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Companies filing for Chapter 11 protection are exiting sooner than ever, but is faster always better?
Vincent Ryan, CFO Magazine
June 1, 2010
The bankruptcy process is a lot faster than it used to be. When United Airlines entered Chapter 11 in 2002, for example, it languished there for three years. By comparison, in 2009 automaker Chrysler spent all of 40 days in bankruptcy. A recreational-vehicle dealer, Lazydays, sped through even faster: "We were in and out of [the] Delaware [courts] in five weeks," says CFO Randy Lay.
The average duration of nonprepackaged, large public-company bankruptcies fell from 944 days in 2008 to 483 days last year, the shortest time in at least 10 years (see "Fast Times," below). Why are companies exiting Chapter 11 sooner? For one thing, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 has made it almost impossible to linger in bankruptcy. Among other things, the act reduced the exclusivity period for filing a plan of reorganization, introduced a "hard stop" in the deadline for rejecting an unexpired commercial lease, and limited the bonuses that could be offered to retain key employees while a company restructured.
Also, prepackaged bankruptcies have become more acceptable, thanks to the stingy capital markets and economic uncertainty of the past two years, says Rob McMahon, head of the refinancing group at GE Corporate Lending. Debtor-in-possession financing was hard to find given the difficulties in predicting what the financial markets would be like 6, 12, or 18 months ahead. "So bankruptcy advisers realized they needed to solve the company's problems before filing, often through a prepackaged deal," says McMahon.
Given that bankruptcy is a near-death experience for a company, it would seem that the faster a company exits Chapter 11, the better. And, in fact, there are many advantages to shorter bankruptcies. But experts also warn that too much speed poses risk, even to the point of causing a company to plunge into the abyss.
The Quick and the Dead
The biggest advantage of moving quickly in bankruptcy is simply that it gives a company a better chance of survival. Senior secured lenders often have little patience in Chapter 11, especially when they think the debtor's assets have been dissipated and the business is unsustainable. "In many cases they think they would be better off if the firm were liquidated," Lay says.
"Those lenders are the 800-pound gorilla," adds Bill Lenhart, BDO Consulting's national director of restructuring, "especially if they are providing liquidity through debtor-in-possession financing."
Any financing is quickly consumed in bankruptcy, says Charles F. Kuoni III of CRG Partners. "If you can exit faster, you minimize the cost of paying all the professionals. That's a big savings," he says.
What's more, with contracts suspended and customers worried about the business's survival, a dip in revenue is common, points out Laura Marcero, a partner at Grant Thornton. "You get hit from the top line and the expense structure," she says.
While some experts say that fast-track Chapter 11 does not give a company enough time to fix the business, others argue that with a well-defined plan companies can achieve quickly what Chapter 11 was created for — rejecting contracts, exiting leases, selling assets, and negotiating with creditors. "The clock is ticking," says Jacen Dinoff, chief executive of KCP Advisory Group. Every day a lease is in place, for example, the debtor owes rent, and that cost is considered a priority claim that is paid dollar-for-dollar, says Dinoff.
With the market for automobiles and other vehicles hard hit in 2009, Lazydays, like Chrysler, didn't think it was wise to dawdle in Chapter 11. So CFO Lay, who has a professional background in turnarounds, led the Florida company through a prepackaged bankruptcy. It helped that Lazydays had been negotiating with noteholders for a year, resulting in a debt-for-equity swap agreed to pre-filing. Also working in the company's favor was that its problem was clear: investors that had bought the business in 2004 had loaded it with $152 million of high-yield debt priced at 11.75%. It was the classic "good business, bad balance sheet," says Lay.
Of course, management can't always control the speed of a bankruptcy. If senior debtors try to cram a reorganization plan down the throats of junior creditors, the court may apply the brakes. "If a judge smells the situation isn't right and certain creditors are treated unfairly, he will slow the process down," BDO's Lenhart says.
Dealing with unsecured creditors can chew up lots of time. "I've been involved in cases where we were out in less than nine months, but the bulk of the work was done in the first four or five months," says Kuoni. "The balance was spent resolving claims disputes." And claims can come from the government as well as the private sector. "If the Pension Benefit Guaranty Corp. files a claim, that can take a while to resolve," he says. Ditto when taxing authorities file claims for tax years still open for audit.
Recently, several large bankruptcy cases — Visteon, Six Flags (which has since exited), and Tribune Co. among them — have run aground. Unsecured creditors and even shareholders are fighting reorganization plans and proposing alternate exit strategies. "The further you get down the capital structure, [the more] people become a nuisance," says Grant Thornton's Marcero.
One of the principal ways creditors are delaying company exits is by disputing the debtor's valuation. With the economy recovering, "if the advisers do a valuation at one point in time and then begin creditor negotiations, debt that is still trading may increase in value," Marcero says. Constituents out of the money in the initial reorganization may claim to be deserving of a recovery. Trading of claims while the company is in Chapter 11 can also throw a wrench into the process, as new noteholders enter in the middle of negotiations.
"Any time you're in the process of Chapter 11, changes in the economy are going to impact the value of the business in bankruptcy, although the relationship is not linear," says Tim Cummins, a managing director at Stout Risius Ross. Valuation models are the same in bankruptcy, but there's plenty of room for disagreement. "In valuing a company that has a difficult road ahead, a discounted cash-flow analysis, for example, is complex. At what point can they expect to be cash-flow positive?" Cummins says.
One thing management can do to avoid lengthy battles with unsecured creditors is to emphasize the relationship going forward. "If the creditor is receiving something on the dollar for its old payable but will also continue as a supplier, that may be a good deal," Kuoni says. More broadly, getting on the same page with creditors is key, Lay counsels. "If you don't establish a very good relationship with the creditors' committee up front, that causes a lot of squabbling over the ultimate reorganization."
It's possible, though, to go too fast. With a prepack, for example, the company may address its balance sheet but not thornier problems, leading to a second bankruptcy in short course, says Jonathan Carson, managing director of Kurtzman Carson Consultants, a noticing agent.
Also, accelerating a bankruptcy process usually means compressing administrative milestones, like the deadlines for creditors to file claims and for companies to mail ballots. "The more you compress, the more difficult it becomes logistically," Carson says. For large companies with tens of thousands of claimants, it may be impossible to comply with requirements in short time.
But perhaps the biggest risk in a fast bankruptcy is in not getting all the value that Chapter 11 can offer. "The court and the debtor look to maximize the value of the estate," says Christopher Meyer, a partner at Squire, Sanders & Dempsey. "If I can take a more measured route and get greater value — and not lose so much in the meantime — then I'll want to do that."
"'I'm giving up my assets for less than their worth because everybody knows I need to sell them' — that's what you worry about," says Lay. "Am I getting the right value for this business?"
More time may be advisable, for example, when trying to get the best price for assets in a so-called 363 sale. "If you have unanimity on the part of the management, the board, and creditors that this is a decent business, you can buy some time to get the best deal," Lay says. "You must convince creditors that they won't get the value they want if they force the company into an unnaturally quick liquidation."
Avoiding the courts is still, in many cases, a preferred method for restructuring. Since 2005, out-of-court deals have become popular again, Dinoff says. "I do believe with the changes in the code creditors have gotten a lot smarter about the risk of Chapter 11," Dinoff says. "They're more willing to take a settlement outside of bankruptcy."
Ultimately, however, time is not on the side of a business in Chapter 11. "I'm hard-pressed to say there is any benefit to prolonging [a bankruptcy] case — you run the risk of the judge not being very happy with you," Kuoni says. "If you can't fix the operation in six to nine months, or at least get it profitable, maybe you ought to look at liquidation."
Vincent Ryan is senior editor for capital markets at CFO.