The Examiners: Adam Levitin on the Outlook for Corporate Restructuri...

Interest rates that remain near zero and debt maturities that have been pushed out to 2017 and 2018 have helped drive chapter 11 filings to historic lows. Has this difficult environment put corporate restructuring on life support?

A common misconception about business bankruptcy is that filings rise and fall with the overall state of the economy. This is only partially true. A depressed economy does contribute to Chapter 11 filings, but so do other things.

First, in any given decade, there is also always an industry or two in the throes of financial distress for reasons unrelated to the business cycle, such as a secular shock to its business model because of a disruptive technology, an increase in foreign competition, or a mass tort. And then there are the airlines, which never seem to have a sustainable business model.

Second, and more important, interest rates drive the bankruptcy-filing cycle. When rates are low, there is institutional investor demand for high-yield debt because of a need to meet investment hurdles. For example, a pension fund might need to make an 8% annual return. If investment grade debt won’t produce such a return, then the pension fund will look to high-yield markets. Institutional investor demand for high-yield debt in a low-rate environment makes it easier for marginal businesses to obtain financing. When rates rise, however, institutional money jumps into investment grade debt, leaving marginal businesses unable to obtain fresh financing. As maturities come due, Chapter 11 filings mount.

It’s also important to recognize that bankruptcy business isn’t all related to actual filings. Not all financial restructuring occurs in Chapter 11, and Chapter 11 cases can have a long tail, especially for debtor-side work. Lehman Brothers is still generating billables for professionals more than five years after its filing.  Nonetheless, there’s no question that the low rate environment has produced a drop in Chapter 11 filings. This drop affects bankruptcy professionals and places strains on their own businesses, just as occurred in the previous Chapter 11 filing drought, in 2005-2007, which witnessed significant personnel reshuffling in the bankruptcy world.

Adam J. Levitin is a professor of law at Georgetown University Law Center in Washington, D.C.