The only thing missing on Oct. 20 was the sound of blaring trumpets when Goody's Family Clothing Inc. emerged from bankruptcy. The Knoxville, Tenn., retailer of clothing, shoes and accessories boasted about how successfully it had revamped its business model, trimmed operating costs and bolstered its capital structure, replete with a $220 million exit financing.
The high-fives didn't end there. Cooley Godward Kronish LLP, the counsel to the official committee of unsecured creditors, released its own statement two days later, triumphantly declaring Goody's exit as only the second successful retailer reorganization since the federal bankruptcy code was reformed in 2005. The topper came when newsletter Turnarounds & Workouts, in its January issue, congratulated Goody's as one of the best restructurings of 2008.
But the Goody's lovefest ended on Jan. 13, when the company again filed for Chapter 11, less than four months after exiting. Goody's this time around was liquidated. How could a bankruptcy be deemed so successful, only to have the company fall back into it so quickly?
Professionals in the case point to the economic slump. But former denizens of Chapter 11 also seem to be making more regularly return visits, suggesting that what constitutes a successful stay in bankruptcy -- if there is such a thing -- may depend on the beholder. That suggests that some companies exiting bankruptcies are doing so faster, more carelessly and on the basis of possibly misguided agendas.
Bankruptcies are negotiating bazaars. There are many constituencies -- the debtor, lenders, creditors of all kinds, potential acquirers. There are armies of lawyers, bankers, crisis managers and other professionals that argue and battle on their behalf. It's often a scrum, with every man and woman for themselves. Rarely is there common ground, much less a discussion of what a successful outcome would look like for all the parties involved.
For debtors, success may simply mean reorganizing to fight another day. Creditors mostly want to just get paid, not really caring whether a company reorganizes or liquidates as long as they walk away with something. Managers who oversee operations likely want a business to be viable again by the time a company exits, while financial officers want a balance sheet devoid of as much debt as possible.
Seldom do all constituents get what they want. Companies may come out of Chapter 11 larded with almost as much debt as they went in with. Debtors may sell some assets and streamline, but it may be too late. Lenders and other creditors may see recoveries, but through more debt or shares in the reorganized company, not cash.
Now stakes are even higher, given the crippled economy, stricter bankruptcy laws and uncertain credit markets. Debtors may be eager to escape Chapter 11, and more of them are going to extreme lengths to do so. Goody's, for example, left its first bankruptcy armed with a $220 million exit financing, but there were as many as four liens on the retailer's assets as part of it. "Goody's was a situation where we restructured the balance sheet and went into it with our eyes open," says unsecured creditors' counsel Jay Indyke at Cooley Godward. "You have to question whether Goody's would have emerged if the deal for the exit financing hadn't been struck before the Lehman collapse."
Several other companies over the past year have returned to Chapter 11 shortly after leaving. Foamex International Inc., Fortunoff Fine Jewelry and Silverware LLC, Dan River Inc., Avado Brands Inc., Steve & Barry's LLC, Performance Transportation Services Inc. and Intermet Corp. are only a few examples.
Or consider Bally Total Fitness Holding Corp., which first filed for Chapter 11 on July 31, 2007, citing a crushing debt load. It remained in bankruptcy only two months, exiting on Oct. 1, 2007, with a $233.6 million equity investment from Harbinger Capital Partners Master Fund I Ltd. and Harbinger Capital Partners Special Situations Fund LP and $292 million in exit financing from Morgan Stanley Senior Funding Inc. On Dec. 3, Bally filed for Chapter 11 again. Its reason? Continued high debt on the balance sheet. Wouldn't it have been worthwhile to stay in bankruptcy longer the first time and solve that problem, or was the "success" of a fast Chapter 11 stay too compelling?
Kevin Nystrom, a managing director at Zolfo Cooper, thinks more repeat filings, or Chapter 22s, are on the way because of all the paper held by collateralized loan obligation funds. These funds are now participants in creditor groups, but they aren't likely to bend in negotiations. "Often these CLO funds have restrictions on taking equity or unrated paper," he says. "As a result, it's more difficult to arrive at a consensus within a lender group, impeding the ability to develop a consensual reorganization plan."
In the end, the debtor becomes only weaker because it has to produce more cash to repay creditors instead of swapping more debt or equity for the CLO funds' claims. "If a company confirms a plan and then it's back in six months, maybe the assumptions under the plan weren't valid," says Harvey Miller of New York law firm Weil, Gotshal & Manges LLP. If the company had been out of bankruptcy for two or three years and then goes back in, "I wouldn't say it was a failure, [because] no one predicted the severity of what we are going through right now."
Debtor attorneys generally acknowledge that reorganization, not liquidation, is their primary goal. "Success [in bankruptcy] is a company that's healthy and stable and never has to think about bankruptcy again and has the ability to adequately compete in its marketplace," notes Brad Erens of law firm Jones Day.
But lawyers say some bankruptcies are shaped by a big push to save jobs, including management's, as well as to provide creditors with cash or other distributions.
And there are many shades of gray. For example, liquidation may not necessarily be a negative result. "If the company isn't viable on a standalone basis, a sale of the business or a wind-down may be the best alternative, given the facts and circumstances," says Randall Eisenberg of FTI Consulting Inc., a financial adviser in bankruptcies. "I do not consider it a failure when a company is not deemed viable as a standalone business for it to be sold or wound down."
Eisenberg cites the Dec. 15 liquidation of Hoop Holdings LLC, the operator of the Disney store chain. Hoop, which was owned by the Children's Place Retail Stores Inc., was sold to Walt Disney Co. for $65 million. Eisenberg considers the outcome a triumph because many of the stores remained open, the unsecured creditors received a reasonable 25% to 36% recovery and Children's Place no longer had exposure to the chain's operations, which was believed to be dragging down its share price.
Investment banker Greg Barrow of General Capital Partners LLC, which usually represents debtors, feels it's not reorganization or liquidation that determines success, but speed. "When you put a company in Chapter 11, the quicker you can come up with a resolution, the more successful the case is," he says. "There is an erosion of value the longer [a debtor] is in Chapter 11."
But even among investment bankers, there's disagreement on the speed issue. William Welnhofer of Robert W. Baird & Co. argues that liquidation is not a winning solution for an investment banker representing a debtor. "The mission is to realize the going concern value of the business," he says. "If it liquidates, you are not realizing the going-concern value. You are just realizing the value of the assets."
Crisis managers who are brought in to run bankrupt companies or financial advisers trying to rebuild a debtor's business, tend to think much like debtor lawyers in terms of trying to get the business reorganized and viable. But they often go a step further, arguing that they want to preserve jobs, achieve a more solid financial footing and reshape operations where necessary.
Accomplishing those multiple feats takes money and time, which aren't usually plentiful in bankruptcies. Also conspiring against these operational goals may be the dynamics of a debtor's industry. Daniel Wikel, a managing director of Huron Consulting Group Inc., points to the spate of airline bankruptcies, where success depended on any number of factors: not disrupting flight operations, obtaining debtor-in-possession and exit financing to finance those operations and restructuring debt.
Leverage, and the struggle to reduce it, is a recurrent theme with operations managers and advisers, but it's rarely achieved in a satisfactory way.
Debt that can be reasonably serviced is always on the mind of AlixPartners LP's Holly Etlin, who acts as an interim CEO, chief restructuring officer or chief operating officer for bankrupt companies. So are efficient operations while maintaining staffing levels. She says Winn-Dixie Stores Inc.'s Nov. 21, 2006, emergence from Chapter 11 abided by those commandments. Etlin, Winn-Dixie's interim CRO, says the supermarket chain restructured its debt, fixed its operations and closed stores.
What punctuates that success, she says, is Winn-Dixie's continued health so far. Winn-Dixie announced Feb. 11 that its adjusted Ebitda grew by 65%, to $35.5 million, for its fiscal second quarter when compared with the same year-earlier period. Net income rose to $16.1 million, from $4.1 million in the same 2008 period.
Zolfo Cooper's Nystrom, who often serves as an interim COO or CRO, says success in bankruptcy can be as simple as a debtor making payroll the next day. "We try to save the core business and save jobs, but there are situations where it's not logical for certain companies to be around," he says. Many mortgage lenders, he adds, eventually just liquidated because there was simply too much capacity in the industry.
Sometimes the crisis manager's operational focus appeals to other constituencies in a bankruptcy, and sometimes it doesn't. For example, Jones Day's Eren says acquirers of bankrupt assets have concerns about the effect that time in Chapter 11 or Chapter 7 has had on them. "Purchasers are concerned with having good management and advisers on the company side to make sure that the company remains stable before the deal closes," he says.
But Jean Robertson, a partner at Cleveland law firm Calfee, Halter & Griswold LLP, who splits her time between representing debtors and creditors, says lenders aren't enamored of the same things as crisis managers. Employees having jobs "is nice and well and good," she says, but, ultimately, the bank just wants its money back. "If the company restructures and the debtor is successful, then to some degree everyone is more successful in that process."
Lenders are pretty much like all creditors and put a premium on recovering as much as possible on their bankruptcy claims. Indeed, Weil Gotshal's Miller has, over the years, voiced concern that bankruptcy in the U.S. is less about rehabilitating debtors and more about satisfying creditors. Even before the recession hit, more liquidations and bankruptcy sales were occurring because of changes to the federal bankruptcy code that gave creditor rights greater heft and debtors far less time to regroup.
Cooley Godward's Indyke says the Aug. 1 exit of fabric manufacturer and distributor Hancock Fabrics Inc. epitomizes the kind of success a creditor's attorney is after. Unsecured creditors recovered 100% of their claims, plus interest. "Clearly, [it] is the home run you're looking for," he says.
But cash isn't always a motivator for some creditors, such as hedge funds. Baird's Welnhofer says that for a hedge fund that owns the debt beneath the senior debt, success may mean taking over all of the equity in a reorganization plan.
Unsecured creditors, too, may look beyond cash. In their case, Calfee Halter's Robertson says, the debtor's ability to exit bankruptcy and build enterprise value may generate real interest, especially if unsecureds must settle for shares of the reorganized company for their claims recovery.
Some of the bloodiest fights in a bankruptcy, in fact, aren't between debtors and creditors, but betwen creditors themselves. That's because success for an unsecured creditor often comes down to getting more senior creditors to share, says David Stratton of Pepper Hamilton LLP, who usually represents unsecured creditor committees.
The case of Greatwide Logistics Services Inc. is an example where unsecured creditors found themselves "completely out of the money, but we managed to negotiate a modest ... distribution ... from first-lien holders, so we achieved something positive," says Stratton, the co-counsel to the company's unsecured creditors.
Still, just when you think the battle lines are clearly drawn between what a debtor, a creditor or a purchaser wants, along comes a situation such as Lenox Group Inc. A prenegotiated plan for the bankrupt maker of flatware and giftware centered on a credit bid of up to $98.75 million from prepetition lenders UBS AG and Clarion Capital Partners LLC for Lenox's assets. Like many debtor-in-possession lenders nowadays, UBS Securities LLC and J.P. Morgan Chase Bank NA gave Lenox a very small window for making a sale: The company filed for bankruptcy on Nov. 23 but had to win court approval of a sale by Jan. 31.
Calling the proposed sale process tied to the DIP a "recipe for disaster and failure," prepetition lender Bank of New York Mellon Corp. tried to slow the proceedings down rather than speed them up like most creditors. When a rival bidder surfaced and made an offer that BNY Mellon called "grossly inadequate," a New York bankruptcy judge continued the Lenox sale hearing for five days.
The extra time paid off, because the Clarion-led term lenders were able to secure more financing and ultimately won Lenox for roughly $100 million in cash and debt.
AlixPartners' Etlin argues that moving quickly can have its advantages in minimizing professional fees and boosting creditor recoveries. She cites the liquidation of New Century Financial Corp., a bankruptcy in which she served as CRO and CEO.
"It was very clear early in the process [in the first 30 days] that it would not be able to be resuscitated, so the idea of success changed," Etlin says.
The goal became "getting the company liquidated and getting the litigation claims resolved as quickly as possible," she says. "Time is money when winding down."
In the end, New Century, once one of the U.S.'s largest subprime lenders, was liquidated on Aug. 1, 15 months after its April 2, 2007, filing date. Unsecured creditors recovered between 2.2% and 17.1% on $2 billion in claims, and about $277 million was raised from asset sales, $230.4 million of which went to satisfy some $35 billion in claims.
"If the company is fundamentally not viable, then a quick and effective liquidation in bankruptcy is still a success," Etlin says. "The key is to make a determination early in if the company is viable."
But the debate over liquidations is only intensifying. For every professional who agrees with Etlin, there's one who doesn't. And while bankruptcy has always been about backroom negotiations, the frenetic pace of new filings and the speed the federal bankruptcy code requires for cases to proceed has made the combatants only more focused on what they want, as opposed to what is in the best interest of the debtor, its creditors and other stakeholders.
"Anytime assets are sold for pennies on a dollar, creditors are getting wiped out, jobs are lost, but secured creditors might be paid in full, it's hard to view that as a success under any rubric," says Howard Seife of Chadbourne & Parke LLP. "If the debtor finds a buyer who keeps it as a going concern and is able to provide a return to creditors, that could be viewed as a success."
Indyke says the difference for him now is that he doesn't walk into a case assuming the debtor will reorganize. Other lawyers and advisers readily agree, particularly since enterprise values have contracted, DIP and exit financing is harder to get. Overall, a realism has crept into most proceedings.
"The core premise [of what makes a case successful] is still the same," says Zolfo Cooper's Nystrom. "But today you don't have the tools in the toolbox needed to get it done."