Bankruptcy has changed from a tool used to dissolve businesses to one that helps resurrect them--at the cost of everyone but the executives
SURVIVAL OF THE "UN" FITTEST
Richard Lehmann, Distressed Debt Securities, 09.08.04, 2:55 PM ET
NEW YORK - What happens to the losers in a competitive business environment? Those that have no debt close up shop and go home. Those that do, file for bankruptcy. The historical intent of bankruptcy law was to provide a mechanism for the orderly dissolution of a business--an intent still observed in many countries today.
In the United States, however, things are different. The bankruptcy process is principally a tool for business reorganization, social engineering and off-loading problems that could not be resolved by other means. Very few large corporate bankruptcies today result in a liquidation of the business. Instead, these companies insulate themselves from existing creditors by obtaining a new line of credit called a DIP (Debtor In Possession) loan that is senior to all existing loans, and then proceed to continue operations as before, albeit with a judge's blessing. Never mind that the current management may be inept, this is America, the land of second (even third) chances. Besides, winding up the business would mean job losses, something most judges have a hard time endorsing. Hence, we have companies kept alive because they employ so many people, even though their bankruptcy protection jeopardizes the survival of the remaining players in an industry. Look at the airlines.
The most revolutionary change in the bankruptcy process has been the use of the courts to off-load problems that cannot be solved otherwise. Recent examples include freezing punitive damage awards or addressing class action issues, such as asbestos litigation. The latest ploy is the off-loading of unfunded pension liabilities. This was first done by the steel industry and is now catching on for airlines.
United Airlines (nyse: UAL - news - people ), currently in bankruptcy, recently announced that it would skip pension benefit payments. The expectation is that the Pension Benefit Guarantee Fund would pick up the liability. The rule is that if the company can prove that its existence is threatened by its pension obligations, it can walk away from them and give them to the government. This is essentially taking government money and giving it to United's creditors. However, this is not as bad as it may seem. The bail out also benefits creditors by enhancing their return (as the new shareholders) and makes them more willing to throw good money after bad. Workers benefit because they keep their jobs and pensions. The government takes on a liability in the beginning, but ensures future revenue from collected taxes from the surviving business, assuming an airline can ever put together two or more profitable years.
Those companies that learn from their failures and get a fresh start are usually winners. The number of companies going through bankruptcy more than once is small. And then some, like Donald Trump, seem to consider it a normal business option. However, there must be times when a company, even a big one, should be liquidated. As with the airlines, some participants should be removed because there's not enough business to keep everyone alive and profitable. The resources invested in that company won't disappear but will be distributed among competitors. This is what's expected to happen in the telecom industry and may be the answer for airlines as well. In the case of United Airlines, the total capacity of the U.S. airline industry will be better allocated if there are fewer competitors. As for United's employees, other airlines taking up the slack will need experienced workers.
Keeping failed companies going only serves to increase the financial stress on companies not in bankruptcy. In a competitive industry, one bankruptcy can cause additional bankruptcies. Those carriers who have entered bankruptcy and emerge with better union contracts, lower debt, new equity and an overall lower cost of doing business will surely be a tougher competitor against other airlines. Healthy airlines, which are still in business because of superior management, will suffer when a post-bankrupt company with a clean balance sheet competes against them. The healthy company will have to match fares to stay competitive. The problem only compounds if a second airline files, so what ensues is a domino effect taking out the whole of the industry.
There are examples of whole industries going bankrupt because of competitive pressures. The movie-theater industry went bankrupt en masse within a short time period. Today we see Ford Motor (nyse: F - news - people ) and General Motors (nyse: GM - news - people ) trying to stay competitive against foreign suppliers while choking on their pension costs. Unless an alternative solution can be found, the point may well be reached when they see bankruptcy the same way as Donald Trump.
Forbes.com article
SURVIVAL OF THE "UN" FITTEST
Richard Lehmann, Distressed Debt Securities, 09.08.04, 2:55 PM ET
NEW YORK - What happens to the losers in a competitive business environment? Those that have no debt close up shop and go home. Those that do, file for bankruptcy. The historical intent of bankruptcy law was to provide a mechanism for the orderly dissolution of a business--an intent still observed in many countries today.
In the United States, however, things are different. The bankruptcy process is principally a tool for business reorganization, social engineering and off-loading problems that could not be resolved by other means. Very few large corporate bankruptcies today result in a liquidation of the business. Instead, these companies insulate themselves from existing creditors by obtaining a new line of credit called a DIP (Debtor In Possession) loan that is senior to all existing loans, and then proceed to continue operations as before, albeit with a judge's blessing. Never mind that the current management may be inept, this is America, the land of second (even third) chances. Besides, winding up the business would mean job losses, something most judges have a hard time endorsing. Hence, we have companies kept alive because they employ so many people, even though their bankruptcy protection jeopardizes the survival of the remaining players in an industry. Look at the airlines.
The most revolutionary change in the bankruptcy process has been the use of the courts to off-load problems that cannot be solved otherwise. Recent examples include freezing punitive damage awards or addressing class action issues, such as asbestos litigation. The latest ploy is the off-loading of unfunded pension liabilities. This was first done by the steel industry and is now catching on for airlines.
United Airlines (nyse: UAL - news - people ), currently in bankruptcy, recently announced that it would skip pension benefit payments. The expectation is that the Pension Benefit Guarantee Fund would pick up the liability. The rule is that if the company can prove that its existence is threatened by its pension obligations, it can walk away from them and give them to the government. This is essentially taking government money and giving it to United's creditors. However, this is not as bad as it may seem. The bail out also benefits creditors by enhancing their return (as the new shareholders) and makes them more willing to throw good money after bad. Workers benefit because they keep their jobs and pensions. The government takes on a liability in the beginning, but ensures future revenue from collected taxes from the surviving business, assuming an airline can ever put together two or more profitable years.
Those companies that learn from their failures and get a fresh start are usually winners. The number of companies going through bankruptcy more than once is small. And then some, like Donald Trump, seem to consider it a normal business option. However, there must be times when a company, even a big one, should be liquidated. As with the airlines, some participants should be removed because there's not enough business to keep everyone alive and profitable. The resources invested in that company won't disappear but will be distributed among competitors. This is what's expected to happen in the telecom industry and may be the answer for airlines as well. In the case of United Airlines, the total capacity of the U.S. airline industry will be better allocated if there are fewer competitors. As for United's employees, other airlines taking up the slack will need experienced workers.
Keeping failed companies going only serves to increase the financial stress on companies not in bankruptcy. In a competitive industry, one bankruptcy can cause additional bankruptcies. Those carriers who have entered bankruptcy and emerge with better union contracts, lower debt, new equity and an overall lower cost of doing business will surely be a tougher competitor against other airlines. Healthy airlines, which are still in business because of superior management, will suffer when a post-bankrupt company with a clean balance sheet competes against them. The healthy company will have to match fares to stay competitive. The problem only compounds if a second airline files, so what ensues is a domino effect taking out the whole of the industry.
There are examples of whole industries going bankrupt because of competitive pressures. The movie-theater industry went bankrupt en masse within a short time period. Today we see Ford Motor (nyse: F - news - people ) and General Motors (nyse: GM - news - people ) trying to stay competitive against foreign suppliers while choking on their pension costs. Unless an alternative solution can be found, the point may well be reached when they see bankruptcy the same way as Donald Trump.
Forbes.com article
