The Examiners: Successful Restructurings Require Strong Leaders

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

Repeat corporate bankruptcy filers pose an existential dilemma for courts. New York University Professor Edward Altman counts 215 so-called Chapter 22 filings between 1984 and 2009. By one estimate, this represents fully a third of public companies that emerged from Chapter 11 in that period. Coupled with a long-running debate over excessive administrative costs of bankruptcy cases, the seeming failure to sustain a recovery following confirmation of a plan of reorganization has rightfully drawn attention.

Professor Altman’s studies identify several factors from among which two seem to explain most companies’ returns to bankruptcy court. These characteristics are a continued decline in operating performance and an over-leveraged balance sheet in spite of the opportunities afforded in the prior reorganization. While both factors are intuitive, each is ambiguous, particularly when trying to allocate blame.

Based on direct experience (Galey & Lord, Loehmann’s, Portrait Corp. of America and Payless Cashways come to mind), I think the statistical studies are very helpful in framing issues, but they miss the critical dynamic in cases of repeated failure. The single most significant cause of an eventual return to bankruptcy court is structural change in the business. This typically results from global competition, emerging technology or the deleterious impact of game-changing strategies. Examples include the effects of labor cost differentials, digitalization, and “big box” category killers. Mitigating these factors requires experienced managers who recognize the urgency and have the determination to drive change. Such accomplished and qualified executives invariably must be identified from outside an existing business. Responsibility and authority to recruit management comes with the selection of the emergent company’s board of directors and key senior executives. In turn, that prerogative usually rests with the plan sponsor, the reorganized company and the respective advisers.

The bankruptcy process works as a means to rejuvenate once-failed businesses. It’s then incumbent on the new owners to capitalize on that opportunity through the selection of a capable new board and management. It’s clear from the number of Chapter 22 filings that too frequently, distressed investors miss this critical prerequisite for a successful reorganization.

Anders J. Maxwell is a managing director in the restructuring & recapitalization group at New York-based investment banking advisory firm Peter J. Solomon Co.