Bankruptcy 101

By Mike Kroll

Large corporate bankruptcies are very different from those of individuals or small, closely held businesses even though the presumed goal is the same. Most small businesses that go bankrupt are liquidated under what is known as Chapter 7 of the bankruptcy statutes. The business is dead and whatever remain of its assets are distributed among its secured creditors while unsecured creditors typically get little or nothing. Most corporations that declare bankruptcy do so under Chapter 11 which putatively permits them to "reorganize" their business operations and debts to permit continuation of the business in a different, presumably profitable, manner. In the case of a larger business unsecured creditors still fare poorly but joining them are many of the employees and the community.

"Business bankruptcies are frequently devastating to many of the people involved and there are very few happy endings," noted Galesburg attorney Barry Barash. Bankruptcy is his specialty and he has been handling all kinds of bankruptcies for the past 43 years. Barash has a national reputation in the field and it isn't because he runs tacky television commercials, its because he has been involved in many major business, agriculture and personal bankruptcies. A member of the prestigious American College of Bankruptcy Attorneys since 1993 Barash is the only member of that group practicing in Illinois outside of Chicago.

"I would describe my reputation as more regional than national although I have been involved in bankruptcies across the country. I don't make my living as a local attorney. The current bad economy is sure to spur many more business bankruptcies than just those that have received recent national attention and many will be directly related to the excesses that led to the investment banking crisis."

Just as individuals got "upside-down" due to questionable mortgage practices resulting in debt well beyond the value of their assets the same is true of many American businesses that are "heavily leveraged." Many of the leveraged buyouts of American corporations that first began appearing with regularity in the 1980s create businesses that are financially unsustainable unless the business is torn apart and the individual pieces sold more profitably than the value of the corporation as a whole.

This is directly analogous to the operation of an automotive chop shop. Car thieves steal cars (low cost-high risk acquisition) only to disassemble them to sell the component parts for more than the value of the whole car. The car thieves, like the greedy corporate mogul behind a leveraged buyout, expose themselves to relatively little personal financial risk but stand to reap substantial gains if successful. Unfortunately whether the gambit is successful or not there are typically few other winners in such a situation.

Billionaire Sam Zell's purchase of the Tribune Corporation is a good example of this phenomena. Zell bought the Tribune with very little capital of his own as the sale was financed by borrowing heavily against the assets of the company. This resulted in relatively little personal risk to Zell and an extremely heavy debt load to the Tribune corporation that would have been difficult to support in a good economy. In the present recession/depression economy the Tribune Company's financial underpinnings were almost assured of failing and that is why the Tribune is now in Chapter 11 bankruptcy as it attempts to deal with over $13 billion in debt and ongoing financial losses.

According to Barash what this will do is permit Zell to escape a bad business deal virtually unscathed while the Tribune's employees and creditors "take it on the chin." The days of the Tribune as a single corporate entity were over almost as soon as Zell's purchase was finalized but now that the house of cards has collapsed there seems little prospect for a happy ending for either the component parts or the many Tribune creditors and employees. The business press is now abuzz with analysis of what the Tribune experience says about the financial security of leveraged buyouts but Barash believes most of these deals were highly speculative even in good economic times.

While most people think of the Tribune Company as a holding company for its namesake newspaper the company consists of 10 daily newspapers 23 television stations, the Chicago Cubs and numerous other holdings and boasts over 20,000 employees. Zell and his managers had already begun cutting costs by reducing that employee number and now many of those separated employee will be among the first to pay the price of bankruptcy as payments to their severance packages or deferred compensation. And the employee stock ownership plan publicly vaunted as a means of sharing the wealth with employees by Zell when he first consummated the deal will likely be among the bankruptcy victims.

The American auto industry is a slightly different story. In Barash's view the big-3 automotive companies have been in perilous financial shape for years and simply waited too long to change their business practices or seek assistance. "It is most probably too late to save the American auto industry not matter what is done but as currently structured the bailout will accomplish very little at high cost to the taxpayer."

"To survive the American car industry needs to make major fundamental changes in not only its products but how it operates and those changes will be very painful for everyone concerned. That is why the industry has delayed making even modest real changes until now and even now all they seem willing to do is tinker with their failing strategy. As currently conceived the bailout merely delays briefly the end of the American auto industry."

The significant fundamental changes Barash has in mind would be very painful for everyone involved in the car industry, management, labor, the dealer network and the huge network of dependent vendors. Ironically, Barash says failure to make these changes only guarantees the far more painful death of the industry.

"The auto industry is one of the most heavily secured major corporation in America today. Just about every company asset can be claimed by one or more creditors yet in most cases the realistic value of those assets pale in comparison to the debt."

As Barash explains it the currently proposed "loan guarantees" from Congress would seem to amount to little more than enabling an industry addicted to bad business practices and unable or unwilling to significantly alter their product mix sufficiently to become competitive with foreign car manufacturers. If Barash were the new "car czar" he would push for the three automotive companies to declare Chapter 11 bankruptcy and for the Federal government to make debtor in possession loans to help keep the companies afloat.

"This approach would make the Federal government first in line in terms of secured debt and that would permit the kind of reorganization that will be necessary to save what is left of the American auto industry. Even if this path were taken, and so far it doesn't appear likely, if the American auto industry survives it will be a very different animal and very likely a single corporate entity. If the American auto industry does fail it will have far reaching ripple effects across this country and few communities will escape the fallout."

For many smaller companies Chapter 11 bankruptcy is simply not a good option explained Barash. "Many companies have debt that can't be easily reconfigured and in many cases the secured assets are of little real value to the creditors. Consider most small retailers or restaurants or a mom and pop drug store and imagine what a creditor would want with the available assets. In the case of a contractor or physician or other professional service business the issue is even clearer. Most of the time by the time bankruptcy becomes a real consideration the owners have already invested just about all the personal capital they had trying to make the business work and the biggest business asset is in the heads of the principals. In cases like these a Chapter 7 liquidation bankruptcy is much more common and often in the best interests of the business owners."

The current bad economy creates ample opportunities for a lawyer like Barash. Not only will their be a higher than normal number of failing businesses but there is also the opportunity to help struggling businesses who are wise enough to seek advice before all their options are ruled out. "I never expected to become a turn-around consultant but for some clients that is exactly how the best outcome works out. While bankruptcy is nearly always painful often times it is the best of a bad set of outcomes and sometimes it actually works out for the best."

12/11/08