis, the board must obtain and understand sufficient information to further direct the staff to produce additional information where the information presented to the board is insufficient to make well-considered decisions about the entity’s present and future. Among the financial product that the board must obtain and review – as quickly as possible – are the entity’s most recent annual budget, monthly and quarterly financial statements, and tax returns. The board will likely have seen and reviewed most of this, and perhaps all of it, on a regular basis, but absent a crisis, may have done so with a less-than-critical eye, relying heavily on management to note issues of concern. Now, the board is forced to look under the hood.

As noted above, there are over 900 Directors on NAR’s Board of Directors. I have attended NAR Board of Directors meetings in the past and have seen men and women open their information packet for the first time during the Board meeting. Most of them are there to “represent” the views of their “constituents” and opine on things like language of the Code of Ethics. Few are financially literate to the extent that a large corporate Chapter 11 will require from the Board.

Y’all are gonna have to get educated on corporate finance stuff very quickly. Or resign as soon as possible after adverse judgment is entered.

One very strong reason you’ll want to do this immediately is that most state laws protect directors — especially of non-profits — from personal liability for business decisions, lack of decisions, financial illiteracy, and negligence. So no matter how ignorant you were about the finances of NAR, you can’t get sued personally for anything that NAR has done.

However, most of those laws protecting nonprofit board members have exceptions for intentional misconduct or gross negligence. Not knowing diddly squat about the financial statements of NAR, then opening the information packet for the first time at the Board meeting, is probably going to meet the standard for gross negligence. Which means the organization, the U.S. Trustee, or the creditors might be able to sue you personally to have your assets join the pile of cash that they will be dividing up afterwards. You don’t want that.

So either get used to reading financial statements and questioning NAR’s finance staff about line items, or resign. For your own protection. Seriously.

Two, there will be a deep and thorough audit of NAR’s books. When I did my summer at the big international bankruptcy law firm, I learned they use “forensic accountants” all the time to go through a company’s books with a fine-tooth comb to find every little place they spent money and find every little place they stashed assets. This is standard operating procedure in a bankruptcy, and often, the Board of Directors demands one as well since they are now heavily involved and answerable to people outside the company — U.S. Trustee, the bankruptcy court, and the creditors.

There is bound to be political fallout. I can just about guarantee it, because any large organization always has expenditures that were perfectly legal and perfectly legitimate… but look bad. Given how political NAR and REALTOR world tend to be, all I can say is, be prepared for fallout.

Plan of Reorganization

The second issue is what happens after all of the work is done. All of the assets have been identified, sold off, liquidated or otherwise gathered together. (That includes things like clawbacks, where the court forces vendors and employees and creditors to return what they were paid a certain period of time before the bankruptcy filing, by the way.) All of the claims and liabilities are identified and collected together.

Usually, the debtor-in-possession would put together and file a plan of reorganization that set out exactly who is going to get paid what. A 2/3 supermajority of creditors have to agree to the plan. After a period of time, the creditors can file their own plan. And we go back and forth, back and forth, and cases could drag out for years.

The entire time that the plan is being negotiated and argued over, the company is basically a ward of the court. You can do very little of substance without getting permission from the bankruptcy judge.

The way I see things today, the creditor committee is but one major creditor: the plaintiffs in Sitzer and Moehrl, and the lawyers who represent them. I have no idea how much debt NAR has today, but if they have to file for bankruptcy protection, it will be because of the judgments in those lawsuits. They will easily have 2/3 of the amount of debt so what they agree to goes and what they don’t agree to does not.

Let’s say the Moehrl decision results in a $300 billion judgment, and say that gets divided five ways equally between the five defendants. (It won’t, but let’s just say for our purposes.) So NAR owes $60 billion to the Moehrl plaintiffs. Let’s further assume that the Moehrl lawyers know full well that NAR cannot possibly pay $60 billion in damages within this geological epoch. They know they will have to settle for less.

Question is, how much less?

Ten cents on the dollar is still $6 billion. And I have trouble believing that those lawyers will agree to 10%. Say they agree to 20 cents on the dollar; that’s $12 billion. Say they agree to have NAR pay that over ten years. That’s $1.2 billion a year.

Even if we assume that NAR will maintain a million REALTOR members for the next ten years… there will have to be a special assessment to pay these damages to the tune of $1,200 per year per member.

And oh yeah, until the plan is not only approved but implemented and then consummated (all of the payments made), NAR will remain in a sort of receivership under the oversight of the U.S. Trustee and the bankruptcy court. That’s ten years of operating under judicial oversight.


The direct implication of these realities is that until some kind of plan is proposed, accepted, confirmed and then consummated, we should expect NAR to operate on an absolute shoestring, bare-bones budget. Seriously, the creditors and the U.S. Trustee will be watching like hawks to make sure that there are no expenditures that could harm the creditors’ interests in getting repaid.

Don’t expect a lot of lavish events. Do expect a ton of layoffs. The ~$70 million NAR spends on its marketing firm (Form 990) is likely going to be questioned by creditors and the Trustee. Don’t expect NAR to be funding a lot of innovation or investing in startups during this period. They just won’t have the money, because they have to pay the creditors.

The Mission: Out the Other End

This is all assuming that NAR does a Chapter 11 reorganization to wipe out all of its liabilities outside of the plan. It’s entirely possible, I suppose, depending on how the Moehrl people are going to handle the judgment amount, that NAR will simply do a liquidation, give the lawyers whatever NAR has today, closes up shop, and everybody goes home. I don’t think that’s what will happen.

Because NAR is a not-for-profit with a mission. You’ve read it. It starts, “Under all is the land.” As long as the Board and (some of) the membership wants that mission carried on, NAR has a reason to continue, get through this worst-case scenario storm, and come out the other side.

The NAR that emerges out of bankruptcy will be smaller, because it will have gone through years of austerity. The Board of Directors may be a rational size, because most of the 953 Directors will have chosen not to spend all their evenings poring through financial and operating reports. NAR is unlikely to have much if any control over the MLS, who will have gone through their own special hell.

But if the mission remains, or if the mission is revitalized, then NAR will come out the other end far more focused than when it went in. It might even emerge stronger than before, because of that focus. Its leaders will have been tested as in a crucible, and all of the extraneous stuff, all the distractions and internal politicking and power plays will have gotten burned out. It will likely remain the most important housing lobbying organization in the country, but perhaps with a membership who is fired up as never before… if fewer in number. I don’t know that that’s such a horrible outcome, as worst case scenarios go.

That which does not kill you makes you stronger.


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Rob Hahn

Managing Partner of 7DS Associates, and the grand poobah of this here blog. Once called "a revolutionary in a really nice suit", people often wonder what I do for a living because I have the temerity to not talk about my clients and my work for clients. Suffice to say that I do strategy work for some of the largest organizations and companies in real estate, as well as some of the smallest startups and agent teams, but usually only on projects that interest me with big implications for reforming this wonderful, crazy, lovable yet frustrating real estate industry of ours.

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