It appears that businesses are not filing bankruptcy at a pace that was predicted earlier this year, after Kodak and Hostess filed their bankruptcy cases, and following AMR‘s fourth quarter filing in 2011. See Where Are the Tidal Waves of Chapter 11 Bankruptcies and Where Are the Bankruptcy Filings (Part II). Indeed, in May 2012, the American Bankruptcy Institute reported that, as of April 2012, total commercial bankruptcy filings nationwide were down approximately 18% from the same period in 2011.
More recently, Vinson & Elkins, LLP, a reputable Texas law firm, estimated, based on the most recent data reported, that business bankruptcy filings in Texas were down during the first six months of 2012, by approximately 39% from the prior year.
What Does This Mean
All of this recent information on reduced filings, however, is not necessarily a sign that the economy is doing well and businesses are doing great. The reality is that many distressed businesses would elect to restructure sooner, but simply do not have the resources to do so, either because they are tapped out on their existing lines of credit, their existing cash flow from operations provides insufficient liquidity and/or they have been unsuccessful in raising investment capital. The only option then is to find a new lender or investor to provide financing or capital–during a period when the ailing company’s financial performance is less than stellar.
What kind of debtor can restructure in this environment. Well, let’s start with American Airlines, which entered bankruptcy with over $4 billion in cash. But, a company does not need to be that financially strong to restructure in a chapter 11 proceeding.
Recent Examples of Chapter 11 Candidates
In July 12, 2012, Valence Technology filed bankruptcy in the Western District of Texas, listing $32 million in assets, $83 million in liabilities, and $44 million in revenues. See earlier blog. Valence is a battery maker with leading technology in the core lithium battery markets. The reason for the Company’s filing was that its current revenue was insufficient to funds its operating and capital needs. When it filed, the Company announced that it would need a lender to provide post-petition bankruptcy for working capital and restructuring costs. The Company is expected to announce such a lender shortly and thereafter petition the court for permission to enter into a post-petition facility.
So what Valence’s example demonstrate about what it takes to obtain post-petition financing to assist a company restructure its operations and/or capital structure. Valance suggests that you need a company with a strong business model (or unique technology) that, while overlevered prepetition, may be extremely valuable once it is able to clean up its balance sheet through reorganization. Even then there is no assurance, as in the case of Valence, where the Debtor did have enough time to secure financing prior to entering into bankruptcy.
Let’s also look at Reddy Ice, a leading ice manufacturer and distributor, which filed a pre-packaged bankruptcy earlier this year. See earlier blog. The Company obtained $70 million in post-petition financing to help pay for operating and restructuring costs. The secured claims of the prepetition lenders, approximately $500 million, encumbered substantially all the assets of the Company. One of its secured lenders, Centerbridge, was willing to, and did, convert approximately $70 million of its first lien notes into the preferred stock of the Company. Overall, through its restructuring efforts, the Company was able to reduce its debt by approximately $145 million and reduce its cash interest expense by approximately $20 million annually. Through its prenegotiated plan, Reddy Ice will also receive a $25 million in additional investment capital by Centerbridge and other secured lenders.
In Reddy Ice‘s case, it took a sophisticated equity partner, Centerbridge, which saw substantial value in a reorganized entity, with a cleaner balance sheet, to lead the way in arranging necessary financing to restructure a leading ice-maker. Without the support of such equity partner, it would have been less probably that the Company could have raised the necessary funds to restructure.
Other ailing companies do not, however, have the same support from their lenders. And many distressed companies are in default of one or more the financial covenants under their debt instruments. Thus, they are in desperate need of a financial partner, so-to-speak.
So, why haven’t the lenders prodded these debtors into bankruptcy? One reason is likely that a company without sufficient liquidity to restructure has a high probability of not surviving in bankruptcy. If the company is then forced to convert its reorganization case to a chapter 7 liquidation, the value of the enterprise, and consequently the collateral held by secured parties, diminishes substantially, many times to the point where secured parties becomes undersecured and may have to write off substantial portions of the debt owed to them. That is never attractive.
While liquidity remains scarce for many companies, we may see less businesses trying to reorganize in chapter 11. But, that should not easily be mistaken for the fact that businesses are doing great or the economy is doing well. It is more likely a reflection that most distressed companies and their creditors cannot, or do not want to, finance chapter 11 restructurings and otherwise do not find the option of liquidating in chapter 7 very attractive. Ultimately, the financial problems of distressed companies, with no financial support, will come to a head as such companies amass more and more problems and chapter 7 bankruptcy may become the only option. At that point, however, the likely recovery to the stakeholders of those companies will be diminished.
- Reddy Ice to Exit Bankruptcy (corporaterestructuringreview.com)
- Demystifying the Law: Chapter 11 Bankruptcy for Individuals & Businesses (blogs.lawyers.com)