The Examiners: Some Repeat Filings May Have No Clear Source of Blame

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

Toward the end of the last decade, New York University Professor Edward Altman published several well-researched articles that observed that nearly one-third of firms emerging from Chapter 11 as a publicly registered company experience some form of subsequent distressed restructuring again, including the filing of a second or third bankruptcy case.

Professor Altman’s research found that serial bankruptcy filers had a significantly worse financial profile than the average sample of reorganized companies—whether measured in terms of corporate liquidity, solvency, profitability or leverage. Moreover, he predicted that serial filings would likely increase in the context of the increased predilection of investors and other stakeholders to focus Chapter 11 activity and reorganization plans on financial re-engineering, as opposed to operational performance improvement, of the distressed business.

A significant number of repeat filers are victims of exogenous events and other unforeseeable circumstances. Companies failed (again) after the Sept. 11 attacks. Many airlines filed for Chapter 11 (including a serial filing) when unprecedented increases in fuel prices in 2003 and 2004 exceeded industry expectations. Some industries, like housing and discretionary consumer businesses, were burdened disproportionately by the Great Recession of 2008 and its rapid contraction of the credit markets and consumer confidence.

Putting aside these outliers, the troubling reality is that the warning signs of continuing distress that will eventually lead to a serial bankruptcy filing might well be discernible at the confirmation hearing on the initial reorganization plan. But who is going to ring that bell? Certainly not the plan proponents or stakeholders who have settled with the company. And it’s a tall order for the bankruptcy court to uncover feasibility issues surrounding corporate liquidity, solvency, profitability and leverage unless raised by stakeholders. Some jurists have taken extraordinary action to proactively evaluate plan feasibility. For example, Judge Steven W. Rhodes appointed an “estate neutral” to evaluate Detroit’s Chapter 9 plan. The expert’s testimony was a main attraction at Detroit’s recent plan-confirmation hearing and will no doubt be featured prominently—one way or another—in Judge Rhodes’s ruling Friday.

For other serial filers, there may be no substantive culpability for the second business failure that is reasonably attributable to the administration and resolution of the prior bankruptcy. After all, Professor Altman’s research revealed that some serial filers did not file against for more than eight years, while others filed in less than two years—the average was a little less than 3 1/2 years. While we should all be skeptical of a serial filing in less than 24 months (absent exogenous events and unforeseeable circumstances), that same scrutiny doesn’t seem sensible for companies that encounter difficulties more than half a decade after they emerge. A lot can, and does, happen in such intervals.

Jack Butler is an executive vice president with Hilco Global, where he provides advisory services to healthy and distressed companies, creditors and other stakeholders.