The Examiners: Courts, Bankruptcy Pros Must Ask Tough Questions

When a company files for Chapter 11 protection a second, third or even fourth time, who’s to blame?

A recurring discussion among bankruptcy professionals and the public alike relates to the phenomenon of serial filers: Chapter 11 debtors who emerge from bankruptcy protection and later find themselves back on the courthouse steps again. This discussion arises when a high-profile, former debtor seeks bankruptcy protection a second or third time, as Trump Entertainment did recently. Almost immediately, observers ask, who is responsible for this supposed abuse of the judicial process? But before trying to ascribe blame (and there is plenty to be shared), the first question should be: Does anyone actually deserve blame?

The underlying purpose of Chapter 11 is to provide debtors with the breathing room necessary to reorganize their business and maximize the value of the enterprise for all creditors. Debtors often emerge from Chapter 11 having met all of the confirmation prerequisites and with the best of intentions to succeed. A number of reasons, such as declining market share, macroeconomic issues or an overleveraged balance sheet, can unfortunately lead them back into the courthouse. In this situation, is there any reason the Bankruptcy Code shouldn’t be available for a debtor to try again to get it right? Generally, the Bankruptcy Code doesn’t think so.

Unfortunately, the situation is rarely so simple, and this is why responsibility must be shared. It starts with Congress, which has chosen to set no time limit on successive filings, and, as the Ninth Circuit recently noted, made clear that “corporate debtors are exempt from even the minimal constraints on serial filings imposed on other kinds of debtors.” This is not to say that the Bankruptcy Code is void of tools to reduce the likelihood of repeat filers. This is why responsibility must be shared by bankruptcy courts, bankruptcy professionals and virtually all other stakeholders.

Under the Bankruptcy Code, a plan of reorganization may be confirmed only if that’s “not likely to be followed by the liquidation, or the need for further financial reorganization.” The feasibility requirement isn’t a guarantee of a plan’s success, but the plan must offer a “reasonable assurance” of success. The court has an affirmative obligation to evaluate a plan’s likelihood of success, yet the courts and bankruptcy professionals all too often do the bare minimum to meet this mandate. Often, the only support for plan feasibility is uncontroverted testimony by a debtor’s representative or financial professional, which the court is reluctant to question when a plan has been agreed to by the significant creditors. When the hard questions are not asked at this critical juncture, the results can be troubling.

Indeed, the consensual bankruptcy plan, while a highly laudable goal, can often lead to the inevitability of a subsequent filing. In trying to get everyone to the table, concessions are often made that will translate into post-confirmation capital requirements that the debtors cannot realistically meet. Throw into this mix that fact that many reorganizing debtors fail to recognize the business failures that led to Chapter 11 in the first place and further fail to understand and implement the financial and operational fixes required to remedy these mistakes. Thus, in the urge in exit Chapter 11, too many debtors and their stakeholders are willing to risk a second, or potentially third, voyage into bankruptcy.

Richard A. Chesley is the co-chair of DLA Piper’s restructuring practice, focusing on bankruptcy transactions both in the United States and internationally. He is based in Chicago.