Ever since Polaroid Corp. slipped ignominiously under Chapter 11 bankruptcy protection in October 2001, it has been portrayed as a textbook case of how bankruptcy proceedings can help a failing company emerge with a promising future.

True, the Cambridge, Massachusetts, company, which introduced instant-imaging photography in 1947, still needs to find a way to recover from management errors that caused it to miss most of the digital-photo revolution — while making bad investments and bad recapitalization moves.

But just 10 months after filing, the company had sold all of its assets to Bank One Corp.'s One Equity Partners (OEP) venture-capital arm for an announced $255 million in cash and $200 million in assumed trade liabilities. Secured creditors have been paid off nearly in full, while unsecured creditors are to receive a healthy 35 percent of a new, privately held Polaroid. Former Ford Motor Co. CEO Jacques Nasser has been named Polaroid's nonexecutive chairman, with responsibility for filling the vacant chief executive spot. (CFO William Flaherty and general counsel Neal Goldman have run the company since CEO Gary DiCamillo resigned last July.)

Officers of the debtor, the original Polaroid, have congratulated themselves for getting the escape from bankruptcy on track so quickly. In the waning days of 2002, Polaroid was close to a final reorganization that would end its case, if approved by the court.

Not everyone has fared so well, of course, including Polaroid shareholders, employees, and retirees. The company has had sweeping layoffs and has discontinued some severance payments. And three days before its filing, it terminated retiree health benefits. Still, both OEP and Judge Peter Walsh, who presided over the case in U.S. Bankruptcy Court for the District of Delaware, have praised the results of the process, which Walsh calls "in the best interest of the estate."

But some critics are pointing to the Polaroid case as a demonstration of what's wrong with corporate-bankruptcy reorganization. They say the system is so weighted toward debtors that it fails to encourage the active bidding that could produce fairer, more-lucrative resolutions for creditors and other stakeholders. There are complaints, too, that the courts fail to scrutinize the financial and operational steps that debtors take before their bankruptcy filings.

Ultimately, these critics say, Polaroid provides a look at a system failing miserably even at its stated goal of maximizing returns to creditors and parties in interest. Among the questions emerging from this bankruptcy: Did Polaroid unfairly favor OEP over other bidders? Did it wield too much power over the sale process? In the end, was the price paid too cheap? By some accounts, OEP paid a net amount of less than $80 million, plus assumed trade liabilities, to gain a company with more than 1,000 patents and $1.5 billion­plus in worldwide asset value.

"It's possibly the worst case I've ever seen," says Lynn LoPucki, a law professor at the University of California at Los Angeles. The bankruptcy court's job "is to regulate the relationship between debtors and creditors," he says, but in recent years, debtors and the largest creditors, usually banks, "have taken control of the courts," and get from judges "whatever they want." Poorly supervised reorganization plans often result, and less-powerful parties are cowed into approving them — just to get some semblance of a return. "The current system just destroys value," says LoPucki.

Was It a Fire Sale?
Compared with the explosive wide-screen, Technicolor collapses of Enron and WorldCom, Polaroid's bankruptcy has been more of a long, slow fade. Yet because of the way it used the bankruptcy courts, Polaroid seems worthy of the same kind of scrutiny that accompanied those other collapses.

In theory, of course, Chapter 11 is designed to provide financially troubled corporations with protection from secured and unsecured creditors while a plan is formulated for paying off debts. A court-approved plan gives creditors first crack — often in the form of equity in a new company — with common shareholders typically receiving little or nothing. Along with the court, creditors themselves serve as watchdogs, making sure the company plays by the book and preserves value.

But in reality, according to LoPucki, the competition for business by bankruptcy courts — especially in Delaware and its closest rival district, New York State — creates "a race to the bottom" that invites venue-shopping by companies. The jurisdictions gain reputations for letting debtors call more of their own shots, he says. And this may contribute to a rate of repeat bankruptcy filings in the Delaware bankruptcy court that is 10 times higher than the average elsewhere, except New York.

Some observers suggest that Polaroid didn't belong in Chapter 11 in the first place. "OEP got the assets at a fire sale," says Ulysses Yannas, a Buckman, Buckman & Reid Inc. analyst who has followed Polaroid for 30 years. "It's a company that should never have died." In his opinion, "the judge should have forced the company to come up with a plan to run the entire company...properly." Polaroid's initial bankruptcy petition, citing a July 1, 2001, filing with the Securities and Exchange Commission, actually listed worldwide assets of $1.8 billion and liabilities of $948.4 million — although Polaroid claimed revenue declines had stifled its ability to pay off or restructure maturing loans and bonds. It blamed the sales fall-off on a weak instant-film market, among other factors, while asserting that high manufacturing costs had penalized earnings.

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