In the spectacle that many large corporate bankruptcies become,high-profile executives and huge amounts of debt grab all the attention. Less notice is paid to the many whose lives are affected – the company's workers,who are often left with little,and the shareholders,who usually get nothing.
Although overwhelming competition and economic recession are factors,most bankruptcies result from management problems,such as accumulating too much debt or not being able to sell the product,said Ed Ketz,master of business administration faculty director at Pennsylvania State University and author of “Hidden Financial Risk,” a book about accounting scandals.
But unlike the United Kingdom,where directors of companies that go deeply into debt are prohibited from serving on a board of directors again,U.S. directors can be given a “second bite at the proverbial apple,” said Peter Chapman,president of Bankruptcy Creditors’ Service in Trenton,N.J.
U.S. bankruptcy law strikes a balance,allowing businesses to file under Chapter 7 for liquidation or Chapter 11 for reorganization. But many businesses that reorganize for a second chance end up back in court,Chapman said. For example,Samuels Jewelers,a Texas-based company,filed for Chapter 11 bankruptcy last week for the third time.
During 2002,more than 38,500 U.S. businesses filed for bankruptcy. More than 10,000 of those were Chapter 11 filings,including discount chain Kmart,which had the largest retail bankruptcy ever,with about $17 billion in assets when it filed,said Jack Ferry,a spokesman for Kmart. Despite being what Chapman calls a “fundamentally screwed-up retailer,” Kmart sells $25 billion worth of merchandise a year and employs about 170,000 people.
The company,which emerged from reorganization in May,projects it will make a profit in 2004,but Chapman said he thinks Kmart will have trouble overcoming its problems. He said many reorganizations go the way of Montgomery Ward,a company that emerged from bankruptcy in 1999 with a new perspective but closed its doors just a year later.
During Kmart's more than 15-month reorganization period,the retailer closed nearly 600 stores and terminated 57,000 employees.
Workers often feel slighted during both liquidation and reorganization proceedings,which focus on creditors' interests first,said Suzanne Ffolkes,spokeswoman for the AFL-CIO. The coalition of unions supports legislative changes that would put more emphasis on workers during bankruptcies.
The AFL-CIO,which helped WorldCom and Enron employees in lawsuits over their severance pay,frequently puts pressure on companies to make reforms in accounting practices and executive compensation by filing shareholders resolutions,she said.
During bankruptcy proceedings,executives leaving and entering the company sometimes receive large severance packages or salaries. For example,the severance package for one executive who left Kmart during the reorganization period included about $4 million in cash and the company's forgiveness of a $5 million loan.
Ffolkes called the practice “outrageous,” and said the union works to ensure “CEOS and top executives are not given excessive compensation packages while a company is in the midst of a financial crisis that could lead to mass layoffs.”
Shareholders can bring suit against a company or its accountants for violations of federal securities laws,such as misstating the company's financial health or accounting fraud. Managers who commit fraud also are subject to criminal proceedings. But “just because a firm failed it doesn't mean that people are corrupt or not,” said Robert Rasmussen,associate dean of academic affairs and professor at Vanderbilt University Law School.
For very large companies,the likelihood of abuse in the Chapter 11 reorganization itself is minimal,said Martin Zohn,a partner in the bankruptcy practice group of Proskauer Rose law firm in Los Angeles. Chapter 11 proceedings mostly “force everybody into one court to resolve their differences.”
Zohn said individuals often complain about the outcome because “the fact of the matter is,the party whose interest gets steamrolled often feels abused.”
Bankruptcy has been used in some cases as a strategic tool,Ketz said. For example,Johns-Manville,an asbestos manufacturer,used bankruptcy to avoid lawsuits in the late 1970s. Also,Continental Airlines went into bankruptcy in the early 1980s to nullify its labor contracts during a union dispute.
But most managers do not embrace bankruptcy as a solution,especially because their reputations are often tarnished,Zohn said.
“A test of whether it's a preferred mechanism for companies is that companies only tend to use it as a last resort,” he said. “Management resists it in almost every case.”
To protect investors' interests in bankruptcy suits,the U.S. Trustee,the bankruptcy arm of the Justice Department,will appoint a shareholder committee to negotiate with the debtor company in rare cases when it appears equity will be left over.
Sometimes,the U.S. Securities and Exchange Commission steps in if the court fails to appoint a shareholder committee when SEC officials think it is warranted. The last time the SEC did this was in May 2002,when it asked that a shareholder committee be appointed for the Kmart case because of the large number of investors and because the company appeared to have high equity,said John Nester,SEC spokesman.
What investors should know about their stock:
1. After bankruptcy proceedings,the company's stock is typically worthless. “Use it for wallpaper” said Ric Edelman,head of Edelman Financial Services in Fairfax,Va. Stockholders have the least amount of claim on the company's assets,behind banks and bondholders,because they take the most risk in their investment.
2. In a typical bankruptcy proceeding,everyone gets less than they are owed. Usually the old stock is canceled and shares are reissued. That means it's a bad idea to buy stock in a company going through bankruptcy proceedings,unless you like your stocks “on your wall,” joked Robert Rasmussen,a law professor at Vanderbilt University.
3. Susan Wyderko of the U.S. Securities and Exchange Commission said shareholders should consult with tax advisers about whether they can claim a tax loss for their now-worthless shares. In bankruptcy proceedings when assets might be left over to pay stockholders,sometimes they get a chance to vote on the company's Chapter 11 reorganization plan.
What workers should know about their retirement:
1. Workers can lose a lot of their retirement account if it is tied up in company stock when the company goes bankrupt. With a 401(k),if 100 percent of the employee's investment is in stock,then it's usually worthless,Edelman said. “Make sure retirement accounts are not all in the company in which you are employed,” Wyderko warned. Diversification provides a better chance of reducing exposure to a particular stock's failure.
2. For workers who have a defined benefit pension plan,what they will receive is part of the bankruptcy negotiation,Edelman said. There are several possibilities:
a. In some cases,the company will continue to provide pensions as originally agreed.
b. Sometimes the company will continue to provide pensions,but reduce the payments.
c. Often,the pension plan is dissolved and the Pension Benefit Guarantee Corp. steps in. (PBGC is to pensions what FDIC is to banks.) Its benefits are based on a formula,and there are limitations. Typically,workers get less than they would have in their original pension plan.
Bankruptcy stats 2002
Total business filings: 38,540
Total business Chapter 11: 10,286
Total business Chapter 7: 22,321
Total non-business filings: 1,539,111
Source: U.S. Courts Web site
Source: American Bankruptcy Institute